Item 2. Management’s Discussion and Analysis
Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition
Recent Developments and Acquisitions
On January 1, 2023, we acquired GrandSouth, a community bank headquartered in Greenville, South Carolina, in an all-stock transaction. The terms of the merger agreement provided that each share of common and preferred stock of GrandSouth issued and outstanding immediately prior to the effective time of the acquisition was converted into 0.91 shares of the Company's common stock. As a result, the Company issued 5,032,834 shares of the Company common stock effective January 1, 2023. In addition, GrandSouth common stock options outstanding at the merger effective time were converted to options to acquire 0.91 shares of the Company's common stock resulting in 542,345 options with an average exercise price of approximately $20.14.
The GrandSouth acquisition contributed $1.02 billion in loans and $1.05 billion in deposits, with eight branches in South Carolina being added to the Company's branch network. The acquisition accomplished the Company's strategic initiative to expand its presence in South Carolina, specifically in the the high-growth markets of the state including Greenville, Charleston and Columbia.
Overview and Highlights at and for Three Months Ended March 31, 2023
We earned net income of $15.2 million, or $0.37 diluted EPS, during the three months ended March 31, 2023 compared to net income of $34.0 million, or $0.95 diluted EPS, for the three months ended March 31, 2022.
As noted above, we acquired GrandSouth on January 1, 2023 which has significantly impacted comparison for the financial periods presented. The primary driver of the reduced earnings for the first quarter of 2023 as compared to the same period last year was the charges associated with the Company's acquisition of GrandSouth, including merger expenses totaling $12.2 million and a one-time loan loss provision of $12.2 million to establish an initial allowance for credit losses for acquired loans in accordance with our CECL model.
Highlights of the results for the quarter are presented below (refer also to additional discussion in the "Results of Operations" and "Financial Condition" sections following).
• Net interest income for the first quarter of 2023 was $92.5 million, a 20.3% increase from the $76.9 million recorded in the first quarter of 2022. The increase in net interest income from the prior year period was driven by higher earning assets related to both the GrandSouth acquisition and organic growth.
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• Net interest margin ("NIM") on a tax-equivalent basis increased in the first quarter of 2023 to 3.31% from 3.21% for the first quarter of 2022 related to the increase in market interest rates driving higher yields on loans and increased loan accretion, which offset higher cost of funds.
• For the three months ended March 31, 2023, the Company recorded $11.5 million in provision for credit losses. This is compared to a provision of $3.5 million for the first quarter of 2022. The amount recorded for the current quarter was directly related to a one-time provision of $12.2 million for non-credit deteriorated loans acquired from GrandSouth, partially offset by fluctuations in our CECL model calculation for loan balance changes and updated economic forecasts during the first quarter of 2023.
• Noninterest income for the three months ended March 31, 2023 decreased $5.7 million, or 29.7%, from the comparable period of 2022 primarily related to lower SBA and mortgage loan sale gains, and lower other gains for 2022 BOLI death benefits.
• Noninterest expense increased $22.7 million, or 44.1%, for the quarter ended March 31, 2023, as compared to the prior year period driven by merger and acquisition costs of $12.2 million, higher intangible amortization, and higher operating expenses in general resulting from the GrandSouth acquisition.
• Total assets at March 31, 2023 amounted to $12.4 billion, a 16.4% increase from December 31, 2022, driven primarily by the acquisition of GrandSouth.
• Total loans amounted to $7.8 billion at March 31, 2023, with acquired balances contributing $1.02 billion and organic growth of $113.7 million, for an annualized growth rate (exclusive of acquired loans) of 5.9% from December 31, 2022.
• Total deposits amounted to $10.4 billion at March 31, 2023, an increase of $1.1 billion from December 31, 2022. Acquired deposits contributed $1.05 billion while organic growth totaled $95.2 million for the quarter, an annualized organic growth rate (exclusive of acquired deposits) of 3.7%.
