Item 2. Management’s Discussion and Analysis
Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition
Acquisitions
On October 15, 2021 we completed the acquisition of Select Bancorp, Inc. ("Select") which was headquartered in Dunn, North Carolina and which contributed total assets of $1.8 billion, total loans of $1.3 billion, and total deposits of $1.6 billion as of the acquisition date. As such, comparisons for the financial periods presented are impacted by our acquisition of Select.
On June 21, 2022, we announced an agreement to acquire GrandSouth Bancorporation ("GrandSouth"), headquartered in Greenville, South Carolina, in an all-stock transaction. The terms of the agreement provide that each share of GrandSouth common and preferred stock issued and outstanding immediately prior to the effective time of the acquisition will be converted into 0.91 shares of the Company's common stock. We have received all regulatory approvals for the transaction. Approval by GrandSouth's shareholders remains pending and is expected in the fourth quarter of 2022. The acquisition is expected to close in early January 2023. GrandSouth operates eight branches throughout South Carolina and currently has $1.3 billion in total assets, $995.1 million in loans, and $1.1 billion in deposits.
Overview and Highlights at and for Three Months Ended September 30, 2022
We earned net income of $37.9 million, or $1.06 diluted EPS, during the three months ended September 30, 2022 compared to net income of $27.6 million, or $0.97 diluted EPS, for the three months ended September 30, 2021.
The main drivers to the increase in net income are presented below. Refer also to additional discussion in the Results of Operations section following.
• Net interest income for the third quarter of 2022 was $85.3 million, a 45.7% increase from the $58.6 million recorded in the third quarter of 2021. The increase in net interest income from the prior year period was driven by higher earning assets related to both organic growth and the Select acquisition.
• Also contributing to the increase in net interest income was the higher net interest margin ("NIM") which increased in the third quarter of 2022 to 3.40% from 3.03% for the third quarter of 2021 related to the increase in market interest rates driving higher yields on loans, while our cost of funds has remained low and was essentially unchanged from the same period of the prior year.
• For the three months ended September 30, 2022, the Company recorded $5.1 million in provision for credit losses. This is compared to a release of provisions of $1.4 million for the third quarter of 2021. Fluctuations each period are based on loan growth during the period, changes in the levels of nonperforming loans, economic forecasts impacting loss drivers, and other assumptions and inputs to the CECL model.
• Noninterest income for the three months ended September 30, 2022 increased slightly, up $0.4 million, or 2.4%, from the comparable period of 2021 with higher service charges and other gains offset by lower loan sale gains, consulting income and other fees.
• Noninterest expense increased $7.9 million, or 19.3%, for the quarter ended September 30, 2022, as compared to the prior year period driven by higher operating expenses resulting from the Select acquisition.
Total assets at September 30, 2022 amounted to $10.5 billion, a 0.1% increase from December 31, 2021. The primary balance sheet changes are presented below. Refer also to additional discussion in the Financial Condition section following.
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• Total loans amounted to $6.5 billion at September 30, 2022, an increase of $443.6 million, a 9.7% annualized growth rate, from December 31, 2021 due to organic growth in all markets. Organic growth for the third quarter of 2022 amounted to $282.1 million.
• Total investment securities decreased $261.8 million from December 31, 2021 to total $2.9 billion at September 30, 2022, as cash flows were utilized to fund loan growth. Also contributing to the decline was the increase in unrealized losses on available for sale securities which totaled $464.6 million at September 30, 2022.
• Total deposits amounted to $9.2 billion at September 30, 2022, an increase of $104.6 million, or 1.1%, from December 31, 2021. While deposits have continued to grow for the year to date period, the third quarter of 2022 realized a decline in total deposits of $130.5 million as market rates for deposits have become more competitive and customer behaviors may be shifting from activity experienced during the COVID-19 pandemic.
• We remain well-capitalized by all regulatory standards with a total common equity Tier 1 ratio of 12.76% and total risk-based capital ratio of 14.84%.
• Accumulated other comprehensive loss increased $333.1 million related to higher unrealized losses on available for sale securities due to increased market rates experienced starting in March 2022.
Overview and Highlights for Nine Months Ended September 30, 2022
Total net income of $108.5 million, or $3.04 diluted EPS, was reported during the nine months ended September 30, 2022 compared to net income of $85.1 million, or $2.99 diluted EPS, for the nine months ended September 30, 2021.
The main drivers to the increase in net income are presented below. Refer also to additional discussion in the Results of Operations section following.
• Net interest income for the nine months ended September 30, 2022 was $240.5 million, a 39.4% increase from the $172.6 million recorded in the nine months ended September 30, 2021. The increase in net interest income from the prior year period was due in large part to higher earning assets related to both organic growth and the Select acquisition completed in the fourth quarter of 2021. Also contributing to the increase in net interest income was the higher NIM which increased 10 basis points in 2022 as compared to the prior year.
• For the nine months ended September 30, 2022, we recorded a provision for credit losses of $8.6 million based on loan growth for the period and CECL model assumptions including deterioration economic forecasts. This is compared to a reversal of the provision for credit losses of $1.4 million for the comparable period of 2021.
• Noninterest income declined $5.1 million, or 8.8%, from the prior year period primarily due to a $7.0 million decrease in mortgage banking income related to lower levels of activity due to market rate increases. Other decreases in SBA consulting and loan sale gains where more than offset by higher service changes and other income income related to higher level of accounts and transactions arising from the Select acquisition.
• Noninterest expense increased $27.7 million, or 22.7%, for the nine months ended September 30, 2022 as compared to the same period in the prior year. Included in the current year period was $4.8 million in merger and acquisition expenses primarily related to computer system conversion costs resulting from the Select acquisition. The balance of the increase in noninterest expenses was driven by higher operating expenses resulting from the Select acquisition.
