EAGLE BANCORP INC 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of Eagle Bancorp, Inc. and its subsidiaries (collectively, the "Company") as of the dates and periods indicated. The Company’s primary subsidiary is EagleBank (the "Bank"), and the Company’s other direct and indirect active subsidiaries are Bethesda Leasing, LLC, Eagle Insurance Services, LLC and Landroval Municipal Finance, Inc. This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report and the Management Discussion and Analysis in the Company's Annual Report on Form 10-K for the year ended December 31, 2023. Caution About Forward Looking Statements . This report contains forward looking statements. These forward looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements and are typically identified with words such as "may," "will," "can," "anticipates," "believes," "expects," "plans," "outlook," "estimates," "potential," "assume," "probable," "possible," "continue," "should," "could," "would," "strive," "seeks," "deem," "projections," "forecast," "consider," "indicative," "uncertainty," "likely," "unlikely," "likelihood," "unknown," "attributable," "depends," "intends," "generally," "feel," "typically," "judgment," "subjective" and similar words or phrases. For details on factors that could affect these expectations, see the risk factors contained in this report and the risk factors and other cautionary language included in the Company's Annual Report on Form 10-K for the year ended December 31, 2023, and in other periodic and current reports filed by the Company with the Securities and Exchange Commission ("SEC"). These forward looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward looking statements. The Company's past results are not necessarily indicative of future performance, and nothing contained herein is meant to or should be considered and treated as earnings guidance of future quarters' performance projections. All information is as of the date of this report. Any forward-looking statements made by or on behalf of the Company speak only as to the date they are made. Except to the extent required by applicable law or regulation, the Company undertakes no obligation to revise or update publicly any forward looking statement for any reason. GENERAL The Company is a growth-oriented, one-bank holding company headquartered in Bethesda, Maryland, which is currently celebrating twenty-five years of successful operations. The Company provides general commercial and consumer banking services through the Bank, its wholly owned banking subsidiary, a Maryland chartered bank which is a member of the Federal Reserve System ("Federal Reserve Board," "Federal Reserve" or "FRB"). The Company was organized in October 1997, to be the holding company for the Bank. The Bank was organized in 1998 as an independent, community oriented, full service banking alternative to the super regional financial institutions that dominate the Company's primary market area. The Company's philosophy is to provide superior, personalized service to its customers. The Company focuses on relationship banking, providing each customer with a number of services and becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has a total of twelve branch offices, including six in Suburban Maryland, three in Northern Virginia, and three in Washington, D.C. The Bank also operates four lending offices, with two in Suburban Maryland, one in Northern Virginia, and one in Washington, D.C. In April 2024, one branch was closed as it had an expiring lease. The branch's clients will be served from our other branches, and through digital channels. The Bank offers a broad range of commercial banking services to its business and professional clients, as well as full service consumer banking services to individuals living and/or working primarily in the Bank's market area. The Bank emphasizes providing commercial banking services to sole proprietors, small and medium-sized businesses, non-profit organizations and associations, and investors living and working in and near the primary service area. These services include the usual deposit functions of commercial banks, including business and personal checking accounts, "NOW" accounts and money market and savings accounts, business, construction, and commercial loans, consumer loans, and cash management services. The Bank is also active in the origination of Small Business Administration ("SBA") loans. 34 The Bank generally sells the guaranteed portion of the SBA loans in a transaction apart from the loan origination generating noninterest income from the gains on sale, as well as servicing income on the portion participated. The Company originates multifamily Federal Housing Administration ("FHA") loans through the Department of Housing and Urban Development's Multifamily Accelerated Program ("MAP"). The Company securitizes these loans through the Government National Mortgage Association ("Ginnie Mae") MBS I program and shortly thereafter sells the resulting securities in the open market to authorized dealers in the normal course of business, and periodically bundles and sells the servicing rights. Bethesda Leasing, LLC, a subsidiary of the Bank, holds title to and manages other real estate owned ("OREO") assets. Landroval Municipal Finance, Inc., a subsidiary of the Bank, focuses on lending to municipalities by buying debt on the public market as well as direct purchase issuance. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Company's Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP") and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the Consolidated Financial Statements; accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The Company applies the accounting policies contained in Note 1 to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2023 and Note 1 to the Consolidated Financial Statements included in this report. There have been no significant changes to the Company's accounting policies as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2023 except as indicated in "Accounting Standards Adopted in 2024" in Note 1 to the Consolidated Financial Statements in this report. Allowance for Credit Losses on Loans and Reserve for Unfunded Commitments A consequence of lending activities is that we may incur credit losses, so we record an allowance for credit losses ("ACL") with respect to loan receivables and a reserve for unfunded commitments ("RUC") as estimates of those losses. The amount of the ACL on loans is based on management's assessment of current expected credit losses ("CECL") in the portfolio. The amount of such losses will vary depending upon the risk characteristics of the loan portfolio as affected by economic conditions such as changes in interest rates, the financial performance of borrowers and regional unemployment rates, which management estimates by using a national forecast and estimating a regional adjustment based on historical differences between the two. Management has significant discretion in making the judgments inherent in the determination of the provisions for credit loss, ACL and the RUC. Our determination of these amounts requires significant reliance on estimates and significant judgment as to the amount and timing of expected future cash flows on loans, significant reliance on historical loss rates on homogenous portfolios, consideration of our quantitative and qualitative evaluation of economic factors and the reliance on our reasonable and supportable forecasts. We estimate the ACL on loans using a quantitative model that uses a probability of default ("PD") / loss given default ("LGD") cash flow method with an exposure at default ("EAD") model to estimate expected credit losses for its loan segments. The modeling of expected prepayment speeds is based on historical internal data and adjustments to account for loan-specific risk characteristics after pooling our loan portfolio based on similar risk characteristics. 35 The Company uses regression analysis of historical internal and peer data provided by a third-party service provider (as Company loss data is insufficient) to determine suitable loss drivers to utilize when modeling lifetime PD and LGD. This analysis also determines how expected PD will react to forecasted levels of the loss drivers. During the three months ended March 31, 2024, management enhanced the cash flow model to incorporate three additional macroeconomic variables. The four economic variables selected, national unemployment (original variable used), Commercial Real Estate ("CRE") Price Index, House Price Index and Gross Domestic Product ("GDP"), are incorporated by utilizing a Loss Driver Analysis approach that factors in historical losses, including during the Great Recession, of regional peer banks and the Bank. The updated model incorporates a weighting of three economic scenarios; baseline, upside and downside. The scenarios cover the four economic forecast variables, with each segment of the portfolio linked to two of these variables, depending on the segment. The loss driver analysis is spread over a reasonable and supportable period of 18 months and reverts back to a historical loss rate over twelve months on a straight-line basis over the loan's remaining maturity. Management leverages economic projections from reputable and independent third parties to inform its loss driver forecasts over the forecast period. Loans that have evidence of credit deterioration are excluded from the loan segments subject to the quantitative model above and are individually assessed. The RUC represents the expected credit losses on off-balance sheet commitments such as unfunded commitments to extend credit and standby letters of credit. The RUC is determined by estimating future draws and applying the expected loss rates on those draws. The ACL also includes an amount for inherent risks not reflected in the historical analyses. Relevant factors include, but are not limited to, concentrations of credit risk, changes in underwriting standards, experience and depth of lending staff and trends in delinquencies. While our methodology in establishing the reserve for credit losses attributes portions of the ACL and RUC to the commercial and consumer portfolio segments, the entire ACL and RUC is available to absorb credit losses expected in the total loan portfolio and total amount of unfunded credit commitments, respectively. Our model may reflect assumptions by management that are not covered by the qualitative and environmental factors, and we reevaluate all of its factors quarterly. Management has developed an analytical process to monitor the adequacy of the ACL. Our methodology for determining our ACL was developed utilizing, among other factors, the guidance from federal banking regulatory agencies and relevant available information from internal and external sources and relating to past events, current conditions and reasonable and supportable forecasts. The process is being continually enhanced and refined based on periodic reviews. Material changes to these and other relevant factors may result in greater volatility to the reserve for credit losses, and therefore, greater volatility to our reported earnings. For example, the effects of the COVID-19 pandemic and related hybrid or fully remote working environment has negatively impacted the performance outlook in the central business district office CRE segment of our loan portfolio, which informed our CECL economic forecast and continued to adversely impact our loss reserve as of March 31, 2024. Refer to the "Provision for Credit Losses" and "Allowance for Credit Losses" of Management's Discussion and Analysis of Financial Condition and Results of Operations for more information on the provision for credit losses and ACL for the loan portfolio. Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill is subject to impairment testing, which must be conducted at least annually or upon the occurrence of a triggering event. Various factors, such as the Company’s results of operations, the trading price of the Company’s common stock relative to the book value per share, macroeconomic conditions and conditions in the banking sector, inform whether a triggering event for an interim goodwill impairment test has occurred. Goodwill is recorded and evaluated for impairment at its reporting unit, the Company. The Company's policy is to test goodwill for impairment annually as of December 31, or on an interim basis if an event triggering an impairment assessment is determined to have occurred. Testing of goodwill impairment comprises a two-step process. First, the Company performs a qualitative assessment to evaluate relevant events or circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company determines that it is more likely than not that an impairment has occurred, it proceeds to the quantitative impairment test, whereby it calculates the fair value of the reporting unit and compares it with its carrying amount, including goodwill. In its performance of impairment testing, the Company has the unconditional option to proceed directly to the quantitative impairment test, bypassing the qualitative assessment. If the carrying amount of the reporting unit exceeds the fair value, the amount by which the carrying amount exceeds fair value, up to the carrying value of goodwill, is recorded through earnings as an impairment charge. If the results of the qualitative assessment indicate that it is not more likely than not that an impairment has occurred, or if the quantitative impairment test results in a fair value of the reporting unit that is greater than the carrying amount, then no impairment charge is recorded. 