• Credit quality continued to be strong at March 31, 2023, with decreases in NPAs for the fifth straight quarter. The NPA to total assets ratio declined to 0.25% as of March 31, 2023 from 0.46% for the comparable period of 2022.
• Our liquidity ratio increased to 26.2% at March 31, 2023 and was in excess of 30% when including available off-balance sheet sources.
• We remain well-capitalized by all regulatory standards with a total common equity Tier 1 ratio of 12.53% and total risk-based capital ratio of 14.88%.
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.
The following should be read in conjunction with our significant accounting policies are presented in Note 1 of the 2022 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”).
Allowance for Credit Losses on Loans and Unfunded Commitments
The ACL 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
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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 the 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.
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. For example, inflationary pressures and recessionary concerns leading to macroeconomic deterioration of the economy, higher unemployment and declines in real estate and other asset valuations could affect our loss experience and assumptions utilized in our model.
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 forecasts.
Additional information on the loan portfolio and ACL can be found in the “Nonperforming Assets” and “Allowance for Credit Losses and Loan Loss Experience” sections below.
Business Combinations and Goodwill
We believe that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. Pursuant to applicable accounting guidance, we recognize assets acquired, including identified intangible assets, and the liabilities assumed in acquisitions at their fair values as of the acquisition date, with the related transaction costs expensed in the period incurred. Specified items such as acquired operating lease assets and liabilities as lessee, employee benefit plans, and income-tax related balances are recognized in accordance with accounting guidance that results in measurements that may differ from fair value. Determining the fair value of assets acquired and liabilities assumed often involves estimates based on internal or third-party valuations which include appraisals, discounted cash flow analysis, or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, discount rates, credit risk, multiples of earnings, or other relevant factors. The determination of fair value may require us to make point-in-time estimates about discount rates, future expected cash flows, market conditions, and other future events that can be volatile in nature and challenging to assess. While we use the best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, the estimates are inherently uncertain and subject to refinement.
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 represents 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
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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.
The ACL for PCD assets is recognized within business combination accounting with no initial impact to net income. Changes in estimates of expected credit losses on PCD loans after acquisition are recognized as provision expense (or reversal of provision expense) in subsequent periods as they arise. The ACL for non-PCD assets is recognized as provision expense in the same reporting period as the business combination. Estimated loan losses for acquired loans are determined using methodologies and applying estimates and assumptions that were described previously in the "Allowance for Credit Losses on Loans" foregoing section.
Non-PCD loans acquired are generally estimated at fair value using a discounted cash flow approach with assumptions of discount rate, remaining life, prepayments, probability of default, and loss given default. The actual cash flows on these loans could differ materially from the fair value estimates. The amount we record as the fair values for the loans is generally less than the contractual unpaid principal balance due from the borrowers, with the difference being referred to as the “discount” on the acquired loans. Discounts on acquired non-PCD loans are accreted to interest income over their estimated remaining lives, which may include prepayment estimates in certain circumstances.
Similarly, premiums or discounts on acquired debt are accreted or amortized to interest expense over their remaining lives. Actual accretion or amortization of premiums and discounts from a business acquisition may differ materially from our estimates impacting our operating results.
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 three months ended March 31, 2023 , there were no triggers warranting interim impairment assessments and for the 2022 annual assessment, we concluded that it was more likely than not that the fair value exceeded its carrying value.
Current Accounting Matters
See Note 1 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 March 31, 2023 amounted to $92.5 million, an increase of $15.6 million, or 20.3%, from the $76.9 million recorded in the first quarter of 2022. The increase was primarily driven by higher average earning assets from both the GrandSouth acquisition and organic growth.
Also contributing to the higher net interest income was the increase in our NIM which, on tax-equivalent basis, increased from 3.21% for the first quarter of 2022 to 3.31% for the three months ended March 31, 2023. For
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internal purposes, we evaluate our NIM on a tax-equivalent basis by adding the tax benefit realized from tax-exempt loans and securities to reported interest income then dividing by total average earning assets. We believe that analysis of NIM on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest income in different periods without taking into account the different mix of taxable versus non-taxable loans and investments that may have existed during those periods. The following is a reconciliation of reported net interest income to tax-equivalent net interest income and the resulting NIM as reported and on a tax-equivalent basis.