Critical Accounting Policies and Estimates
The accounting principles we follow and our methods of applying these principles conform with GAAP and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and may involve the use of estimates based on our best assumptions at the time of the estimation. We have identified the accounting policies discussed below as being more sensitive in terms of judgments and estimates taking into account their overall potential impact to our consolidated financial statements.
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Allowance for Credit Losses on Loans and Unfunded Commitments
The allowance for credit losses represents management’s current estimate of credit losses for the remaining estimated life of financial instruments. We perform periodic and systematic detailed reviews of the loan portfolio to identify trends and to assess the overall collectability of the portfolio. We believe the accounting estimate related to the ACL is a “critical accounting estimate” as: (1) changes in it can materially affect the provision for credit losses and net income; (2) it requires management to predict borrowers’ likelihood or capacity to repay, including evaluation of inherently uncertain future economic conditions; (3) the value of underlying collateral must be estimated on collateral-dependent loans; (4) prepayment activity must be projected to estimate the life of loans that often are shorter than contractual terms; and (5) it requires estimation of a reasonable and supportable forecast period for credit losses. Accordingly, this is a highly subjective process and requires significant judgment since it is difficult to evaluate current and future economic conditions in relation to an overall credit cycle and estimate the timing and extent of loss events that are expected to occur prior to end of a loan’s estimated life.
Our ACL is assessed at each balance sheet date and adjustments are recorded in the provision for credit losses. The ACL is estimated based on loan level characteristics using historical loss rates, a reasonable and supportable economic forecast, and assumptions of probability of default and loss given default. Loan balances considered uncollectible are charged-off against the ACL. There are many factors affecting the ACL, some of which are quantitative, while others require qualitative judgment. Although management believes its process for determining the ACL adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and is susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for credit losses could be required that could adversely affect our earnings or financial position in future periods.
Purchased credit deteriorated ("PCD") loans represent assets that are acquired with evidence of more than insignificant credit quality deterioration since origination as of the acquisition date. At acquisition, an allowance on PCD assets is booked directly to the ACL. Any subsequent changes in the ACL on PCD assets is recorded through the provision for credit losses.
We believe that the ACL is adequate to absorb the expected life of loan credit losses on the portfolio of loans as of the balance sheet date. Actual losses incurred may differ materially from our estimates.
We estimate expected credit losses on unfunded commitments to extend credit over the contractual period in which we are exposed to credit risk on the underlying commitments, unless the obligation is unconditionally cancellable. The allowance for off-balance sheet credit exposures, which is included in "Other liabilities" on the Consolidated Balance Sheets, is adjusted for as an increase or decrease to the provision for unfunded commitments. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. The methodology is based on a loss rate approach that starts with the probability of funding based on historical experience. Similar to methodology discussed above related to the loans receivable portfolio, adjustments are made to the historical losses for current conditions and reasonable and supportable forecast.
Goodwill and Other Intangible Assets
We believe that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. Accounting Standards Codification 350-10 establishes standards for the amortization of acquired intangible assets, generally over the estimated useful life of the related assets, and impairment assessment of goodwill. At September 30, 2022, we had core deposit and other intangibles of $13.9 million subject to amortization and $364.3 million of goodwill, which is not subject to amortization.
Goodwill arising from business combinations represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. At each reporting date between annual goodwill impairment tests, we consider potential indicators of impairment. During 2022 there were no triggers warranting interim impairment assessments and for the 2021 annual assessment, we concluded that it was more likely than not that the fair value exceeded its carrying value.
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The primary identifiable intangible asset we typically record in connection with a whole bank or bank branch acquisition is the value of the core deposit intangibles which represent the estimated value of the long-term deposit relationships acquired in the transaction. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. The core deposit intangibles are amortized over the estimated useful lives of the deposit accounts based on a method that we believe reasonably approximates the anticipated benefit stream from this intangible. The estimated useful lives are periodically reviewed for reasonableness and have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization. We review identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our policy is that an impairment loss is recognized, equal to the difference between the asset’s carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.
Current Accounting Matters
See Note 2 to the Consolidated Financial Statements for information about recently announced or adopted accounting standards.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is our largest source of revenue and is the difference between the interest earned on interest-earning assets (generally loans and investment securities) and the interest expense incurred in connection with interest-bearing liabilities (generally deposits and borrowed funds). Changes in the net interest income are the result of changes in volume and the net interest spread which affects NIM. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. NIM refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. Net interest income is also influenced by external factors such as local economic conditions, competition for loans and deposits, and market interest rates.
Net interest income for the three months ended September 30, 2022 amounted to $85.3 million, an increase of $26.8 million, or 45.7%, from the $58.6 million recorded in the third quarter of 2021. Net interest income on a tax-equivalent basis for the three months ended September 30, 2022 amounted to $86.0 million, an increase of $26.9 million, or 45.5%, from the $59.1 million recorded in the third quarter of 2021. For internal purposes, we evaluate our NIM on a tax-equivalent basis by adding the tax benefit realized from tax-exempt loans and securities to reported interest income then dividing by total average earning assets. We believe that analysis of NIM on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest in different periods without taking into account the different mix of taxable versus non-taxable loans and investments that may have existed during those periods.
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The following table presents an analysis of net interest income for the three months ended September 30, 2022 and 2021.