36 As part of its annual testing for goodwill impairment, the Company concluded that no impairment existed at December 31, 2023. Management has evaluated and will continue to evaluate economic conditions in interim periods for triggering events. As of the time of this report's filing, the Company did not identify any triggering events for interim testing. However, future events, including the continuation of the Company's recent common stock trading below the book value per share, could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations, however, it would not impact our regulatory capital ratios, tangible common equity ratio, nor its liquidity position. RESULTS OF OPERATIONS Earnings Summary Three Months Ended March 31, 2024 vs. Three Months Ended March 31, 2023 Net loss for the three months ended March 31, 2024 was $338 thousand, as compared to net income of $24.2 million for the same period in 2023, a decrease of $24.6 million, or 101.4%. The decrease of $24.6 million to net loss for the three months ended March 31, 2024 from net income for the same period in 2023 was due primarily to an increase in provision for credit losses of $29.0 million, partially offset by a reduction of income tax expenses of $3.9 million. For more information on the drivers and the components of these changes, see the "Provision for Credit Losses" and "Income Tax Expenses" sections below. When the impact of the provision is excluded, pre-provision net revenue ("PPNR"), a non-GAAP measure, was $38.3 million for the three months ended March 31, 2024, as compared to $38.1 million for the same period in 2023. Refer to the "Use of Non-GAAP Financial Measures" section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. Total revenue (i.e. net interest income plus noninterest income) was $78.3 million for the three months ended March 31, 2024, as compared to $78.7 million for the same period in 2023. The net interest margin, which measures the difference between interest income and interest expense (i.e. net interest income) as a percentage of earning assets, was 2.43% for the three months ended March 31, 2024 and 2.77% for the same period in 2023. The drivers of the change are detailed in the "Net Interest Income and Net Interest Margin" section below. Noninterest income was $3.6 million for the three months ended March 31, 2024, as compared to $3.7 million for the same period in 2023. Noninterest expense was $40.0 million for the three months ended March 31, 2024, as compared to $40.6 million for the same period in 2023. The drivers of the change are detailed in the "Noninterest Income" and "Noninterest Expense" sections below. The efficiency ratio remained steady at 51.09% for the three months ended March 31, 2024 as compared to 51.55% for the same period in 2023. Refer to the "Use of Non-GAAP Financial Measures" section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. For the three months ended March 31, 2024 and 2023, the Company had average assets of $12.8 billion and $11.4 billion, respectively, the increase of which was primarily attributable to an increase in average interest-bearing deposits with other banks and other short-term investments over the comparative period. For the three months ended March 31, 2024 and 2023, the Company had average common equity of $1.3 billion and $1.2 billion, respectively. For the three months ended March 31, 2024 and 2023, the Company had average tangible common equity, a non-GAAP measure, of $1.2 billion and $1.1 billion, respectively. Refer to the "Use of Non-GAAP Financial Measures" section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. For the three months ended March 31, 2024, the Company reported an annualized return on average assets ("ROAA") of (0.01)%, as compared to 0.86% for the same period in 2023. The annualized return on average common equity ("ROACE") for the three months ended March 31, 2024 was (0.11)% as compared to 7.92% for the same period in 2023. The annualized return on average tangible common equity ("ROATCE"), a non-GAAP measure, for the three months ended March 31, 2024 was (0.11)% as compared to 8.65% for the same period in 2023. The decline in returns was primarily attributable to a reduction in net income to a net loss. Refer to the "Use of Non-GAAP Financial Measures" section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. 37 Net Interest Income and Net Interest Margin Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans, investment securities, and interest bearing deposits with other banks and other short-term investments. The cost of funds includes interest expense on deposits, customer repurchase agreements and other borrowings, which consist primarily of federal funds purchased, advances from secured financing arrangements, including the Federal Home Loan Bank of Atlanta ("FHLB") and the Federal Reserve's Bank Term Funding Program ("BTFP") and Discount Window, and subordinated notes. Noninterest bearing deposits and capital are other components representing funding sources. Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income. Net interest income was $74.7 million for the three months ended March 31, 2024, as compared to $75.0 million for the same period in 2023. The decrease was primarily due to the $35.7 million increase in interest expense outpacing the $35.4 million increase in interest income. The increase in interest expense was primarily attributable to increased volume of time deposits, other borrowings, and interest bearing transactions, and to a lesser extent was attributable to increases in average deposits and rates (4.29% for the three months ended March 31, 2024, compared to 3.63% for the same period in 2023). The increase in interest income was primarily attributable to increased volume and rates on loans (6.95% for the three months ended March 31, 2024, compared to 6.35% for the same period in 2023) and interest bearing bank deposits and other short-term investments (5.43% for the three months ended March 31, 2024, compared to 4.45% for the same period in 2023) The net interest margin decreased by 34 basis points from the three months ended March 31, 2023 as compared to the three months ended March 31, 2024 (from 2.77% to 2.43%). The yield on earning assets increased by 54 basis points (from 5.17% to 5.71%) while cost of funds increased 96 basis points (from 2.62% to 3.58%). Average loans (excluding loans held for sale) increased to $8.0 billion for the three months ended March 31, 2024 compared to $7.7 billion for the same period in 2023. Average interest bearing deposits increased to $7.4 billion for the three months ended March 31, 2024 from $5.5 billion for the three months ended March 31, 2023, while average noninterest bearing demand deposits decreased to $2.1 billion for the three months ended March 31, 2024 from $3.3 billion for the three months ended March 31, 2023. Additionally, average borrowings increased from $1.3 billion in the three months ended March 31, 2023 to $1.8 billion in the three months ended March 31, 2024. Overall yields and rates increased during the three months ended March 31, 2024 as compared to the same period in 2023 as variable rate loans adjusted upwards and an increased number of loans moved off their rate floors. The table below presents the average balances and rates of the major categories of the Company's assets and liabilities for the three months ended March 31, 2024 and 2023. Included in the tables are measurements of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest rate paid on interest bearing liabilities. While the interest rate spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin, together with net interest income, provides a better measurement of performance. The net interest margin (as compared to net interest spread) includes the effect of noninterest bearing sources in its calculation. Net interest margin is net interest income expressed as a percentage of average earning assets. 38 Eagle Bancorp, Inc. Consolidated Average Balances, Interest Yields And Rates (Unaudited) (dollars in thousands) Three Months Ended March 31, 2024 2023 Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate ASSETS Interest earning assets: Interest bearing deposits with other banks and other short-term investments $ 1,841,771 $ 24,862 5.43 % $ 526,506 $ 5,774 4.45 % Loans held for sale (1) — — — % 4,093 60 5.95 % Loans (1) (2) 7,988,941 137,994 6.95 % 7,712,023 120,790 6.35 % Investment securities available for sale (2) 1,516,503 7,247 1.92 % 1,660,258 7,811 1.91 % Investment securities held-to-maturity ( 2) 1,011,231 5,433 2.16 % 1,087,047 5,734 2.14 % Federal funds sold 7,051 66 3.76 % 14,890 78 2.12 % Total interest earning assets 12,365,497 175,602 5.71 % 11,004,817 140,247 5.17 % Total noninterest earning assets 508,987 495,889 Less: allowance for credit losses (90,014) (74,650) Total noninterest earning assets 418,973 421,239 TOTAL ASSETS $ 12,784,470 $ 11,426,056 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest bearing liabilities: Interest bearing transaction $ 1,833,493 $ 16,830 3.69 % $ 1,065,421 $ 6,107 2.32 % Savings and money market 3,423,388 35,930 4.22 % 3,326,807 33,274 4.06 % Time deposits 2,187,320 26,623 4.90 % 1,078,227 9,573 3.60 % Total interest bearing deposits 7,444,201 79,383 4.29 % 5,470,455 48,954 3.63 % Customer repurchase agreements 36,084 315 3.51 % 38,257 302 3.20 % Borrowings 1,796,863 21,206 4.75 % 1,321,206 15,967 4.90 % Total interest bearing liabilities 9,277,148 100,904 4.37 % 6,829,918 65,223 3.87 % Noninterest bearing liabilities: Noninterest bearing demand 2,057,460 3,263,670 Other liabilities 160,206 91,490 Total noninterest bearing liabilities 2,217,666 3,355,160 Shareholders’ Equity 1,289,656 1,240,978 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 12,784,470 $ 11,426,056 Net interest income $ 74,698 $ 75,024 Net interest spread 1.34 % 1.30 % Net interest margin 2.43 % 2.77 % Cost of funds (3) 3.58 % 2.62 % (1) Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges included in interest income on loans totaled $5.1 million and $3.7 million for the three months ended March 31, 2024 and 2023, respectively. (2) Interest and fees on loans and investments exclude tax equivalent adjustments. 39 (3) Beginning in the second quarter of 2023, the Company revised its cost of funds methodology to use a daily average calculation where interest expense on interest bearing liabilities is divided by average interest bearing liabilities and average noninterest bearing deposits. Previously, the Company calculated the cost of funds as the difference between yield on earning assets and net interest margin. The cost of funds for the three months ended March 31, 2023 has been recalculated using the current methodology. Rate/Volume Analysis of Net Interest Income The rate/volume table below presents the composition of the change in net interest income for the period indicated, as allocated between the change in net interest income due to changes in the volume of average earning assets and interest bearing liabilities, and the changes in net interest income due to changes in interest rates. Three Months Ended March 31, 2024 Compared With The Three Months Ended March 31, 2023 (dollars in thousands) Change Due to Volume Change Due to Rate Total Increase (Decrease) Interest earned on Loans $ 4,337 $ 12,867 $ 17,204 Loans held for sale (60) — (60) Investment securities available-for-sale (676) 112 (564) Investment securities held-to-maturity (400) 99 (301) Interest bearing bank deposits 14,424 4,664 19,088 Federal funds sold (41) 29 (12) Total interest income 17,584 17,771 35,355 Interest paid on Interest bearing transaction 4,403 6,320 10,723 Savings and money market 966 1,690 2,656 Time deposits 9,847 7,203 17,050 Customer repurchase agreements (17) 30 13 Other borrowings 5,675 (436) 5,239 Total interest expense 20,874 14,807 35,681 Net interest income $ (3,290) $ 2,964 $ (326) Provision for Credit Losses The provision for credit losses represents the amount of expense charged to current earnings to record the ACL on loans and the ACL on available-for-sale and held-to-maturity investment securities. The amount of the ACL on loans is based on management's assessment of CECL in the portfolio. Those factors include historical losses based on internal and peer data, economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company. The provision for credit losses for unfunded commitments is presented separately on the Consolidated Statements of Operations. This provision considers the probability that unfunded commitments will fund among other factors. Refer to the discussion under "Critical Accounting Policies and Estimates" in Management's Discussion and Analysis of Financial Condition and Results of Operations above and in Note 1 to the Consolidated Financial Statements in "Item 1 - Financial Information" for an overview of the methodology management employs on a quarterly basis to assess the adequacy of the ACL and the provisions charged to expense. Also, refer to the table in the "Allowance for Credit Losses" section in Management's Discussion and Analysis of Financial Condition and Results of Operations, which reflects activity in the ACL. During the three months ended March 31, 2024, the Company recorded a provision for credit losses of $35.2 million on its loan portfolio. The provision for credit losses was primarily attributable to an updated valuation for a CRE office property collateralizing a lending relationship with two loans outstanding, the total of which was partially charged off in the first quarter 2024. Additionally, the provision was attributable to an increase in the ACL factor associated with CRE office loans. 