($ in thousands) Three Months Ended March 31,
2023 2022
Net interest income, as reported $ 92,486 76,878
Tax-equivalent adjustment 700 697
Net interest income, tax-equivalent $ 93,186 77,575
Net interest margin, as reported 3.28 % 3.18 %
Net interest margin, tax-equivalent 3.31 % 3.21 %
Overall, as demonstrated in the table below, higher earning asset volumes, arising from both organic growth and the GrandSouth acquisition, combined with an expansion in NIM, drove the increase in net interest income.
• Market interest rates increased 450 basis points between March 2022 and March 2023 to result in an average prime rate of 7.69% for three months ended March 31, 2023 compared to 3.29% for the prior year period.
• Average loan volumes for the three months ended March 31, 2023 were $1.7 billion higher than the same period in 2022. In addition to higher volumes arising from both the GrandSouth acquisition and organic growth, interest rates on loans increased 92 basis points to 5.22% for the first quarter of 2023, resulting in an increase in loan interest income of $35.2 million.
• Primarily due to higher market rates and increased average balances related in large part to the GrandSouth acquisition, deposit interest expense for the three months ended March 31, 2023 increased $17.1 million compared to the same period in 2022. Average interest-bearing deposit balances increased $643.2 million while rates on those deposits increased 107 basis points as compared to the same period in the prior year.
• The combination of higher rates on borrowings, up 257 basis points in the first quarter of 2023 from the first quarter of 2022 due to increasing market rates, and the increase in volume of borrowings between periods drove the $5.3 million increase in interest expense for this category. Average borrowings increased $371.2 million in the first quarter of 2023 due in large part to the higher levels of short-term borrowings utilized as needed to fund loan growth and manage fluctuations in deposit balances.
• The increase in NIM was directly related to higher loan yields from market rate increases and improved pricing on new loans, combined with increased loan discount accretion which offset the higher cost of funds between the comparative periods.
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The following table presents an analysis of net interest income for the three months ended March 31, 2023 and 2022:
Average Balances and Net Interest Income Analysis
For the Three Months Ended March 31,
2023 2022
($ in thousands) Average
Volume Average
Rate Interest
Earned
or Paid Average
Volume Average
Rate Interest
Earned
or Paid
Assets
Loans (1) (2) $ 7,728,425 5.22 % $ 99,380 $ 6,051,487 4.30 % $ 64,202
Taxable securities 3,022,398 1.80 % 13,416 2,995,377 1.79 % 13,210
Non-taxable securities 298,842 1.53 % 1,130 288,468 1.47 % 1,048
Short-term investments, primarily interest-bearing cash 379,124 3.47 % 3,248 478,861 0.55 % 649
Total interest-earning assets 11,428,789 4.16 % 117,174 9,814,193 3.27 % 79,109
Cash and due from banks 95,041 115,748
Premises and equipment 151,211 135,990
Other assets 367,257 498,488
Total assets $ 12,042,298 $ 10,564,419
Liabilities
Interest-bearing checking $ 1,526,650 0.23 % $ 866 $ 1,576,323 0.06 % $ 224
Money market deposits 2,974,478 1.47 % 10,814 2,606,133 0.13 % 853
Savings deposits 728,918 0.07 % 129 721,911 0.06 % 108
Other time deposits 884,668 2.55 % 5,553 545,309 0.18 % 245
Time deposits >$250,000 313,377 2.01 % 1,556 335,240 0.41 % 341
Total interest-bearing deposits 6,428,091 1.19 % 18,918 5,784,916 0.12 % 1,771
Borrowings 438,556 5.34 % 5,770 67,381 2.77 % 460
Total interest-bearing liabilities 6,866,647 1.46 % 24,688 5,852,297 0.15 % 2,231
Noninterest-bearing checking 3,788,817 3,435,437
Other liabilities 113,399 66,563
Shareholders’ equity 1,273,435 1,210,122
Total liabilities and
shareholders’ equity $ 12,042,298 $ 10,564,419
Net yield on interest-earning assets and net interest income 3.28 % $ 92,486 3.18 % $ 76,878
Net yield on interest-earning assets and net interest income – tax-equivalent (3) 3.31 % $ 93,186 3.21 % $ 77,575
Interest rate spread 2.70 % 3.17 %
Average prime rate 7.69 % 3.29 %
(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 in the amounts of $0.4 million, and $1.4 million for three months ended March 31, 2023 and 2022, respectively.