Average Balances and Net Interest Income Analysis
For the Three Months Ended September 30,
2022 2021
($ in thousands) Average
Volume Average
Rate Interest
Earned
or Paid Average
Volume Average
Rate Interest
Earned
or Paid
Assets
Loans (1) (2) $ 6,389,996 4.49 % $ 72,239 $ 4,820,007 4.09 % $ 50,957
Taxable securities 3,078,561 1.73 % 13,450 2,274,336 1.46 % 8,381
Non-taxable securities 299,822 1.48 % 1,115 193,511 1.41 % 688
Short-term investments, primarily interest-bearing cash 260,009 2.27 % 1,486 447,759 0.47 % 528
Total interest-earning assets 10,028,388 3.49 % 88,290 7,735,613 3.11 % 60,554
Cash and due from banks 89,042 82,204
Premises and equipment 134,903 123,190
Other assets 314,800 378,320
Total assets $ 10,567,133 $ 8,319,327
Liabilities
Interest-bearing checking $ 1,529,233 0.06 % $ 250 $ 1,349,796 0.06 % $ 194
Money market deposits 2,480,043 0.13 % 841 1,865,477 0.13 % 613
Savings deposits 752,042 0.06 % 111 617,064 0.06 % 96
Time deposits >$100,000 494,707 0.32 % 394 504,437 0.44 % 558
Other time deposits 295,134 0.34 % 252 214,686 0.30 % 165
Total interest-bearing deposits 5,551,159 0.13 % 1,848 4,551,460 0.14 % 1,626
Borrowings 110,180 3.99 % 1,108 60,822 2.45 % 375
Total interest-bearing liabilities 5,661,339 0.21 % 2,956 4,612,282 0.17 % 2,001
Noninterest-bearing checking 3,748,119 2,728,815
Other liabilities 69,912 59,244
Shareholders’ equity 1,087,763 918,986
Total liabilities and
shareholders’ equity $ 10,567,133 $ 8,319,327
Net yield on interest-earning assets and net interest income 3.38 % $ 85,334 3.00 % $ 58,553
Net yield on interest-earning assets and net interest income – tax-equivalent (3) 3.40 % $ 86,026 3.03 % $ 59,129
Interest rate spread 3.28 % 2.94 %
Average prime rate 5.35 % 3.25 %
(1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. Interest earned includes recognized net loan fees, including late fees, prepayment fees, and deferred loan fee amortization (including deferred PPP fees), in the amounts of $0.8 million, and $1.9 million for three months ended September 30, 2022 and 2021, respectively.
(2) Includes accretion of discount on acquired and SBA loans of $2.6 million and $1.2 million for three months ended September 30, 2022 and 2021, respectively.
(3) Includes tax-equivalent adjustments of $0.7 million and $0.6 million for three months ended September 30, 2022 and 2021, respectively, to reflect the tax benefit that we receive related to tax-exempt securities and tax-exempt loans, which carry interest rates lower than similar taxable investments/loans due to their tax exempt status. This amount has been computed assuming a 23% tax rate and is reduced by the related nondeductible portion of interest expense.
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Overall, as demonstrated in the table above, net interest income grew $26.8 million for the three months ended September 30, 2022 from the comparable period of the prior year. Higher earning asset volumes, from both organic growth and the Select acquisition, combined with an expansion in NIM, drove the increase. Rates on interest-bearing deposits remained stable year-over-year while rated on borrowings increased relative to higher market rates.
• Market interest rates increased 300 basis points between March and September 2022 to result in an average prime rate of 5.35% for three months ended September 30, 2022 compared to 3.25% for the prior year period.
• Average loan volumes for the three months ended September 30, 2022 were $1.6 billion higher than the same period in 2021. In addition to higher volumes, interest rates on loans increased 40 basis points to 4.49% for the third quarter of 2022, to result in an increase in loan interest income of $21.3 million.
• Interest income on total investment securities increased $5.5 million for the three months ended September 30, 2022 when compared to the same period in 2021 related primary to the higher yields on the portfolio as reinvestment rates increased between the periods. Average volumes increased $910.5 million between periods contributing to the increase in interest income.
• Higher average balances in interest-bearing deposits of $1.0 billion drove a $0.2 million increase in deposit interest expense for the three months ended September 30, 2022 compared to the same period in 2021. Rates for the same periods remained essentially unchanged.
• The combination of higher rates on borrowings, up 154 basis points from the third quarter of 2021 as compared to the third quarter of 2022, related to increasing market rates, and the increase in volume of borrowings between periods drove the $0.7 million increase in interest expense for this category. Starting in the third quarter of 2022, short-term borrowings were utilized as needed to fund loan growth and manage fluctuations in deposit balances.
• The increase in NIM was in large part the result of market rate increases and improved pricing on new loans.
Net interest income for the nine months ended September 30, 2022 amounted to $240.5 million, an increase of $67.9 million, or 39.4%, from the $172.6 million recorded in the nine months ended September 30, 2021. Net interest income on a tax-equivalent basis for the nine months ended September 30, 2022 amounted to $242.5 million, an increase of $68.5 million, or 39.3%, from the $174.1 million recorded in the nine months ended September 30, 2021. For internal purposes, we evaluate our NIM on a tax-equivalent basis by adding the tax benefit realized from tax-exempt loans and securities to reported interest income then dividing by total average earning assets. We believe that analysis of NIM on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest in different periods without taking into account the different mix of taxable versus non-taxable loans and investments that may have existed during those periods.
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The following table presents an analysis of net interest income for the nine months ended September 30, 2022 and 2021.