40 The provision for credit losses on loans for the three months ended March 31, 2023 was $4.9 million. The provision was primarily driven by adjustments to the qualitative components of the CECL model owing to the high inflationary environment and uncertainty in the macroeconomic outlook and the related changes in economic growth and the broader economy, changes in the qualitative and economic component of the model associated with CRE office properties, as well as the increases in total loans. During the three months ended March 31, 2024 and 2023, the provision for credit losses for the held-to-maturity securities portfolio was $1 thousand and $1.2 million, respectively, which, in 2023, were recorded primarily on several corporate bonds. During the three months ended March 31, 2023, the provision for credit losses for the available-for-sale securities portfolio was $14 thousand. There was no provision for credit losses on the available-for-sale securities portfolio for the three months ended March 31, 2024. The provision for unfunded commitments is presented separately on the Consolidated Statements of Operations. This provision considers the probability that unfunded commitments will fund. During the three months ended March 31, 2024 and 2023, provisions of $456 thousand and $848 thousand, respectively, were incurred for unfunded commitments. Noninterest Income Noninterest income includes service charges on deposits, gain on sale of loans, gains and losses on sale of investment securities, income from bank owned life insurance ("BOLI") and other income. The following table summarizes the comparative noninterest income for the three months ended March 31, 2024 and 2023: Three Months Ended March 31, (dollars in thousands) 2024 2023 Dollar Change Percent Change Service charges on deposits $ 1,699 $ 1,510 $ 189 13 % Gain on sale of loans — 305 (305) (100) % Net gain (loss) on sale of investment securities 4 (21) 25 (119) % Increase in the cash surrender value of bank-owned life insurance 703 655 48 7 % Other income 1,183 1,251 (68) (5) % Total $ 3,589 $ 3,700 $ (111) (3) % Total noninterest income for the three months ended March 31, 2024 decreased to $3.6 million from $3.7 million for the three months ended March 31, 2023, a 3% decrease. The decrease was primarily attributable to a decrease in gains on sale of residential mortgage loans, partially offset by an increase in service charges on deposits. The Company ceased originations of first lien residential mortgages for secondary sale in the first quarter of 2023, and completed residual origination and sales activities in the second quarter of 2023. Noninterest Expense Total noninterest expense includes salaries and employee benefits, premises and equipment expenses, marketing and advertising, data processing, legal, accounting and professional, Federal Deposit Insurance Corporation ("FDIC") insurance assessments, and other expenses. The following table summarizes the comparative noninterest expense for the three months ended March 31, 2024 and 2023: Three Months Ended March 31, (dollars in thousands) 2024 2023 Dollar Change Percent Change Salaries and employee benefits $ 21,726 $ 24,174 $ (2,448) (10) % Premises and equipment expenses 3,059 3,317 (258) (8) % Marketing and advertising 859 636 223 35 % Data processing 3,293 3,099 194 6 % Legal, accounting and professional fees 2,507 3,254 (747) (23) % FDIC insurance 6,412 1,486 4,926 331 % Other expenses 2,141 4,618 (2,477) (54) % Total $ 39,997 $ 40,584 $ (587) (1) % 41 Total noninterest expense totaled $40.0 million for the three months ended March 31, 2024, as compared to $40.6 million for the three months ended March 31, 2023, a 1% decrease. The decrease was primarily attributable to a $2.5 million reduction in other expenses, a $2.4 million reduction in salaries and employee benefits, and a $747 thousand reduction in legal, accounting and professional fees. This total of these reductions to expense was partially offset by a $4.9 million increase in FDIC insurance. The decrease in salaries and employee benefits over the comparative three months ended March 31, 2024 and 2023 was primarily due to a reduction in payroll taxes and employee benefits. At March 31, 2024, the Company's full time equivalent staff numbered 451, as compared to 486 at March 31, 2023. The decrease in legal, accounting and professional fees over the comparative three months ended March 31, 2024 and 2023 was primarily due to a $959 thousand reversal of legal fees receivable in the first quarter of 2023 relating to the previously disclosed settled litigations and investigations as Directors & Officers insurance for the 2016-2017 years was fully depleted. The major components of other expenses include franchise taxes, director compensation and insurance expense. The decrease in other expenses over the comparative three months ended March 31, 2024 and 2023 was primarily due to a reduction in director fees of $1.3 million and a $857 thousand recovery of real estate taxes. The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 51.09% for the three months ended March 31, 2024, as compared to 51.55% for the same period in 2023. Refer to the "Use of Non-GAAP Financial Measures" section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. The improvement in the efficiency ratio for the three months ended March 31, 2024 as compared to the same three month period in 2023 was primarily driven by the decrease in noninterest expenses outpacing the decreases in net interest income and noninterest income. As a percentage of average assets, total noninterest expense (annualized) was 1.26% for the three months ended March 31, 2024, as compared to 1.44% for the same period in 2023. The decrease for the three month period ended March 31, 2024 was primarily due to an increase in average interest earning assets. Income Tax Expense The Company's tax provision for the three months ended March 31, 2024 was $3.0 million, compared to $6.9 million for the three months ended March 31, 2023. The decrease in the tax provision over the comparative three months ended March 31, 2024 and 2023 was primarily due to decreases in pre-tax income period over period. The Inflation Reduction Act of 2022 was signed into law by President Biden on August 16, 2022 and made significant changes to the U.S. tax law, including the introduction of a corporate alternative minimum tax of 15% of the “adjusted financial statement income” of certain domestic corporations as well as a 1% excise tax on the fair market value of stock repurchases by certain domestic corporations, effective for tax years beginning in 2023. Effective January 1, 2023, the Company became subject to the tax laws under the Inflation Reduction Act. The Company has not experienced and currently does not expect the tax-related provisions of the Inflation Reduction Act to have a material impact on our financial results. FINANCIAL CONDITION Summary Total assets were $11.6 billion and $11.7 billion at March 31, 2024 and December 31, 2023, respectively. Assets remained at similar levels from December 31, 2023 to March 31, 2024 with minor changes in the asset mix. The decrease in total assets of $51.9 million (or 0.4%) from December 31, 2023 to March 31, 2024 was primarily due to decreases in investment securities and interest-bearing deposits with other banks and other short-term investments, the total of which was partially offset by an increase in loans. The largest component of assets, total loans, had an amortized cost basis of $8.0 billion at March 31, 2024, a 0.2% increase from the balance at December 31, 2023. The increase in loans over the three months ended March 31, 2024, was driven primarily by increased fundings of ongoing construction projects for commercial and residential properties, partially offset by decreases in income producing - CRE, owner occupied - CRE and commercial loans. 42 Investment securities, at amortized cost net of the ACL, totaled $2.6 billion at March 31, 2024 as compared to $2.7 billion at December 31, 2023, a decrease of $69.7 million, or 2.6%, that was primarily driven by the pay down of principal on mortgage-backed securities ("MBS") and calls of securities. At March 31, 2024 and December 31, 2023, investment securities available-for-sale had an amortized cost of $1.6 billion and $1.7 billion, respectively, and a fair value of $1.4 billion and $1.5 billion, respectively. Additionally, March 31, 2024 and December 31, 2023, investment securities held-to-maturity had an amortized cost, less an ACL of $2.0 million, of $1.0 billion and an estimated fair value of $878.2 million and $901.6 million, respectively. In terms of funding, total deposits at March 31, 2024 were $8.5 billion, down from $8.8 billion at December 31, 2023, a decline of 3.5%. Total borrowings (excluding customer repurchase agreements) were $1.7 billion and $1.4 billion at March 31, 2024 and December 31, 2023, respectively. The decrease in deposits was primarily attributable to first quarter seasonality, while the increase in borrowings, attributable to net fundings on the Company's secured borrowings, was primarily to meet funding needs, including to fund loan growth, given the decrease in deposits. Total shareholders' equity remained consistent at $1.3 billion as of March 31, 2024 , and December 31, 2023. During the three months ended March 31, 2024, there was a slight decrease of 1.2%, which was primarily the result of cash dividends and the decrease in earnings. The Company's capital ratios remain substantially in excess of regulatory minimum and buffer requirements. Regulatory ratios based on risk-weighted assets experienced minor fluctuations of less than 1% from December 31, 2023 to March 31, 2024. The total risk based capital ratio was 14.87% at March 31, 2024, as compared to 14.79% at December 31, 2023. The common equity tier 1 capital ("CET1") risk based capital ratio was 13.80% at March 31, 2024, as compared to 13.90% at December 31, 2023. The tier 1 risk based capital ratio was 13.80% at March 31, 2024, as compared to 13.90% at December 31, 2023. The tier 1 leverage ratio was 10.26% at March 31, 2024, as compared to 10.73% at December 31, 2023. The ratio of common equity to total assets was 10.85% at March 31, 2024, as compared to 10.92% at December 31, 2023 as common equity levels remained consistent over the three months ended March 31, 2024. Book value per share was $41.72 at March 31, 2024, a 2.0% decrease over $42.58 at December 31, 2023. In addition, the tangible common equity ratio was 10.03% at March 31, 2024, as compared to 10.12% at December 31, 2023. Tangible book value per share was $38.26 at March 31, 2024, a 2.1% decrease from $39.08 at December 31, 2023. Refer to the "Use of Non-GAAP Financial Measures" section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. In order to be considered well-capitalized, the Bank must have a CET1 risk based capital ratio of 6.5%, a Tier 1 risk-based ratio of 8.0%, a total risk-based capital ratio of 10.0% and a leverage ratio of 5.0%. The Company and the Bank exceed all these requirements and satisfy the capital conservation buffer of 2.5% of CET1 capital. Failure to maintain the required capital conservation buffer would limit the ability of the Company and the Bank to pay dividends, repurchase shares or pay discretionary bonuses. Loan Portfolio In its lending activities, the Company seeks to develop and expand relationships with clients whose businesses and individual banking needs will grow with the Bank. Superior customer service, local decision making, and accelerated turnaround time from application to closing have been significant factors in growing the loan portfolio and meeting the lending needs in the markets served, while maintaining sound asset quality. Loans outstanding were $8.0 billion at March 31, 2024, an increase of $14.0 million, or 0.2%, from the balance at December 31, 2023. The loan portfolio has continued to grow in the three months ended March 31, 2024, driven by increased fundings of ongoing construction projects for commercial and residential properties, partially offset by a reduction in CRE loans. Market rates in 2024 for our new loan originations remained consistent with the market rates at the end of 2023, reflecting that the Federal Reserve has not raised short-term interest rates in 2024. We continue to see opportunities for growth in the commercial real estate market in our focused sectors; our processes for evaluating these opportunities are designed to ensure they are subject to reasonable underwriting standards, including appropriate collateral and cash flow necessary to support debt service. Following origination, we continue to monitor our borrowers' business plans and identify primary and alternative sources for loan repayment and, if necessary, obtain collateral to mitigate credit loss in the event of default. 