(2) Includes accretion of discount on acquired and SBA loans of $3.6 million and $2.3 million for three months ended March 31, 2023 and 2022, respectively.
(3) Includes tax-equivalent adjustments of $0.7 million and $0.7 million for three months ended March 31, 2023 and 2022, respectively, to reflect the tax benefit that we receive related to tax-exempt securities and tax-exempt loans, which carry interest rates lower than similar taxable investments/loans due to their tax-exempt status. This amount has been computed assuming a 23% tax rate and is reduced by the related nondeductible portion of interest expense.
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Our NIM for all periods benefited from net accretion income, primarily associated with purchase accounting discounts on loans, and premiums/discounts on deposits and borrowings associated with acquisitions. Presented in the table below is the amount of purchase accounting adjustments which impacted net interest income in each time period presented.
Three Months Ended March 31,
($ in thousands) 2023 2022
Interest income – increased by accretion of loan discount on acquired loans
$ 3,118 1,671
Interest income - increased by accretion of loan discount on retained SBA loans
448 667
Total interest income impact 3,566 2,338
Interest expense – (increased) reduced by (discount accretion) premium amortization of acquired deposits (1,019) 234
Interest expense – increased by discount accretion of acquired borrowings (82) (73)
Total net interest expense impact (1,101) 161
Total impact on net interest income $ 2,465 2,499
The increase in loan discount accretion on acquired loans fo r the three months ended March 31, 2023 as compared to the same period in the prior year was related to the GrandSouth acquisition which added $23.9 million in accretable discount. Generally, the level of loan discount accretion will decline each year due to the natural paydowns in acquired loan portfolios. At March 31, 2023 and 2022, unaccreted loan discount on purchased loans amounted to $32.4 million and $15.6 million, respectively.
In addition to the loan discount accretion recorded on acquired loans, we recorded 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 March 31, 2023 and 2022, the unaccreted loan discount on SBA loans amounted to $4.0 million and $6.0 million, respectively.
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. Effective January 1, 2023, a one-time loan loss provision of $12.2 million was recorded to establish an initial ACL for non-PCD loans acquired from GrandSouth in accordance with our CECL model. This was the primary contributor to the provision for the three months ended March 31, 2023 which totaled $11.5 million, with the difference related to reversals during the quarter resulting from updated economic forecast inputs driving lower loss rate assumptions, primarily due to slightly improved unemployment and GDP forecasts for the first quarter of 2023. This is compared to a total provision of $3.5 million for the three months ended March 31, 2022 based on the CECL model related to loan growth for that period and changes in economic forecasts in the model.
In addition, a $1.1 million provision for unfunded commitments was recorded for the three months ended March 31, 2023, related primarily to the initial reserve for unfunded commitments of $1.9 million required for the GrandSouth acquisition. There was a $1.5 million reversal of provision for unfunded commitments for the three months ended March 31, 2022 related primarily to fluctuations in commitment levels.
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.
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Noninterest Income
Our noninterest income amounted to $13.5 million and $19.3 million for the three months ended March 31, 2023 and 2022, respectively. Included in noninterest income were nonrecurring amounts totaling $0.2 million and $1.6 million in other gains for the three months ended March 31, 2023 and 2022, respectively.
The following table presents the primary components of noninterest income. The drivers of larger fluctuations between periods are discussed below the table.