Average Balances and Net Interest Income Analysis
For the Nine Months Ended September 30,
2022 2021
($ in thousands) Average
Volume Average
Rate Interest
Earned
or Paid Average
Volume Average
Rate Interest
Earned
or Paid
Assets
Loans (1) (2) $ 6,197,915 4.35 % $ 201,518 $ 4,728,258 4.36 % $ 154,325
Taxable securities 3,070,745 1.74 % 40,045 2,030,491 1.45 % 22,081
Non-taxable securities 296,132 1.48 % 3,267 131,263 1.51 % 1,487
Short-term investments, primarily interest-bearing cash 366,529 1.10 % 3,016 453,267 0.53 % 1,809
Total interest-earning assets 9,931,321 3.34 % $ 247,846 7,343,279 3.27 % 179,702
Cash and due from banks 110,007 83,115
Premises and equipment 135,476 122,605
Other assets 372,405 373,918
Total assets $ 10,549,209 $ 7,922,917
Liabilities
Interest bearing checking $ 1,548,935 0.06 % $ 684 $ 1,278,103 0.07 % $ 685
Money market deposits 2,550,643 0.13 % 2,426 1,764,857 0.18 % 2,330
Savings deposits 739,927 0.06 % 324 579,595 0.08 % 338
Time deposits >$100,000 531,168 0.30 % 1,180 528,589 0.53 % 2,097
Other time deposits 298,112 0.26 % 590 219,031 0.34 % 563
Total interest-bearing deposits 5,668,785 0.12 % 5,204 4,370,175 0.18 % 6,013
Borrowings 81,817 3.53 % 2,160 61,180 2.49 % 1,139
Total interest-bearing liabilities 5,750,602 0.17 % 7,364 4,431,355 0.22 % 7,152
Noninterest bearing checking 3,617,293 2,534,262
Other liabilities 52,130 57,839
Shareholders’ equity 1,129,184 899,461
Total liabilities and
shareholders’ equity $ 10,549,209 $ 7,922,917
Net yield on interest-earning assets and net interest income 3.24 % $ 240,482 3.14 % $ 172,550
Net yield on interest-earning assets and net interest income – tax-equivalent (3) 3.27 % $ 242,540 3.17 % $ 174,086
Interest rate spread 3.17 % 3.05 %
Average prime rate 4.20 % 3.25 %
(1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. Interest earned includes recognized net loan fees, including late fees, prepayment fees, and deferred loan fee amortization (including deferred PPP fees), in the amounts of $2.8 million, and $7.5 million for nine months ended September 30, 2022 and 2021, respectively.
(2) Includes accretion of discount on acquired and SBA loans of $7.2 million and $6.2 million for nine months ended September 30, 2022 and 2021, respectively.
(3) Includes tax-equivalent adjustments of $2.1 million and $1.5 million for nine months ended September 30, 2022 and 2021, respectively, to reflect the tax benefit that we receive related to tax-exempt securities and tax-exempt loans, which carry interest rates lower than similar taxable investments/loans due to their tax exempt status. This amount has been computed assuming a 23% tax rate and is reduced by the related nondeductible portion of interest expense
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Overall, as demonstrated in the table above, net interest income grew $67.9 million for the nine months ended September 30, 2022 from the comparable period of the prior year. Higher earning asset volumes, from both organic growth and the Select acquisition, combined with an expansion in NIM, drove the increase.
• Average loan volumes for the nine months ended September 30, 2022 were $1.5 billion higher than the same period in 2021. Interest rates on loans remained fairly stable between periods as increases in market rates during 2022 were offset by a decline of $5.2 million in PPP loan fee accretion for 2022 as compared to 2021. The combination of factors resulted in an increase in loan interest income of $47.2 million.
• Higher average volume of $1.2 billion on total securities resulted in an increase of $19.7 million in interest income for the nine months ended September 30, 2022 when compared to the same period in 2021. Also contributing to the increase in interest income was the higher yields on the taxable portfolio as reinvestment rates increased between the periods.
• Lower interest rates paid on deposits drove a $0.8 million decrease in deposit interest expense for the nine months ended September 30, 2022 compared to the same period in 2021. Reductions in rates on deposits more than offset the $1.3 billion increase in average volume for total interest-bearing deposits.
• Starting in the third quarter of 2022, short-term borrowings were utilized as needed to fund loan growth and manage fluctuations in deposit balances. In addition, higher market interest rates drove the increase in rates on borrowings, up 104 basis points for nine months ended September 30, 2022 as compared to the prior year period. and resulted in an increase of $1.0 million increase in interest expense for this category.
• The increase in NIM was in large part the result of higher market rates and lower deposit pricing, partially offset by lower PPP loan fee accretion.
Our NIM for all periods benefited from net accretion income, primarily associated with purchase accounting premiums/discounts on loans, deposits and borrowings associated with acquisitions. Presented in the table below is the amount of accretion which increased net interest income in each time period presented.
Three Months Ended September 30, Nine Months Ended September 30,
($ in thousands) 2022 2021 2022 2021
Interest income – increased by accretion of loan discount on acquired loans
$ 1,519 530 4,735 4,195
Interest income - increased by accretion of loan discount on retained SBA loans
1,032 697 2,428 2,004
Total interest income impact 2,551 1,227 7,163 6,199
Interest expense – reduced by premium amortization of deposits
121 8 524 34
Interest expense – increased by discount accretion of borrowings
(64) (45) (190) (133)
Total net interest expense impact 57 (37) 334 (99)
Total impact on net interest income $ 2,608 1,190 7,497 6,100
The increase in loan discount accretion on purchased loans fo r both the three months and the nine months ended September 30, 2022 as compared to the same periods in the prior year is related to the Select acquisition. Generally, the level of loan discount accretion will decline each year due to the natural paydowns in acquired loan portfolios. At September 30, 2022 and 2021, unaccreted loan discount on purchased loans amounted to $12.5 million and $4.8 million, respectively.
In addition to the loan discount accretion recorded on acquired loans, we record accretion on the discounts associated with the retained unguaranteed portions of SBA loans sold in the secondary market. The level of SBA loan discount accretion will vary relative to fluctuations in the SBA loan portfolio. At September 30, 2022 and 2021, unaccreted loan discount on SBA loans amounted to $4.6 million and $6.6 million, respectively.