43 Loans, net of amortized deferred fees and costs, at March 31, 2024 and December 31, 2023 by major category are summarized below. March 31, 2024 December 31, 2023 (dollars in thousands, except amounts in the footnote) Amount % Amount % Commercial $ 1,408,767 18 % $ 1,473,766 18 % PPP loans 467 — % 528 — % Income producing - commercial real estate 4,040,655 50 % 4,094,614 51 % Owner occupied - commercial real estate 1,185,582 15 % 1,172,239 15 % Real estate mortgage - residential 72,087 1 % 73,396 1 % Construction - commercial and residential 1,082,556 13 % 969,766 12 % Construction - C&I (owner occupied) 138,379 2 % 132,021 2 % Home equity 53,251 1 % 51,964 1 % Other consumer 958 — % 401 — % Total loans 7,982,702 100 % 7,968,695 100 % Less: allowance for credit losses (99,684) (85,940) Loans, net (1) $ 7,883,018 $ 7,882,755 (1) Excludes accrued interest receivable of $46.3 million and $45.3 million at March 31, 2024 and December 31, 2023, respectively, which is recorded in other assets. As noted above, a significant portion of the loan portfolio consists of commercial, construction and commercial real estate loans, primarily made in the Washington, D.C. metropolitan area, and is secured by real estate or other collateral in that market. Although these loans are made to a diversified pool of unrelated borrowers across numerous businesses, adverse developments in the Washington, D.C. metropolitan real estate market could continue to have an adverse impact on this portfolio of loans and the Company’s income and financial position. Management believes that the CRE concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices and ongoing portfolio monitoring and market analysis. While our basic market area is the Washington, D.C. metropolitan area, the Bank has made loans outside that market area where the applicant is an existing customer and the nature and quality of such loans was consistent with the Bank’s lending policies. The Company's concentration in the Washington, D.C. metro area includes "Washington's Maryland Suburbs," which comprise Frederick, Prince George's and Montgomery counties and "Northern Virginia," which comprises Alexandria, Arlington, Falls Church, Fairfax, Loudoun and Prince William counties. At March 31, 2024, 31.8%, 26.9%, 24.2%, 5.4% and 11.7% of the loan portfolio, as a percentage of total amortized cost, was concentrated in Washington D.C., Washington's Maryland Suburbs, Northern Virginia, other counties in Maryland and other locations in the United States, respectively. At December 31, 2023, 31.5%, 26.4%, 25.1%, 5.5% and 11.5% of the loan portfolio, as a percentage of total amortized cost, was concentrated in Washington D.C., Washington's Maryland Suburbs, Northern Virginia, other counties in Maryland and other locations in the United States, respectively. While we remain cautious with regard to CRE market conditions, principally office, the strength of the Washington D.C. metro area in certain sectors, particularly multi-family CRE and the housing market, continue to drive premiums for well-located properties. As part of its lending strategy, the Company maintains a substantial portfolio of CRE loans, with $6.2 billion and $6.1 billion, or 77.1% and 77.0% of total loans, of amortized cost outstanding at March 31, 2024 and December 31, 2023, respectively. Management meets regularly in order to monitor its existing CRE loan portfolio and to evaluate the pipeline for CRE loan investment. The Company has remained focused on monitoring sectors that have had a lasting impact from the ramifications of the COVID-19 pandemic, particularly income producing CRE loans collateralized by office properties, which comprised approximately $898.7 million and $949.0 million, or 11.2% and 11.9% of total loans, at March 31, 2024 and December 31, 2023, respectively. Office loans within Washington D.C., Washington's Maryland Suburbs and Northern Virginia were $829.5 million and $879.0 million, or 10.4% and 11.0% of total loans, at March 31, 2024 and December 31, 2023, respectively. As a percentage of total income producing - CRE office loans, 37.4%, 31.4% and 23.5% were located in Washington's Maryland Suburbs, Northern Virginia, and Washington, D.C. at March 31, 2024. 44 The following table summarizes the Company's income producing - commercial real estate loans, at principal, at March 31, 2024: Maryland Virginia (dollars in thousands) Washington D.C. Washington Suburbs Other Northern Virginia Other Other Total Percent of Total Collateral Type: Hotel & motel $ 138,330 $ 85,641 $ 83,327 $ 66,982 $ — $ 22,129 $ 396,409 10 % Industrial 5,854 78,924 40,898 19,713 3,815 — 149,204 4 % Mixed use 265,432 45,969 372 54,511 25,793 5,380 397,457 10 % Multifamily 384,408 214,415 320 72,131 84,636 47,877 803,787 20 % Office 211,181 336,043 4,349 282,297 64,823 47 898,740 22 % Retail 82,279 97,738 62,018 77,094 99,788 1,938 420,855 10 % Single / 1-4 Family & Res. Condo 73,737 2,775 2,543 14,496 6,554 4,080 104,185 2 % Other 155,520 188,186 39,918 459,291 9,355 27,255 879,525 22 % Total $ 1,316,741 $ 1,049,691 $ 233,745 $ 1,046,515 $ 294,764 $ 108,706 $ 4,050,162 100 % Percent of total 32 % 26 % 6 % 26 % 7 % 3 % 100 % Percent of Principal by Loan Size: Less than $1 million 29 % 23 % 45 % 26 % 30 % 34 % $1 million to $15 million 16 % 16 % 6 % 10 % 8 % 8 % $5 million to $10 million 8 % 7 % — % 10 % 35 % 49 % $10 million to $25 million 25 % 37 % 43 % 26 % 24 % 9 % $25 million to $50 million 18 % 17 % 6 % 14 % 3 % — % Greater than $50 million 4 % — % — % 14 % — % — % Total 100 % 100 % 100 % 100 % 100 % 100 % At March 31, 2024, $248.9 million of principal of loans collateralized by office properties were criticized or classified. At March 31, 2024, the Company had no concentrations of loans with any one borrower in any one industry exceeding 10% of its total loan portfolio. An industry for this purpose is defined as a group of businesses that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. 45 The following table sets forth the time to the final contractual maturity of the loan portfolio as of March 31, 2024: March 31, 2024 (dollars in thousands) Total One Year or Less (1) Over One Year to Five Years Over Five Years to Fifteen Years Over Fifteen Years Commercial $ 1,408,767 $ 356,329 $ 879,193 $ 169,699 $ 3,546 PPP loans 467 — 467 — — Income producing - commercial real estate (2) 4,040,655 1,499,809 2,218,712 322,134 — Owner occupied - commercial real estate 1,185,582 211,602 442,072 308,355 223,553 Real estate mortgage - residential 72,087 16,956 43,995 487 10,649 Construction - commercial and residential 1,082,556 289,929 755,137 7,689 29,801 Construction - C&I (owner occupied) 138,379 24,314 18,586 36,681 58,798 Home equity 53,251 2,331 2,192 1,092 47,636 Other consumer 958 771 — — 187 Total loans $ 7,982,702 $ 2,402,041 $ 4,360,354 $ 846,137 $ 374,170 Loans with: Predetermined fixed interest rate $ 3,132,625 $ 963,405 $ 1,668,486 $ 403,587 $ 97,147 Floating or adjustable interest rate 4,850,077 1,438,636 2,691,868 442,550 277,023 Total loans $ 7,982,702 $ 2,402,041 $ 4,360,354 $ 846,137 $ 374,170 (1) Demand loans, having no contractual maturity, and overdrafts are reported as due in one year or less. (2) Income producing CRE office loans, which had total principal of $898.7 million at March 31, 2024 and are included within income producing - commercial real estate, had principal of $323.8 million, $559.8 million, and $15.1 million aggregated with one year or less, over one year to five years, and over five years to fifteen years remaining until contractual maturity, respectively. Approximately $107.8 million and $368.8 million of income producing CRE office loans as of March 31, 2024 were due to mature within three months and 18 months, respectively. Allowance for Credit Losses The ACL is an estimate based on many factors which reflect management’s assessment of the risk in the loan portfolio. Those factors include economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio and internal loan processes of the Company and Bank. A full discussion of the accounting for ACL is contained in Note 1 to the Consolidated Financial Statements and activity in the ACL is contained in Note 4 to the Consolidated Financial Statements. Also, please refer to the discussion under the caption "Provision for Credit Losses" for a discussion of the Company's calculation of the provision for credit losses during the three months ended March 31, 2024 and 2023. The ACL for loans at March 31, 2024, or $99.7 million, reflected a $13.7 million increase from December 31, 2023, or $85.9 million, reflecting a provision for credit losses of $35.2 million and $21.4 million in net charge-offs during the three months ended March 31, 2024. Net charge-offs, on an annualized basis, represented 1.07% of average loans for the three months ended March 31, 2024, an increase from net charge-offs of $975 thousand during the three months ended March 31, 2023, which represented 0.05% of average loans, excluding loans held for sale, on an annualized basis. Net charge-offs during the three months ended March 31, 2024 included $20.6 million of charge offs on one CRE office lending relationship. At March 31, 2024, the ACL for loans represented 1.25% of total loans outstanding, as compared to 1.08% at December 31, 2023. The ACL represented 109% of nonperforming loans at March 31, 2024, as compared to 131% at December 31, 2023. Refer to the "Provision for Credit Losses" section of Management's Discussion and Analysis of Financial Condition and Results of Operations for more information on the provision for credit losses. As part of its comprehensive loan review process, the Bank’s Risk Committee evaluates loans which are past due 30 days or more. The Committee makes an assessment of the conditions and circumstances surrounding delinquent and potential problem loans. The Bank’s loan policy requires that loans be placed on nonaccrual if they are 90 days past due or if their collection is deemed to be doubtful, unless they are well secured and in the process of collection. The Credit Administration department analyzes the status of development and construction projects, including sales activities and utilization of interest reserves in order to assess potential increased levels of risk which may require additional reserves. 46 The Company believes it has taken a prudent posture with respect to risk rating its loan portfolio. As of March 31, 2024 and December 31, 2023, loans rated special mention had an amortized cost of $265.3 million and $207.1 million, respectively, and loans rated substandard had an amortized cost of $361.8 million and $335.8 million, respectively. The increases in special mention loans were primarily attributable to additions in CRE loans, particularly in income producing - commercial real estate and commercial construction loans, and commercial loans. At March 31, 2024, 97.5% and $73.9% of special mention and substandard loans, respectively, were current. Based upon their status as potential problem loans, loans risk rated special mention or substandard receive heightened scrutiny and ongoing intensive risk management. Additionally, the Company's loan loss allowance methodology incorporates increased reserve factors for certain loans considered potential problem loans as compared to the general portfolio. Management, being aware of the loan growth experienced by the Bank and the risks facing CRE, is intent on maintaining strong portfolio management and a strong risk rating process. The Bank provides analysis of credit requests and the management of problem credits. The Bank has developed and implemented analytical procedures for evaluating credit requests, has refined the Company’s risk rating system and has adopted enhanced monitoring of the loan portfolio and the adequacy of the ACL, in particular on its CRE and construction loans (including those collateralized by office properties). These analyses include stress testing. Additionally, fair value assessments of loans acquired are included in our analytical procedures. The loan portfolio analysis process is ongoing and proactive to support the Company's objective of maintaining a portfolio of quality credits and quickly identifying weaknesses before they become more severe. At March 31, 2024 and December 31, 2023, the Company's performing office coverage ratio, which calculates the ACL attributable to loans collateralized by performing office properties as a percentage of total loans, was 3.67% and 1.91%, respectively. The following table sets forth activity in the ACL for the periods indicated. Three Months Ended March 31, (dollars in thousands) 2024 2023 Balance at beginning of period $ 85,940 $ 74,444 Charge-offs: Commercial (496) (868) Income producing - commercial real estate (20,943) — Construction - commercial and residential (129) (136) Other consumer (1) (50) Total charge-offs (21,569) (1,054) Recoveries: Commercial 115 76 Owner occupied - commercial real estate 24 — Other consumer — 3 Total recoveries 139 79 Net charge-offs (21,430) (975) Provision for credit losses - loans 35,174 4,908 Balance at end of period $ 99,684 $ 78,377 Annualized ratio of net charge-offs during the period to average loans outstanding during the period 1.07 % 0.05 % 47 The following table reflects the allocation of the ACL at the dates indicated. The allocation of the allowance at March 31, 2024 includes ACL of $387 thousand against individually assessed loans of $92.1 million, as compared to ACL of $641 thousand against individually assessed loans of $66.1 million at December 31, 2023. The allocation of the allowance to each category is not necessarily indicative of future losses or charge-offs and does not restrict the use of the allowance to absorb losses in any category. March 31, 2024 December 31, 2023 (dollars in thousands) Amount % of Total ACL % of Total Loans Amount % of Total ACL % of Total Loans Commercial $ 23,682 24 % 18 % $ 17,824 21 % 18 % Income producing - commercial real estate 45,937 46 % 50 % 40,050 47 % 51 % Owner occupied - commercial real estate 13,537 13 % 15 % 14,333 16 % 15 % Real estate mortgage - residential 893 1 % 1 % 861 1 % 1 % Construction - commercial and residential 13,058 13 % 13 % 10,198 12 % 12 % Construction - C&I (owner-occupied) 1,929 2 % 2 % 1,992 2 % 2 % Home equity 618 1 % 1 % 657 1 % 1 % Other consumer 30 — % — % 25 — % — % Total allowance $ 99,684 100 % 100 % $ 85,940 100 % 100 % Nonperforming Assets The Company's level of nonperforming assets, which comprise the amortized cost of loans delinquent 90 days or more and nonaccrual loans, which includes the nonperforming portion of loan modifications, and the carrying value of OREO, totaled $92.3 million at March 31, 2024 representing 0.79% of total assets, as compared to $66.6 million of nonperforming assets, or 0.57% of total assets, at December 31, 2023. The increase is primarily due to the increase in nonperforming loans discussed below. The Company had no accruing loans 90 days or more past due at March 31, 2024 or December 31, 2023. Management prioritizes remaining attentive to early signs of deterioration in borrowers’ financial conditions and to taking action designed to mitigate risk. The Company places loans on nonaccrual status if it deems collection to be doubtful. The Company believes it is diligent in placing loans on nonaccrual status and believes, based on its loan portfolio risk analysis, that its ACL, at 1.25% of total loans at March 31, 2024, is adequate to absorb expected credit losses within the loan portfolio at that date. Total nonperforming loans had an amortized cost of $91.5 million at March 31, 2024, representing 1.15% of total loans, compared to $65.5 million at December 31, 2023, representing 0.82% of total loans. The increase was primarily from the addition of two income-producing commercial real estate loans to non-accruing status following a partial charge-off on the combined balances. The CECL standard allows for institutions to evaluate individual loans in the event that the asset does not share similar risk characteristics with its original segmentation. This can occur due to credit deterioration, increased collateral dependency or other factors leading to impairment. In particular, the Company individually evaluates loans on nonaccrual and those identified as loan modifications to borrowers experiencing financial difficulties, though it may individually evaluate other loans or groups of loans as well if it determines they no longer share similar risk with their assigned segment. Reserves on individually assessed loans are determined by one of two methods: the fair value of collateral or the discounted cash flow. Fair value of collateral is used for loans determined to be collateral dependent, and the fair value represents the net realizable value of the collateral, adjusted for sales costs, commissions, senior liens, etc. Discounted cash flow is used on loans that are not collateral dependent where structural concessions have been made and continuing payments are expected. The continuing payments are discounted over the expected life at the loan’s original contract rate and include adjustments for risk of default. 48 Nonperforming assets include loans that the Company considers to be individually assessed. Individually assessed loans are defined as those as to which we believe it is probable that we will not collect all amounts due according to the contractual terms of the loan agreement, as well as those loans whose terms have been modified in a loan restructuring to a borrower experiencing financial difficulties that has not shown a period of performance as required under applicable accounting standards. Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent financial assets where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the net present value ("NPV") from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset. Generally, all appraisals associated with individually assessed loans are updated on a not less than annual basis. The Company evaluates loan modifications according to the accounting guidance for loan modifications to determine if the modification results in a new loan or a continuation of the existing loan. Loan modifications to borrowers experiencing financial difficulty that result in a direct change in the timing or amount of contractual cash flows include situations where there is principal forgiveness, interest rate reductions, other-than-insignificant payment delays, term extensions, and combinations of the listed modifications. A loan that is considered a restructured loan may be subject to an individually evaluated loan analysis if the commitment is $1.0 million or greater; otherwise, the restructured loan remains in the appropriate segment in the ACL model and associated reserves are adjusted based on changes in the discounted cash flows resulting from the modification of the restructured loan. Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status, foreclosure or repossession of the collateral to minimize economic loss to the Company. Commercial and consumer loans modified are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a loan restructuring subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. During the three months ended March 31, 2024, the Bank modified 11 loans with a total amortized cost of $85.0 million at March 31, 2024 (1.1% of the loan portfolio). These loans received extended loan terms of between approximately one to 12 months. Loans modified in the preceding twelve months totaled $237.5 million, of which approximately $8.0 million are loans 30-89 days past due and $85.3 million are on non-accrual status. All other loans are performing under their modified terms. Alternatively, management, from time-to-time and in the ordinary course of business, implements renewals, modifications, extensions and/or changes in terms of loans to borrowers who have the ability to repay on reasonable market-based terms, as circumstances may warrant, and therefore, such modifications are not considered to be loan restructurings to a borrower experiencing financial difficulty, as the accommodation of a borrower's request does not rise to the level of a concession if the modified transaction is at market rates and terms and/or the borrower is not experiencing financial difficulty. For example: (1) adverse weather conditions may create a short term cash flow issue for an otherwise profitable retail business which suggests a temporary interest only period on an amortizing loan; (2) there may be delays in absorption on a real estate project which reasonably suggests extension of the loan maturity at market terms; or (3) there may be maturing loans to borrowers with demonstrated repayment ability who are not in a position at the time of maturity to obtain alternate long-term financing. Included in nonperforming assets was OREO of $773 thousand, comprising four foreclosed properties, at March 31, 2024 and $1.1 million, comprising two foreclosed properties, at December 31, 2023. OREO properties are carried at the lower of cost or fair value less estimated costs to sell. 49 It is the Company's policy to obtain third party appraisals prior to foreclosure, and to obtain updated third party appraisals on OREO properties generally not less frequently than annually. Generally, the Company would obtain updated appraisals or evaluations on OREO properties where it has reason to believe, based upon market indications (such as: comparable sales, a scenario in which the Company is considering legitimate offers below carrying value, broker indications and similar factors), that the current appraisal does not accurately reflect current value. Two OREO properties were sold during the three months ended March 31, 2024, generating proceeds of $656 thousand. There were no sales of OREO property during the three months ended March 31, 2023. The following table shows the amounts of nonperforming assets, including loans at amortized cost and OREO at the lower of cost or fair value less estimated costs to sell: (dollars in thousands) March 31, 2024 December 31, 2023 Nonaccrual Loans: Commercial $ 1,920 $ 2,049 Income producing - commercial real estate 67,602 40,926 Owner occupied - commercial real estate 19,798 19,836 Real estate mortgage - residential 1,934 1,946 Construction - commercial and residential — 525 Home equity 237 242 Other consumer — — Total nonperforming loans 91,491 65,524 Other real estate owned 773 1,108 Total nonperforming assets $ 92,264 $ 66,632 Coverage ratio, allowance for credit losses to total nonperforming loans 109 % 131 % Ratio of nonperforming loans to total loans 1.15 % 0.82 % Ratio of nonperforming assets to total assets 0.79 % 0.57 % Significant variation in the amount of nonperforming loans may occur from period to period because the amount of nonperforming loans depends largely on the condition of a relatively small number of individual credits and borrowers relative to the total loan portfolio. At March 31, 2024, there were $361.8 million of Substandard loans. Substandard loans are considered potential or actual problem loans due to known information about possible or actual credit problems which causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms, which may in the future result in the reclassification to the past due, nonaccrual or restructured loan categories, as appropriate. Based upon their status as potential or actual problem loans, these loans receive heightened scrutiny and ongoing intensive risk management. Deposits and Other Borrowings The principal sources of funds for the Bank are core deposits, consisting of demand deposits, money market accounts, Negotiable Order of Withdrawal ("NOW") accounts, savings accounts, and certificates of deposits. The deposit base includes transaction accounts, time and savings accounts, and accounts that customers use for cash management and which provide the Bank with a source of fee income and cross-marketing opportunities, as well as an attractive source of lower cost funds. To meet funding needs during periods of high loan demand and seasonal variations in core deposits, the Bank regularly utilizes alternative funding sources such as secured borrowings from the FHLB, federal funds purchased lines of credit from correspondent banks and brokered deposits from regional and national brokerage firms. Additionally, the Bank has participated in the BTFP established by the Federal Reserve in March 2023. The Federal Reserve announced in January 2024 that the BTFP would stop originating new loans on March 11, 2024, as scheduled. The Federal Reserve also modified the terms of the program so that the interest rate for new loans would be no lower than the interest rate on reserve balances in effect on the day the loan is made. In January 2024, prior to these announcements by the Federal Reserve, the Company borrowed an additional $500.0 million through the BTFP and refinanced $500.0 million under the program, each at an interest rate of 4.76% and a maturity date in January 2025. 50 The following table summarizes the Company's deposits at March 31, 2024 and December 31, 2023: March 31, 2024 December 31, 2023 Balance Percentage Balance Percentage Noninterest-bearing demand $ 1,835,524 22 % $ 2,279,081 26 % Interest-bearing transaction 1,207,566 14 % 997,448 11 % Savings and money market 3,235,391 38 % 3,314,043 38 % Time deposits 2,222,958 26 % 2,217,467 25 % Total $ 8,501,439 100 % $ 8,808,039 100 % For the three months ended March 31, 2024, total deposits decreased by $306.6 million as compared to December 31, 2023. The decrease was primarily attributable to a $443.6 million decrease in noninterest bearing demand deposits and a reduction in savings and money market accounts of $78.7 million, which was partially offset by a $210.1 million increase in interest bearing transaction deposits. No single depositor represented more than 10% of total deposits as of March 31, 2024. The ten largest depositors not associated with brokered pass-through relationships represented approximately 19% of total deposits in the aggregate as of March 31, 2024. The Company maintains a significant deposit relationship with a third-party payments processor, whose business results in deposit inflows and outflows on an ongoing basis, which contributes to variations in period end compared to average deposit balances. From time to time, when appropriate in order to fund strong loan demand or account for increased deposit outflow, the Bank accepts brokered time deposits, generally in denominations of less than $250 thousand, from a regional brokerage firm and other national brokerage networks, including IntraFi Network, LLC ("IntraFi"). Additionally, the Bank participates in the Certificates of Deposit Account Registry Service ("CDARS") and the Insured Cash Sweep product ("ICS"), which provide for reciprocal ("two-way") transactions among banks facilitated by IntraFi for the purpose of maximizing FDIC insurance. The total of reciprocal deposits at March 31, 2024 was $1.7 billion (19.9% of total deposits) as compared to $1.6 billion (17.7% of total deposits) at December 31, 2023. These sources are believed by the Company to represent a reliable and cost efficient alternative funding source for the Bank, but there can be no assurance that they will continue to be adequate or appropriate to meet our liquidity needs. The Bank also is able to obtain one-way CDARS deposits and participates in IntraFi's Insured Network Deposit Program ("IND"). The Bank had $823.6 million and $786.5 million of IND brokered deposits as of March 31, 2024 and December 31, 2023, respectively. However, to the extent that the condition or reputation of the Company or Bank deteriorates, to the extent that there are significant changes in market interest rates which the Company and Bank do not elect to match, or if aggregate funding available to banks changes due to changes in the marketplace, we may experience an outflow of brokered deposits or difficulty in obtaining them in the future. In that event, we would be required to obtain alternate sources for funding, which may increase our cost of funds and negatively impact our net interest margin. We have used brokered deposits and intend to continue to use brokered deposits as one of our funding sources to support future growth. At March 31, 2024, total brokered deposits were $4.2 billion, or 49.1% of total deposits, of which $1.7 billion were attributable to the CDARS and ICS two-way accounts. Total brokered deposits comprised $1.7 billion, $1.6 billion, and $853.0 million of time deposits, savings and money market accounts and interest-bearing transaction accounts, respectively, at March 31, 2024. At December 31, 2023, total brokered deposits (excluding the CDARS and ICS two-way) were $2.5 billion, or 28.8% of total deposits, and comprised $1.5 billion, $961.5 million, and $108.2 million of time deposits, savings and money market accounts, and interest-bearing transaction accounts, respectively. At March 31, 2024 and December 31, 2023, total deposits included estimated totals of $2.3 billion and $2.8 billion of uninsured deposits, which represented 27.6% and 31.4% of total deposits, respectively. The decrease in the percentage of the Bank's deposits that are uninsured was in part due to customers' increased use of the products facilitated by IntraFi that enable customers to maximize FDIC deposit insurance coverage for their deposits. 