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Amortization of net deferred loan fees also impacts interest income. During the nine months ended September 30, 2022, we amortized net deferred PPP fees of $2.6 million as interest income compared to $7.8 million for the nine months ended September 30, 2021. At September 30, 2022, there were no remaining deferred PPP origination fees.
Provision for Credit Losses and Provision for Unfunded Commitments
The provisions for credit losses represents our current estimate of life of loan credit losses in the loan portfolio and unfunded loan commitments. Our estimate of credit losses is determined using a complex model that relies on reasonable and supportable forecasts and historical loss information to determine the balance of the ACL and resulting provision for credit losses. The provision for unfunded commitments represents expected losses on unfunded loan commitments that are expected to result in outstanding loan balances. The allowance for unfunded commitments is included in "Other liabilities" in the Consolidated Balance Sheets.
The amount of provision recorded in each period was the amount required such that the total ACL reflected the appropriate balance as determined under CECL. A provision for credit losses of $5.1 million was recorded for the three months ended September 30, 2022 and $8.6 million was recorded for the nine months ended September 30, 2022 based on loan growth during each period, updated economic forecasts impacting loss drivers, and other assumptions and inputs to the CECL model. Also based on the CECL model results and fluctuations in asset quality trends, a reversal provision of $1.4 million was required for the three and nine months ended September 30, 2021.
In addition, a $0.3 million provision for unfunded commitments was recorded for the three months ended September 30, 2022, and a reversal provision of $1.2 million was recorded for the nine months ended September 30, 2022, related primarily to the fluctuations in the levels and mix of outstanding loan commitments. There was a $1.0 million and $3.0 million provision for unfunded commitments for the three and nine months ended September 30, 2021, respectively.
Additional discussion of our asset quality and credit metrics, which impact our provision for credit losses, is provided in the "Nonperforming Assets" and "Allowance for Credit Losses and Loan Loss Experience" sections following.
Noninterest Income
Our noninterest income amounted to $16.9 million and $16.5 million for the three months ended September 30, 2022 and 2021, respectively, and $53.4 million and $58.6 million for the nine months ended September 30, 2022 and 2021, respectively. Included in noninterest income was nonrecurring amounts totaling $2.7 million and $50,000 in other gains for the three months ended September 30, 2022 and 2021, respectively, and $6.0 million and $1.5 million in other gains for the nine months ended September 30, 2022 and 2021, respectively.
The following table presents the primary components of noninterest income.
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
($ in thousands) 2022 2021 2022 2021
Service charges on deposit accounts
$ 4,166 3,209 11,407 8,766
Other service charges and fees - bankcard interchange income, net 3,009 4,405 12,532 12,338
Other service charges and fees - other 3,303 2,059 8,668 6,144
Fees from presold mortgage loans
376 2,096 1,951 8,914
Commissions from sales of insurance and financial products
1,391 1,198 3,487 5,854
SBA consulting fees
479 1,128 1,963 6,079
SBA loan sale gains
479 1,655 4,581 6,981
Bank-owned life insurance ("BOLI") income 962 711 2,880 1,945
Other gains, net 2,747 50 5,958 1,533
Noninterest income $ 16,912 16,511 53,427 58,554
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Service charges on deposit accounts increased $1.0 million, or 29.8%, for the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, and increased $2.6 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The increase was driven by the higher number of new customers and transaction accounts generating fees from both organic growth and the Select acquisition.
Other service charges and fees - bankcard interchange income, net represents interchange income from debit and credit card transactions, net of associated interchange expense, and decreased $1.4 million, or 31.7%, for the three months ended September 30, 2022 as compared to the prior year period, and increased $0.2 million for the nine months ended September 30, 2022 compared to the prior year period. The decrease is a result of the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 limitation on debit card interchange fees. Because the Company exceeded $10 billion in total assets at December 31, 2021, the interchange fee limitation became effective for us July 1, 2022. Higher volumes of accounts and transactions have partially offset the rate limitation.
Other service charges and fees - other includes items such as SBA guarantee servicing fees and related servicing rights amortization, ATM charges, wire transfer fees, safety deposit box rentals, fees from sales of personalized checks, and check cashing fees. The increase in this line item for the three months ended September 30, 2022 compared to the three months ended September 30, 2021 of $1.2 million, or 60.4%, and the increase of $2.5 million for the nine months ended September 30, 2022 compared to the prior year period, was primar ily due to growth in the number of accounts and related transaction activity, as well as the Bank's deposit base increases.
Fees from presold mortgage loans amounted to $0.4 million for the three months ended September 30, 2022, a decline of $1.7 million, or 82.1%, from the same time period in 2021, and a $7.0 million decrease for the nine months ended September 30, 2022 compared to the prior year period. The decrease was due to the general increase in market interest rates and related decline in home mortgage refinancings and new originations during 2022 as compared to the prior year.
Commissions from sales of insurance and financial products for the three months ended September 30, 2022 increased $0.2 million from the same period in 2021. There was a decrease of $2.4 million for the nine months ended September 30, 2022 compared to the prior year period which was directly related to the sale of the majority of the assets of our property and casualty insurance subsidiary in June 2021.
SBA consulting fees decreased for the three months ended September 30, 2022, compared to the same period in 2021 by $0.6 million, or 57.5%, and decreased $4.1 million for the nine months ended September 30, 2022 compared to the prior year period. The declines in fees were directly related to the wind-down of the PPP loan program and lower related revenues earned in the current year periods.
SBA loan sale gains decreased $1.2 million, or 71.1%, for the three months ended September 30, 2022 compared to the three months ended September 30, 2021 and declined $2.4 million for the nine months ended September 30, 2022 compared to the prior year period. The lower gains were related to the timing of sales and the volume of originated loans available to be sold in each period.