51 As an enhancement to the basic noninterest bearing demand deposit account, the Company offers a sweep account, or "customer repurchase agreement," allowing qualifying businesses to earn interest on short-term excess funds, which are not suited for either a certificate of deposit or a money market account. The balances in these accounts were $37.1 million at March 31, 2024 compared to $30.6 million at December 31, 2023. Customer repurchase agreements are not deposits and are not insured by the FDIC, but are collateralized by U.S. agency securities and/or U.S. agency backed MBS. These accounts are particularly suitable to businesses with significant fluctuation in the levels of cash flows. Attorney and title company escrow accounts are examples of accounts which can benefit from this product, as are customers who may require collateral for deposits in excess of FDIC insurance limits but do not qualify for other pledging arrangements. This program requires the Company to maintain a sufficient investment securities level to accommodate the fluctuations in balances which may occur in these accounts. The Company had no outstanding balances under its federal funds lines of credit provided by correspondent banks (which are unsecured) at March 31, 2024 and December 31, 2023. At March 31, 2024, the Company had $600.0 million in FHLB secured borrowings outstanding compared to none at December 31, 2023. Outstanding FHLB advances are secured by collateral consisting of specifically pledged marketable investment securities and a blanket lien on qualifying loans in the Bank's commercial mortgage, residential mortgage and home equity loan portfolios. Additionally, at March 31, 2024 and December 31, 2023, the Company had $1.0 billion and $1.3 billion of outstanding borrowings under the BTFP. Outstanding BTFP advances are secured by collateral consisting of specifically pledged qualifying investment securities. Outstanding short-term advances and borrowings are part of the overall asset liability strategy to support loan growth. The subordinated notes outstanding at March 31, 2024 and December 31, 2023 comprised the Company's August 5, 2014 issuance of $70.0 million of subordinated notes, due September 1, 2024. The Company is considering various options to finance the upcoming maturity of the subordinated debt, and the Company may seek to issue new subordinated notes or other debt securities to replace those that are maturing, or fund the maturity through other means. Given prevailing interest rates, any new debt securities to refinance the subordinated notes are expected to have a higher interest rate than the subordinated notes. Commitments and Contractual Obligations Loan commitments outstanding and lines and letters of credit were as follows: (dollars in thousands) March 31, 2024 December 31, 2023 Unfunded loan commitments $ 1,850,316 $ 1,981,334 Unfunded lines of credit 99,930 98,614 Letters of credit 85,719 87,146 Total $ 2,035,965 $ 2,167,094 Various commitments to extend credit are made in the normal course of banking business. Letters of credit are also issued for the benefit of customers. These commitments are subject to loan underwriting standards and geographic boundaries consistent with the Company’s loans outstanding. Unfunded loan commitments are agreements whereby the Bank has made a commitment to lend to a customer as long as there is satisfaction of the terms or conditions established in the contract and the borrower has accepted the commitment in writing. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee before the commitment period is extended. In many instances, borrowers are required to meet performance milestones in order to draw on a commitment as is the case in construction loans, or to have a required level of collateral in order to draw on a commitment as is the case in asset based lending credit facilities. Collateral obtained varies and may include certificates of deposit, accounts receivable, inventory, property and equipment, residential and CRE. Since commitments may expire without being drawn, the total commitment amount does not necessarily represent future cash requirements. Unfunded lines of credit are agreements to lend to a customer as long as there is no violation of the terms or conditions established in the contract. Lines of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since lines of credit may expire without being drawn, the total unfunded line of credit amount does not necessarily represent future cash requirements. 52 Letters of credit include standby and commercial letters of credit. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance by the Bank's customer to a third party. Standby letters of credit generally become payable upon the failure of the customer to perform according to the terms of the underlying contract with the third party. Standby letters of credit are generally not drawn. Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn when the underlying transaction is consummated between the customer and a third party. The contractual amount of these letters of credit represents the maximum potential future payments guaranteed by the Bank. The Bank has recourse against the customer for any amount it is required to pay to a third party under a letter of credit, and holds cash and or other collateral on those standby letters of credit for which collateral is deemed necessary. Liquidity Management Liquidity is a measure of the Company's and Bank's ability to meet loan demand and to satisfy depositor withdrawal requirements in an orderly manner. The Bank's primary sources of liquidity consist of cash and cash balances due from correspondent banks, excess reserves at the Federal Reserve, loan repayments, federal funds sold and other short-term investments, maturities and sales of investment securities, income from operations and new core deposits into the Bank. Approximately 59% of the Company's investment portfolio of debt securities is held in an available-for-sale status which allows for flexibility, subject to holdings held as collateral for customer repurchase agreements and public funds, to generate cash from sales as needed to meet ongoing loan demand. As of March 31, 2024, the unrealized losses recorded on the available-for-sale securities were acting as a deterrent to any sale of those securities to raise liquidity. However, these securities are utilized as pledged assets that provide secondary liquidity through the form of additional available borrowings. Investment securities that are classified as held-to-maturity can also be used as collateral to pledge against additional borrowings. The Company's primary sources of liquidity are supplemented by the ability of the Company and Bank to borrow funds or issue brokered deposits, which are termed secondary sources of liquidity and which are substantial. The following table summarizes the Company's secondary sources of liquidity in use and available at March 31, 2024: (dollars in thousands, except amount in the footnotes) Secondary Sources of Liquidity in Use Secondary Sources of Liquidity Available March 31, 2024: Unsecured brokered deposits (1) $ 998,220 $ 1,959,516 FHLB secured borrowings 600,000 1,302,153 FRB: BTFP secured borrowings 1,000,000 — Discount window secured borrowings — 568,602 Federal funds lines — 155,000 Customer repurchase agreements 37,059 — Raymond James repurchase agreement — 17,780 Unpledged assets: (2) Interest-bearing deposits with banks N/A 34,626 Investment securities N/A 297,521 Total $ 2,635,279 $ 4,335,198 (1) The available liquidity from the unsecured brokered deposits represents unsecured funds under one-way CDARS and ICS brokered deposits that would require then current market rates and be dependent on the availability of funds in those networks. (2) Comprise unencumbered assets that could be liquidated or used as collateral to obtain additional liquidity through debt financing. The funding mix has continued to change throughout the three months ended March 31, 2024. Deposits at quarter-end were $8.5 billion and $8.8 billion at March 31, 2024 and December 31, 2023, respectively. The decrease in deposits was primarily attributable to a $443.6 million decrease in noninterest bearing demand deposits and a reduction in savings and money market accounts of $78.7 million, partially offset by a $210.1 million increase in interest bearing transaction deposits. Borrowings at quarter-end were $1.7 billion and $1.4 billion at March 31, 2024 and December 31, 2023, respectively. The increase in borrowings was attributable to net fundings on the Company's secured borrowings. 53 The Bank can purchase up to $155.0 million in federal funds on an unsecured basis from its correspondents, against which there were no amounts outstanding at March 31, 2024 and December 31, 2023. The Bank can borrow unsecured funds under one-way CDARS and ICS brokered deposits up to $2.0 billion, against which there was $998.2 million outstanding at March 31, 2024. The Bank also has custodial agreements with various broker-dealers through IntraFi's IND program which provided $823.6 million of brokered deposits at March 31, 2024. At March 31, 2024, the Bank was eligible to draw on advances from the FHLB up to $1.9 billion based on assets pledged as collateral to the FHLB, against which the Bank borrowed $600.0 million as of March 31, 2024. The Bank had no FHLB borrowings outstanding at December 31, 2023. The Bank posted additional collateral to the FHLB during the three months ended March 31, 2024 and during the year ended December 31, 2023 to increase its eligibility for advances to meet its ongoing liquidity needs and expects to continue to utilize this source of funding in the future. In March 2023, the Federal Reserve Board announced that it would make available additional funding to eligible depository institutions through the creation of the BTFP. The BTFP provided eligible depository institutions, including the Bank, an additional source of liquidity. Subsequent to its initiation, the Federal Reserve also modified the terms of the program so that the interest rate for new loans would be no lower than the interest rate on reserve balances in effect on the day the loan is made. In January 2024, the Company borrowed an additional $500.0 million through the BTFP and refinanced $500.0 million under the program at an interest rate of 4.76% and a maturity in January 2025. The Federal Reserve discontinued the origination of new loans on March 11, 2024, as scheduled. At March 31, 2024, the Bank had $1.0 billion of BTFP borrowings outstanding. This alternative source of liquidity is being utilized for balance sheet optimization. The Bank has a back-up borrowing facility through the Discount Window at the Federal Reserve. This facility, which can be used to borrow up to $568.6 million, is collateralized with specific assets identified to the Federal Reserve. It is anticipated that, except for periodic testing, this facility would be utilized for contingency funding only. There can be no assurance, however, that these alternative sources of liquidity will continue to be available or will be sufficient to meet our ongoing liquidity needs. In total, the Bank's aggregate borrowing capacity at March 31, 2024 was $2.2 billion, which consists of $1.3 billion and $568.6 million of additional aggregate capacity to borrow from the FHLB and the Federal Reserve's Discount Window, respectively, on assets that have been pledged; along with $17.8 million of aggregate capacity to borrow on a pledge security through a repurchase agreement with Raymond James. The Bank also has unencumbered securities totaling approximately $297.5 million available for pledging to the FHLB or the Federal Reserve for additional borrowing capacity. The loss of deposits through disintermediation is one of the greater risks to liquidity. Disintermediation occurs most commonly when rates rise and depositors withdraw deposits seeking higher rates in alternative savings and investment sources than the Bank may offer. The Bank makes competitive deposit interest rate comparisons weekly and makes adjustments from time to time to ensure its interest rate offerings are competitive. There is, however, a risk that the cost of funds will increase significantly as the Bank competes for deposits or that some deposits would be lost if rates were to continue to increase and the Bank elected not to remain competitive with its deposit rates. Under those conditions, the Bank believes that it is well positioned to use other sources of funds such as FHLB borrowings, brokered deposits, repurchase agreements and correspondent banks’ lines of credit to offset a decline in deposits in the short run, but the use of such sources may negatively impact our net interest margin and our earnings. The mix of sources used in the first quarter of 2024 negatively impacted our net interest margin and earnings, as is expected in an economic environment with continued elevated rates. There can be no assurance that the mix of sources of funds available to us at any particular time in the future will be adequate to meet our future liquidity needs. However, the market for customer and brokered deposits is highly competitive and the risk of disintermediation is high, particularly in a rising or high interest rate environment. Most of our noninterest bearing deposits are operating deposits or compensating balances that are held in connection with lending relationships. The potential outflow of such deposits is a risk unless we pay a more competitive rate of interest on them, which could significantly and negatively impact the Bank’s interest expense and net interest margin, as the transfer of some noninterest-bearing deposits to interest-bearing deposits did in 2023. Over the long-term, an adjustment in assets and change in business emphasis could compensate for a potential loss of deposits. The Bank also maintains a marketable investment portfolio to provide flexibility in the event of significant liquidity needs. The Asset Liability Committee ("ALCO") has adopted policy guidelines, which emphasize the importance of core deposits, adequate asset liquidity and a contingency funding plan. 54 The Company believes it