Other gains, net for the third quarter of 2022 consisted primarily of a settlement of a prior year cash letter processing differences. Also included in other gains for the nine months ended September 30, 2022 were death benefits realized on BOLI policies. Other gains for the nine months ended September 20, 2021 are primarily related to the sale of the the majority of the assets of our property and casualty insurance subsidiary in June 2021.
Noninterest Expenses
Noninterest expenses totaled $48.7 million and $40.8 million for the three months ended September 30, 2022 and 2021, respectively, and $149.6 million and $121.9 million for the nine months ended September 30, 2022 and 2021, respectively. Included in noninterest expense was nonrecurring merger and acquisition costs totaling $0.5 million and $0.3 million for the three months ended September 30, 2022 and 2021, respectively. Merger and acquisition costs totaled $4.8 million and $0.7 million for the nine months ended September 30, 2022 and 2021, respectively.
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The following table presents the primary components of noninterest expense.
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
($ in thousands) 2022 2021 2022 2021
Salaries $ 24,416 20,651 71,669 61,969
Employee benefits 4,156 4,447 16,044 13,105
Total personnel expense 28,572 25,098 87,713 75,074
Occupancy expense 3,175 2,618 9,681 8,190
Equipment related expenses 1,672 1,125 4,490 3,223
Merger and acquisition expenses 548 254 4,769 665
Amortization of intangible assets 889 695 2,859 2,437
Credit card rewards and other bankcard expenses 805 1,161 3,018 3,353
Telephone and data lines 929 736 2,719 2,226
Software costs 1,590 1,238 4,452 3,947
Data processing expense 1,790 1,440 5,811 4,139
Professional fees 1,117 952 3,295 2,052
Advertising and marketing expense 856 742 2,651 1,972
Non-credit losses 828 321 1,918 782
Deposit related expenses 604 383 1,271 1,145
Foreclosed property losses (gains), net — 23 (372) 7
Other operating expenses 5,325 4,031 15,288 12,655
Total $ 48,700 $ 40,817 $ 149,563 $ 121,867
In general, the increase in noninterest expenses was driven by higher operating expenses from personnel, locations, number of accounts, and higher level of activity resulting from the Select acquisition completed in the fourth quarter of 2021. Merger and acquisition expenses amounted to $4.8 million for the nine months ended September 30, 2022 and primarily related to March 2022 core system conversion costs incurred for the Select acquisition.
Total personnel expense increased $3.5 million, or 13.8%, for the three months ended September 30, 2022 as compared to the three months ended September 30, 2021. Total personnel expense increased $12.6 million for the nine months ended September 30, 2022 compared to the prior year period. The increase for each period was a direct result of the incremental number of associates from the Select acquisition, combined with regular annual salary increases. Also contributing to the increases were higher insurance claims and costs in 2022 compared to the prior year.
Income Taxes
We recorded income tax expense of $10.2 million for the three months ended September 30, 2022 and $7.0 million for the three months ended September 30, 2021. Our effective tax rates increased to 21.2% from 20.1% for the three months ended September 30, 2022 and 2021, respectively. The increase in effective tax rate between quarterly periods was attributable to the utilization of additional federal disaster credits in the third quarter of 2021.
For the nine months ended September 30, 2022 and 2021, we recorded income tax expense of $28.4 million and $22.5 million, respectively. Our effective tax rates remained stable at 20.8% for the nine months ended September 30, 2022 compared to 20.9% for the comparable period of the prior year.
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FINANCIAL CONDITION
Total assets at September 30, 2022 amounted to $10.5 billion, a nominal increase from December 31, 2021 as growth in loans was funded by existing cash and investments shifting the balance sheet mix somewhat. Total loans at September 30, 2022 amounted to $6.5 billion, a 7.3% increase from December 31, 2021, and total deposits amounted to $9.2 billion, a 1.1% increase from December 31, 2021.
For the nine months ended September 30, 2022, the net increase in loans was $443.6 million, or 7.3%, related primarily to core growth and loans amounted to 62.1% of total assets as compared to 57.9% of total assets at December 31, 2021 . We experienced organic growth in most of our loan categories, with commercial real estate, 1-4 family first mortgages, and construction categories experiencing the largest growth. The mix of our loan portfolio remained substantially the same at September 30, 2022 compared to December 31, 2021. The majority of our real estate loans were personal and commercial loans where real estate provides additional security for the loan. Note 4 to the consolidated financial statements presents additional detailed information regarding our mix of loans.
The composition of our investment portfolio remained substantially the same as at December 31, 2021, and continues to reflect our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Total investment securities decreased $261.8 million from December 31, 2021 to total $2.9 billion at September 30, 2022. as cash flows were utilized to fund loan growth. Also contributing to the decline was the increase in unrealized losses on available for sale securities which totaled $464.6 million at September 30, 2022. Note 3 to the consolidated financial statements presents additional detailed information regarding our mix of investments and the unrealized losses for each category.
We invest primarily in securities issued by GSEs including FHLMC, FNMA, GNMA, and SBA, each of which guarantees the repayment of the securities. Nearly all of our mortgage-backed securities are issued by GSEs and are traded in liquid secondary markets. The state and local government investments are comprised almost entirely of highly-rated municipal bonds issued by state and local governments throughout the nation. We have no significant concentration of bond holdings from one state or local government entity. We have evaluated the unrealized losses on individual securities at September 30, 2022 and determined them to be of a temporary nature due primarily to interest rate factors and not credit quality concerns. In arriving at this conclusion, we reviewed third-party credit ratings and considered the severity of the impairment.
For the nine months ended September 30, 2022, we continued to experience growth in our deposit base, with total deposits increasing by $104.6 million, or 1.1%, from December 31, 2021. Deposit growth was primarily in transaction accounts (checking and money market products), which we believe to be related to our ongoing deposit growth initiatives, as well as the build up in liquidity during the pandemic. While deposits have continued to grow for the year to date period, the third quarter of 2022 realized a decline in total deposits of $130.5 million as market rates for deposits have become more competitive and customer behaviors may be shifting from activity experienced during the COVID-19 pandemic.
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Nonperforming Assets
Nonperforming assets include nonaccrual loans, TDRs, loans past due 90 or more days and still accruing interest, and foreclosed real estate. Nonperforming assets are summarized as follows:
$ in thousands
September 30, 2022 December 31, 2021
Nonperforming assets
Nonaccrual loans $ 28,669 34,696
TDRs – accruing 11,355 13,866
Accruing loans >90 days past due — 1,004
Total nonperforming loans 40,024 49,566
Foreclosed real estate 658 3,071
Total nonperforming assets $ 40,682 52,637
Asset Quality Ratios
Nonaccrual loans to total loans 0.44 % 0.57 %
Nonperforming loans to total loans 0.61 % 0.82 %
Nonperforming assets to total loans and foreclosed properties 0.62 % 0.87 %
Nonperforming assets to total assets 0.39 % 0.50 %
Allowance for credit losses to nonaccrual loans 302.02 % 227.08 %
Allowance for credit losses to nonperforming loans 216.34 % 158.96 %
As shown in the table above, nonperforming assets decreased from December 31, 2021 to September 30, 2022, with improvements noted in all categories. At September 30, 2022, total nonaccrual loans amounted to $28.7 million, compared to $34.7 million at December 31, 2021 . "Real estate-mortgage-comm ercial and other" is the largest category of nonaccrual loans, at $11.5 million, or 40.1%, of total nonaccrual loans, followed by "Commercial, financial, and agricultural" at $11.4 million, or 39.6%, of total nonaccrual loans. Included in those categories are nonaccrual SBA loans totaling $15.6 million at September 30, 2022, or 54.4%, of total nonaccrual loans, that have $5.8 million in guarantees from the SBA.
TDRs are accruing loans for which we have granted concessions to the borrower as a result of the borrower’s financial difficulties. At September 30, 2022, total accruing TDRs amounted to $11.4 million, compared to $13.9 million at December 31, 2021, with the decrease being attributed to several large commercial TDR pay-offs or charge-offs during the period which more than offset the new TDRs added during the year to date period.
As reflected in Note 4 to the accompanying consolidated financial statements, total classified loans declined 9.4% to $50.7 million at September 30, 2022 compared to $56.0 million at December 31, 2021. Special mention loans decreased 23.3% from $43.1 million at December 31, 2021 to $33.1 million at September 30, 2022. The majority of the improvements were in the commercial real estate and 1-4 family mortgage categories.
Total foreclosed real estate amounted to $0.7 million at September 30, 2022 and $3.1 million at December 31, 2021. Our foreclosed property balances have generally been decreasing as a result of sales activity during the periods and favorable overall asset quality. During the nine months ended September 30, 2022, we recorded sales of six foreclosed properties partially offset by the addition of one foreclosed property. We believe that the fair values of foreclosed real estate, less estimated costs to sell, equal or exceed their respective carrying values at the dates presented.
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Allowance for Credit Losses and Loan Loss Experience
Our ACL is based on the total amount of loan losses that are expected over the remaining life of the loan portfolio. Our estimate of credit losses on loans is determined using a complex model that relies on reasonable and supportable forecasts and historical loss information to determine the balance of the ACL and resulting provision for credit losses. The ACL is measured on a collective pool basis when similar risk characteristics exist based primarily on discounted cash flows computed for each loan in a pool based on its individual characteristics. When we determine that foreclosure is probable or when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. We have reviewed the collateral for our nonperforming assets, including nonaccrual loans, and have included this review among the factors considered in the evaluation of the ACL.
We have no foreign loans and few agricultural loans, and do not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of our real estate loans are primarily personal and commercial loans where real estate provides additional security for the loan. Collateral for virtually all of these loans is located within our principal market area.
For the nine months ended September 30, 2022 and 2021, we recorded a provision for credit losses of $8.6 million and a reversal of provision for credit losses totaling $1.4 million, respectively. The increase in provision for 2022 as compared to the prior year period was primarily due to growth in the loan portfolio which accounted for approximately half of the higher provision in 2022. Also contributing to the increase was the economic forecast inputs to our CECL model driving higher loss rate assumptions, primarily due to higher unemployment forecasts and deteriorating Commercial Real Estate Index forecasts given the developing uncertain economic environment.
For the periods indicated, the following table summarizes our balances of loans outstanding, average loans outstanding, ACL, charge-offs and recoveries, and key ratios .
Loan Ratios, Loss and Recovery Experience
($ in thousands) Nine Months Ended September 30, 2022 Twelve Months
Ended December 31,
2021 Nine Months Ended September 30, 2021
Loans outstanding at end of period $ 6,525,286 6,081,715 4,869,841
Average amount of loans outstanding 6,197,915 5,018,391 4,728,258
Allowance for credit losses, at period end 86,587 78,789 63,628
Total charge-offs (4,008) (7,602) (5,553)
Total recoveries 3,206 4,922 3,618
Net charge-offs $ (802) (2,680) (1,935)
Ratios:
Net charge-offs as a percent of average loans (annualized) 0.02 % 0.05 % 0.05 %
Allowance for credit losses as a percent of loans at end of period 1.33 % 1.30 % 1.31 %
Recoveries of loans previously charged-off as a percent of loans charged-off 79.99 % 64.75 % 65.15 %
Allowance for Unfunded Commitments
In addition to the ACL on loans, we maintain an allowance for lending-related commitments such as unfunded loan commitments. We estimate expected credit losses associated with these commitments over the contractual period in which we are exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable. The allowance for lending-related commitments on off-balance sheet credit exposures is adjusted as a provision for unfunded commitments expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life.