maintains sufficient primary and secondary sources of liquidity to fund its operations. During the three months ended March 31, 2024, average short term liquidity, comprising interest bearing deposits with other banks and other short-term investments and investment securities available-for-sale, was $3.4 billion, which is above the Bank's average needs. Secondary sources of liquidity available at March 31, 2024 were $4.3 billion, which include the FHLB, other insured brokered deposit sweep programs, unpledged securities, Fed funds lines, and the FRB Discount Window. At March 31, 2024, the Company held total securities available to be pledged with an estimated fair value of $297.5 million. At March 31, 2024, under the Bank’s liquidity formula, it had $5.3 billion of primary and secondary liquidity sources. Management believes the amount is adequate to meet current and projected funding needs. Capital Resources and Adequacy The assessment of capital adequacy depends on a number of factors such as asset quality and mix, liquidity, earnings performance, changing competitive conditions and economic forces, stress testing, regulatory measures and policy, as well as the overall level of growth and complexity of the balance sheet. The adequacy of the Company's current and future capital needs is monitored by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses. The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution's total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution's total risk-based capital and the institution's commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. Although growth in that segment over the past 36 months at 20% did not exceed the 50% threshold laid out in the regulatory guidance, we expect the heightened supervisory expectations to continue to apply to us given the federal banking regulators’ general focus on commercial real estate exposures at banks. At March 31, 2024, we did exceed the construction, land development, and other land acquisitions regulatory concentration threshold, and we continue to monitor our concentration in commercial real estate lending and remain in compliance with the guidance issued by the federal banking regulators. Construction, land and land development loans represent 115% of total risk based capital. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures and strong underwriting criteria with respect to its commercial real estate portfolio. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. Nevertheless, as our commercial real estate concentration fluctuates each quarter, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company seeks to manage the risks relating to commercial real estate and its capital adequacy through the development and implementation of its Capital Policy and Capital Plan, the preparation of pro-forma projections including stress testing and the development of internal minimum targets for regulatory capital ratios that are subject to approval by the Board and in excess of well capitalized ratios. The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. 55 At March 31, 2024, the capital position of the Company and its wholly owned subsidiary, the Bank, continue to exceed regulatory requirements and well-capitalized guidelines. The primary indicators relied on by bank regulators in measuring the capital position are four ratios as follows: Tier 1 risk-based capital ratio, Total risk-based capital ratio, the Leverage ratio and the CET1 ratio. Tier 1 capital consists of common and qualifying preferred shareholders’ equity less goodwill and other intangibles. Total risk-based capital consists of Tier 1 capital, plus qualifying subordinated debt and the qualifying portion of the ACL. Risk-based capital ratios are calculated with reference to risk-weighted assets, which are prescribed by regulation. The measure of Tier 1 capital to average assets for the prior quarter is often referred to as the leverage ratio. The CET1 ratio is the Tier 1 capital ratio but excluding preferred stock. The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required. The FRB and the FDIC have adopted rules (the "Basel III Rules") implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks. Under the Basel III Rules, the Company and Bank are required to maintain a CET1 ratio of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, effectively resulting in a minimum CET1 ratio of 7.0%; a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, or 8.5% with the fully phased in capital conservation buffer; a minimum total capital to risk-weighted assets ratio of 10.5% with the fully phased-in capital conservation buffer; and a minimum leverage ratio of 4.0%. The Basel III Rules also increased risk weights for certain assets and off-balance-sheet exposures. At March 31, 2024, the Company and the Bank meet all these requirements. The Company announced a regular quarterly cash dividend on March 28, 2024 of $0.45 per share to shareholders of record on April 18, 2024 and it was paid on April 30, 2024. The ability of the Company to continue to grow is dependent on its results of operations and those of the Bank, the ability to obtain additional funds for contribution to the Bank’s capital, through additional borrowings, through the sale of additional common stock or preferred stock or through the issuance of additional qualifying capital instruments, such as subordinated debt. The capital levels required to be maintained by the Company and Bank may be impacted as a result of the Bank’s concentrations in commercial real estate loans. The capital amounts and ratios for the Company and Bank as of March 31, 2024 and December 31, 2023 are presented in the table below. Company Bank Minimum Required Basel III To Be Well-Capitalized Under Prompt Corrective Action Regulations (1) Actual Actual (dollars in thousands) Amount Ratio Amount Ratio March 31, 2024 CET1 capital (to risk weighted assets) $ 1,322,880 13.80 % $ 1,317,280 13.81 % 7.00 % 6.50 % Total capital (to risk weighted assets) $ 1,425,534 14.87 % $ 1,419,934 14.89 % 10.50 % 10.00 % Tier 1 capital (to risk weighted assets) $ 1,322,880 13.80 % $ 1,317,280 13.81 % 8.50 % 8.00 % Tier 1 capital (to average assets) $ 1,322,880 10.26 % $ 1,317,280 10.25 % 4.00 % 5.00 % December 31, 2023 CET1 capital (to risk weighted assets) $ 1,335,967 13.90 % $ 1,330,001 13.92 % 7.00 % 6.50 % Total capital (to risk weighted assets) 1,421,347 14.79 % 1,415,381 14.81 % 10.50 % 10.00 % Tier 1 capital (to risk weighted assets) 1,335,967 13.90 % 1,330,001 13.92 % 8.50 % 8.00 % Tier 1 capital (to average assets) 1,335,967 10.73 % 1,330,001 10.72 % 4.00 % 5.00 % (1) Applies to the Bank only. Bank and holding company regulations, as well as Maryland law, impose certain restrictions on dividend payments by the Bank, as well as restricting extensions of credit and transfers of assets between the Bank and the Company. 56 In December 2018, federal banking regulators issued a final rule that provides an optional three-year phase-in period for the adverse regulatory capital effects of adopting the CECL methodology pursuant to new accounting guidance for the recognition of credit losses on certain financial instruments, effective January 1, 2020. In March 2020, the federal banking regulators issued an interim final rule that provides banking organizations with an alternative option to temporarily delay for two years the estimated impact of the adoption of the CECL methodology on regulatory capital, followed by the three-year phase-in period. The cumulative amount that is not recognized in regulatory capital will be phased in at 25 percent per year beginning January 1, 2022. We have elected to adopt the option provided by the March 2020 interim final rule. Asset/Liability Management and Quantitative and Qualitative Disclosures about Market Risk A fundamental risk in banking is exposure to market risk, or interest rate risk, since a bank's earnings is largely dependent on net interest income. The Bank's ALCO formulates and monitors the management of interest rate risk through policies and guidelines established by it and overseen by the Audit Committee and the full Board of Directors and through review of detailed reports discussed quarterly. In its consideration of risk limits, the ALCO considers the impact on earnings and capital, the level and direction of interest rates, liquidity, local economic conditions, outside threats and other factors. Banking is generally a business of managing the maturity and repricing mismatch inherent in its asset and liability cash flows to provide net interest income growth consistent with the Company's profit objectives. During the three months ended March 31, 2024, the Company was able to produce a net interest margin of 2.43% as compared to 2.77% during the same period in 2023 and continues to manage its overall interest rate risk position. The Company, through its ALCO and ongoing financial management practices, monitors the interest rate environment in which it operates and adjusts the rates and maturities of its assets and liabilities to remain competitive and to achieve its overall financial objectives subject to established risk limits. The loan portfolio increased during the first quarter of 2024. The re-pricing duration of the loan portfolio was 13 and 12 months at March 31, 2024 and December 31, 2023, respectively, with fixed rate loans amounting to 39% of total loans at March 31, 2024 and 38% at December 31, 2023. Variable and adjustable rate loans comprised 61% of total loans at March 31, 2024 and 62% at December 31, 2023. Variable rate loans are generally indexed to the Secured Overnight Funding Rate ("SOFR") or the Wall Street Journal prime interest rate, while adjustable rate loans are indexed primarily to the five year U.S. Treasury interest rate. In the current and expected future interest rate environment, the Company has maintained its investment portfolio to manage the balance between yield and risk in its portfolio of MBS. Further, the Company has been principally collecting cash flows from the investment portfolio to provide liquidity. At March 31, 2024, the amortized cost less allowance of the investment portfolio decreased by $69.6 million, or 2.6%, as compared to the balance at December 31, 2023. Based on amortized cost, the percentage mix of municipal securities was 5% of total investments at March 31, 2024 and December 31, 2023. The portion of the portfolio invested in MBS was 61% at March 31, 2024 and December 31, 2023. The portion of the portfolio invested in U.S. agency investments was 27% at March 31, 2024 and December 31, 2023. Corporate bonds made up 5% of total investments at March 31, 2024 and December 31, 2023. U.S. treasury bonds were 2% of total investments at March 31, 2024 and December 31, 2023. The duration of the investment portfolio decreased to 4.3 years at March 31, 2024 from 4.4 years at December 31, 2023. At March 31, 2024, $80.3 million of corporate bonds were subordinated debt from other financial institutions. Corporate bonds generally, and subordinated debt in particular, pose credit risk such that if any of these issuers were to enter bankruptcy or insolvency proceedings, we could experience losses that may be material to operating results and our financial condition. We may also experience increases in provisions for credit losses, adversely affecting our net income, if the creditworthiness of the issuers declines, whether due to idiosyncratic factors, economic conditions generally or other unforeseen factors or events. The Company has credit risk participation agreements ("RPAs") with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. These derivatives are not designated as hedges, are not speculative and have an asset position with a notional value of $49.5 million as of March 31, 2024. The changes in fair value for these contracts are recognized directly in earnings. 