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For the nine months ended September 30, 2022, we recorded a reversal of the provision for unfunded commitments of $1.2 million related to fluctuations in the levels and mix of outstanding loans commitments. For the comparable period of 2021, a $3.0 million provision for unfunded commitments was required related to higher levels of unfunded commitments for the period. The allowance for unfunded commitments of $12.3 million and $13.5 million at September 30, 2022 and December 31, 2021, respectively, is classified on the balance sheet within "Other liabilities".
We believe the ACL is adequate at each period end presented. It must be emphasized, however, that the determination of the allowances using our procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that we will not in any particular period sustain loan losses that are sizable in relation to the amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the ACL or future charges to earnings. See “Critical Accounting Policies – Allowance for Credit Losses on Loans and Unfunded Commitments” in Note 1 to the 2021 Annual Report on Form 10-K filed with the SEC for more information.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review our ACL and value of other real estate. Such agencies may require us to recognize adjustments to the allowance or the carrying value of other real estate based on their judgments about information available at the time of their examinations.
Liquidity, Commitments, and Contingencies
Our liquidity is determined by our ability to convert assets to cash or acquire alternative sources of funds to meet the needs of our customers who are withdrawing or borrowing funds, and to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. Our primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. Our securities portfolio is comprised almost entirely of readily marketable securities, which could also be sold to provide cash. Since the beginning of the COVID-19 pandemic in early 2020, we have seen our liquidity levels increase, with increases in deposits account balances leading to higher cash and investment securities levels.
In addition to internally generated liquidity sources, we have the ability to obtain borrowings under: 1) an approximately $857 million line of credit with the FHLB (of which $160.9 million and $2.0 million were outstanding at September 30, 2022 and December 31, 2021, respectively); 2) federal funds lines with several correspondent banks totaling $265 million (of which none was outstanding at September 30, 2022 or December 31, 2021); and 3) an approximately $161 million line of credit through the Federal Reserve's discount window (of which none was outstanding at September 30, 2022 or December 31, 2021). Unused and available lines of credit amounted to $1.1 billion at September 30, 2022.
Our overall liquidity is essentially the same as at December 31, 2021 with our liquid assets (cash and unpledged securities) as a percentage of our unpledged deposits and borrowings at 26.7% at September 30, 2022. We believe our liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet our operating needs in the foreseeable future.
The amount and timing of our contractual obligations and commercial commitments have not changed materially since December 31, 2021, the detail of w hich is presented in the Contractual Obligations and Other Commercial Commitments table of our 2021 Annual Report on Form 10-K. In addition, we are not involved in any legal proceedings that, in our opinion, could have a material effect on our consolidated financial position.
Off-Balance Sheet Arrangements and Derivative Financial Instruments
Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements pursuant to which we have obligations or provide guarantees on behalf of an unconsolidated entity. We have no off-balance sheet arrangements of this kind other than letters of credit and repayment guarantees associated with our trust preferred securities.
Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in significant derivative activities through September 30, 2022, and have no current plans to do so.
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Capital Resources
The Company is regulated by the Federal Reserve and is subject to the securities registration and public reporting regulations of the SEC. Our banking subsidiary, First Bank, is also regulated by the Federal Reserve and the North Carolina Office of the Commissioner of Banks. We must comply with regulatory capital requirements established by the Federal Reserve. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on our financial statements. We are not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on our liquidity, capital resources, or operations.
Under Basel III standards and capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The capital standards require us to maintain minimum ratios of “Common Equity Tier 1” capital to total risk-weighted assets, “Tier 1” capital to total risk-weighted assets, and total capital to risk-weighted assets of 4.50%, 6.00% and 8.00%, respectively. Common Equity Tier 1 capital is comprised of common stock and related surplus, plus retained earnings, and is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities. Tier 1 capital is comprised of Common Equity Tier 1 capital plus Additional Tier 1 Capital, which includes non-cumulative perpetual preferred stock and trust preferred securities. Total capital is comprised of Tier 1 capital plus certain adjustments, the largest of which is o ur ACL. Risk-weighted assets refer to our on- and off-balance sheet exposures, adjusted for their related risk levels using formulas set forth in Federal Reserve regulations.
In addition to the risk-based capital requirements described above, we are subject to a leverage capital requirement, which calls for a minimum ratio of Tier 1 capital (as defined above) to quarterly average total assets of 3.00% to 5.00%, depending upon the institution’s composite ratings as determined by its regulators. The Federal Reserve has not advised us of any requirement specifically applicabl e to us .
At September 30, 2022, our capital ratios exceeded the regulatory minimum ratios discussed above. The following table presents the capital ratios for the Company and the regulatory minimums discussed above for the periods indicated.
September 30, 2022 December 31, 2021
Risk-based capital ratios:
Common equity Tier 1 to Tier 1 risk weighted assets 12.76 % 12.53 %
Minimum required Common Equity Tier 1 capital 7.00 % 7.00 %
Tier I capital to Tier 1 risk weighted assets 13.59 % 13.42 %
Minimum required Tier 1 capital 8.50 % 8.50 %
Total risk-based capital to Tier II risk weighted assets 14.84 % 14.67 %
Minimum required total risk-based capital 10.50 % 10.50 %
Leverage capital ratio:
Tier 1 capital to quarterly average total assets 10.21 % 9.39 %
Minimum required Tier 1 leverage capital 4.00 % 4.00 %
First Bank is also subject to capital requirements that do not vary materially from the Company’s capital ratios presented above. At September 30, 2022, First Bank exceeded the minimum ratios established by the regulatory authorities.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.