57 The duration of the deposit portfolio decreased as rates rose, measuring 24 months at March 31, 2024 and 28 months at December 31, 2023. The Company experienced a total deposit decrease of $306.6 million for the three months ended March 31, 2024 as compared to a total loan increase of $14.0 million for the same period. The funding mix has continued to change in the three months ended March 31, 2024. The decrease in deposits was primarily attributable to a $443.6 million decrease in noninterest bearing demand deposits and a reduction in savings and money market accounts of $78.7 million, partially offset by a $210.1 million increase in interest bearing transaction deposits. These funding mix changes were the result of an increased disintermediation driven primarily by an increase in interest rates. During the three months ended March 31, 2024, the Company’s cost of interest bearing deposits increased by 18 basis points across its interest-bearing deposits, which comprise 78.4% of its total deposits at March 31, 2024. The net unrealized loss before income tax on the investment securities available-for-sale portfolio was $168.6 million and $162.0 million at March 31, 2024 and December 31, 2023, respectively. At March 31, 2024, the net unrealized loss position represented 10.45% of the investment portfolio's book value. Management relies on the use of models in order to measure the expected future impact on interest income of various interest rate environments, as described above. Through its modeling, the Company makes certain estimates that may vary from actual results. There can be no assurance that the Company will be able to successfully achieve its optimal asset liability mix, given competitive pressures, customer preferences and the inability to forecast future interest rates and movements with complete accuracy. Market rates have stabilized as the last short-term interest rate increase from the Federal Reserve was instituted in July 2023. While yields on interest-earning assets have increased, including the impact of the reset of variable and adjustable rate loans, as scheduled, our cost of funds on interest-bearing liabilities has also increased in connection with increased utilization of interest-bearing deposits and borrowings and increasing rates on those financing sources. As a result, the net interest margin has remained steady, as compared to the two previous quarters. Our rate risk modeling showed net interest margin expansion in an increasing rate environment; however, the model's prediction is the result of increases in both interest income on variable and adjustable rate loans and interest expense on its deposit liabilities, based on our funding needs, market conditions and certain contractual obligations but with no changes in the mix of assets or liabilities or the spreads we are able to earn. The model also assumes a stable interest rate environment after the programmed rate change, allowing assets and liabilities to reprice at their schedule in a stable environment, which may be quite different than real world conditions. Interest rate floors on certain of the Company's variable and adjustable rate loans may provide asset yield protection in a low-interest rate environment; however, they are also expected to delay the impact of increases to market rates on interest income until such floors have been exceeded, though this is not relevant for the current rate environment with most variable rate loans well above their floor rate. At March 31, 2024, the Company had a portfolio of $4.9 billion of variable and adjustable rate loans that were subject to interest rate floors with a weighted average rate of 7.82%, which was consistent with the rate at December 31, 2023. At March 31, 2024, only $210.6 million of loans held by the Company were earning interest at their floor rate, and the majority of those are expected to reset at rates higher than their floor at their next rate reset date. The Company employs an earnings simulation model (immediate parallel shifts along the yield curve) on a quarterly basis to monitor its interest rate sensitivity and risk and to model its balance sheet cash flows and the related income statement effects in different interest rate scenarios. The model utilizes current balance sheet data and attributes and is adjusted for assumptions as to investment maturities (including prepayments), loan prepayments, interest rates, deposit decay rates, and the level of noninterest income and noninterest expense. Further discussion of the limitations of this analysis are listed below and in the risk factors and other cautionary language included in the Company's Annual Report on Form 10-K for the year ended December 31, 2023, and in other periodic and current reports filed by the Company with the SEC. The data is then subjected to a "shock test" which assumes a simultaneous change in interest rates up 100, 200, 300, and 400 basis points or down 100, 200, and 300 basis points, along the entire yield curve, but not below zero. The results are analyzed as to the impact on net interest income, earnings and the market equity over the next twelve and twenty-four month periods from March 31, 2024. In addition to analysis of simultaneous changes in interest rates along the yield curve, an analysis of changes based on interest rate "ramps" is also performed. Such analysis represents the impact of a more gradual change in interest rates, as well as yield curve shape changes. 58 For the analysis presented below, at March 31, 2024, the simulation assumes a 100 basis point change in interest rates on interest bearing deposits for each 100 basis point change in market interest rates in a decreasing interest rate shock scenario with a floor of 10 basis points and assumes a 100 basis point change in interest rates on interest bearing deposits for each 100 basis point change in market interest rates in an increasing interest rate shock scenario. The Bank does have deposits with contractual terms which means these deposits will change 100 basis points for every 100 basis points change in market rates. Thus, the overall measure of the correlation between deposit costs and market rate changes is modeled at 100%. The Company utilized the same assumptions for its analysis at December 31, 2023. Because competitive market behavior does not necessarily track the trend of interest rates but at times moves ahead of financial market influences, the change in the cost of liabilities may be different than anticipated by the interest rate risk model. If this were to occur, the effects of a rising or declining interest rate environment may not be in accordance with management’s expectations. As quantified in the table below, the Company's analysis at March 31, 2024 shows a moderate effect on net interest income (over the next 12 months) as well as a moderate effect on the economic value of equity when interest rates are shocked down 100, 200, and 300 basis points and up 100, 200, 300, and 400 basis points. This moderate impact is due substantially to the significant level of variable rate and repriceable assets and liabilities and related shorter relative durations. At March 31, 2024, the repricing duration of the (a) investment portfolio was 4.3 years, (b) loan portfolio was 1.1 years, (c) interest bearing deposit portfolio was 1.1 years, and (d) the borrowed funds portfolio was 0.5 years. The following table reflects the result of simulation analysis on the March 31, 2024 asset and liabilities balances: Change in interest rates (basis points) Percentage change in net interest income Percentage change in net income Percentage change in market value of portfolio equity + 400 2.7% 6.9% (8.0)% + 300 2.1% 5.2% (5.8)% + 200 1.3% 3.4% (3.8)% + 100 0.6% 1.5% (1.6)% — — — — - 100 0.1% 0.2% 1.1% - 200 1.9% 4.4% 0.9% - 300 2.4% 5.5% (3.3)% The results of the simulation are within the relevant policy limits adopted by the Company for percentage change in net interest income. For net interest income, the Company has adopted a policy limit of -10% for a 100 basis point change, -12% for a 200 basis point change, -18% for a 300 basis point change, and -24% for a 400 basis point change. For the market value of equity, the Company has adopted a policy limit of -12% for a 100 basis point change, -15% for a 200 basis point change, -25% for a 300 basis point change, and -30% for a 400 basis point change. The impact of 0.1% in net interest income and 0.2% in net income given a 100 basis point decrease in market interest rates at March 31, 2024 compares to (1.3)% in net interest income and (2.6)% in net income for the same period in 2023, and reflects in large measure the beta factor discussion above. The analysis at the end of the first quarter of 2024 compared to the first quarter of 2023, showed that in an environment of increasing rates the continued increase in income is dependent on rate increases, which are passed through to borrowers basis point for basis point, as opposed to the prior year where our model suggested rising rates would not be fully passed on to depositors. The changes in net interest income, net income and the economic value of equity in higher interest rate shock scenarios at March 31, 2024 are not believed to be excessive. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that limit changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase. 59 While an instantaneous parallel shift in interest rates was used in this analysis to provide an estimate of exposure under these scenarios, we believe that a non-immediate parallel shifts in interest rates would have a more modest impact. Further, the earnings simulation model does not take into account factors such as future balance sheet growth, changes in product mix, changes in yield curve relationships, the various rate indexes do not move in parallel (e.g. SOFR, Fed Funds), hedging activities we might take and changing product spreads that could mitigate any potential beneficial or adverse impact of changes in interest rates. Another key factor to consider is the behavior of our deposit portfolio in the baseline forecast and in alternate interest rate scenarios set out in the table above is a key assumption in our projected estimates of net interest income. The projected impact on net interest income in the table above assumes no change in deposit portfolio size or mix from the baseline forecast in alternative rate environments. In higher rate scenarios, any customer activity resulting in the replacement of low-cost or noninterest-bearing deposits with higher-yielding deposits or market-based funding would reduce the assumed benefit of those deposits. The projected impact on net interest income in the table above also assumes a "through-the-cycle" non-maturity deposit beta which may not be an accurate predictor of actual deposit rate changes realized in scenarios of smaller and/or non-parallel interest rate movements. Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react to different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. In addition, certain assets, such as adjustable-rate mortgage loans, have features (generally referred to as interest rate caps and floors) that limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios as part of its responsibility to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing and capital policies. Use of Non-GAAP Financial Measures The information set forth below contains certain financial information determined by methods other than in accordance with GAAP. These non-GAAP financial measures are "tangible common equity," "tangible book value per common share," "tangible common equity ratio," "average tangible common equity," "annualized return on average tangible common equity," "efficiency ratio," and "pre-provision net revenue." The Company considers these non-GAAP measurements useful for investors, regulators, management and others to evaluate capital adequacy and to compare against other financial institutions. Management uses these non-GAAP measures in its analysis of our performance because it believes these measures are used as a measure of our performance by investors. The Company calculates the tangible common equity ratio by excluding the balance of intangible assets from common shareholders' equity, or tangible common equity, and dividing by tangible assets. The Company calculates tangible book value per common share by dividing tangible common equity by common shares outstanding, as compared to book value per common share, which the Company calculates by dividing common shareholders' equity by common shares outstanding. The Company calculates the ROATCE by dividing net income available to common shareholders by average tangible common equity which is calculated by excluding the average balance of intangible assets from the average common shareholders' equity. The Company considers this information important to shareholders as tangible equity is a measure that is consistent with the calculation of capital for bank regulatory purposes, which excludes intangible assets from the calculation of risk based ratios, and as such is useful for investors, regulators, management and others to evaluate capital adequacy and to compare against other financial institutions. The Company calculates the efficiency ratio by dividing noninterest expense by the sum of net interest income and noninterest income. The efficiency ratio measures a bank's overhead as a percentage of its revenue. The Company believes that reporting the non-GAAP efficiency ratio more closely measures its effectiveness of controlling operational activities. The Company calculates pre-provision net revenue by subtracting noninterest expenses from the sum of net interest income and noninterest income. PPNR to average assets is calculated by dividing the annualized PPNR by average assets. The Company considers this information important to shareholders because it illustrates revenue excluding the impact of provisions and reversals to the ACL on loans. 60 These disclosures should not be considered in isolation or as a substitute for results determined in accordance with GAAP and are not necessarily comparable to non-GAAP performance measures which may be presented by other bank holding companies. Management compensates for these limitations by providing detailed reconciliations between GAAP information and the non-GAAP financial measures. The following tables reconcile the GAAP financial measures to the associated non-GAAP financial measures: (dollars in thousands except per share data) March 31, 2024 December 31, 2023 Common shareholders' equity $ 1,259,413 $ 1,274,283 Less: Intangible assets (104,611) (104,925) Tangible common equity $ 1,154,802 $ 1,169,358 Book value per common share $ 41.72 $ 42.58 Less: Intangible book value per common share (3.46) (3.50) Tangible book value per common share $ 38.26 $ 39.08 Total assets $ 11,612,648 $ 11,664,538 Less: Intangible assets (104,611) (104,925) Tangible assets $ 11,508,037 $ 11,559,613 Tangible common equity ratio 10.03 % 10.12 % Three Months Ended March 31, (dollars in thousands) 2024 2023 Average common shareholders' equity $ 1,289,656 $ 1,240,978 Less: Average intangible assets (104,718) (104,231) Average tangible common equity $ 1,184,938 $ 1,136,747 Net income available to common shareholders $ (338) $ 24,234 Average tangible common equity 1,184,938 1,136,747 Annualized return on average tangible common equity (0.11) % 8.65 % Net interest income $ 74,698 $ 75,024 Noninterest income 3,589 3,700 Operating revenue $ 78,287 $ 78,724 Noninterest expense $ 39,997 $ 40,584 Efficiency ratio 51.09 % 51.55 % Net interest income $ 74,698 $ 75,024 Noninterest income 3,589 3,700 Less: Noninterest expense (39,997) (40,584) Pre-provision net revenue $ 38,290 $ 38,140 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Please refer to Item 2 of this report, "Management's Discussion and Analysis of Financial Condition and Results of Operations," under the caption "Asset/Liability Management and Quantitative and Qualitative Disclosure about Market Risk." 61