For the Three Months Ended March 31,
($ in thousands) 2023 2022
Service charges on deposit accounts
$ 3,894 3,541
Other service charges and fees - bankcard interchange income, net 2,582 4,711
Other service charges and fees - other 3,338 2,294
Fees from presold mortgage loans
406 1,121
Commissions from sales of financial products 1,306 945
SBA consulting fees
521 780
SBA loan sale gains
255 3,261
Bank-owned life insurance ("BOLI") income 1,046 976
Other gains, net 188 1,622
Noninterest income $ 13,536 19,251
Service charges on deposit accounts increased $0.4 million, or 10.0%, for the three months ended March 31, 2023 as compared to the three months ended March 31, 2022. The increase was driven by the higher number of new customers and transaction accounts generating fees from both organic growth and the GrandSouth acquisition. Partially offsetting the growth as compared to the prior year period was lower NSF charges as the Company discontinued charging consumers for this service effective February 1, 2023.
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 $2.1 million, or 45.2%, for the three months ended March 31, 2023 as compared to the prior year period. The decrease is a result of the Durbin Amendment limitation on debit card interchange fees becoming applicable to the Company in mid-2022.
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 March 31, 2023 compared to the three months ended March 31, 2022 of $1.0 million, or 45.5%, was primar ily due to the GrandSouth acquisition and the resulting growth in the number of accounts and related transaction activity, as well as increases in the Bank's organic deposit base.
Fees from presold mortgage loans amounted to $0.4 million for the three months ended March 31, 2023, a decline of $0.7 million, or 63.8%, from the same time period in 2022. The decrease was due to the general increase in market interest rates starting in 2022 which have resulted in continued lower volumes of home mortgage refinancings and new originations into 2023.
SBA loan sale gains decreased $3.0 million, or 92.2%, for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The decrease was related to slower loan originations and the lower premiums available on SBA loan sales given the current market interest rates, resulting in the Company retaining a higher percentage of originations in the first quarter of 2023.
Other gains, net for the first quarter of 2022 consisted primarily of death benefits realized on BOLI policies and the execution of loans held for sale during the quarter. There were no large or unusual transactions in the first quarter of 2023 giving rise to gains or losses.
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Noninterest Expenses
Noninterest expenses totaled $74.2 million and $51.5 million for the three months ended March 31, 2023 and 2022, respectively. Included in noninterest expenses were nonrecurring merger and acquisition costs totaling $12.2 million and $3.5 million for the three months ended March 31, 2023 and 2022, respectively. The following table presents the primary components of noninterest expenses:
For the Three Months Ended March 31,
($ in thousands) 2023 2022
Salaries $ 29,321 23,454
Employee benefits 6,393 5,578
Total personnel expense 35,714 29,032
Occupancy expense 3,688 3,384
Equipment related expenses 1,379 1,304
Merger and acquisition expenses 12,182 3,484
Amortization of intangible assets 2,145 1,017
Credit card rewards and other bankcard expenses 1,119 1,243
Telephone and data lines 995 935
Software costs 2,170 1,574
Data processing expense 2,412 2,101
Professional fees 1,450 871
Advertising and marketing expense 1,120 911
Non-credit losses 865 602
Deposit related expenses 413 409
Foreclosed property losses (gains), net (35) (80)
Other operating expenses 8,558 4,678
Total $ 74,175 $ 51,465
In general, the 44.1% increase in noninterest expenses was driven by merger and acquisition expenses of $12.2 million and higher intangible amortization, which increased $1.1 million as a result of the GrandSouth acquisition, and additional core deposit intangibles added. The primary factors driving the remaining increases between the periods included:
• Higher salary and benefit expenses, up $6.7 million related primarily to the eight acquired GrandSouth branch locations and related branch and support personnel. Also contributing to the increase is the filling of numerous existing vacant positions starting in the fourth quarter of 2022.
• A one-time charge of $2.4 million, included in "other operating expenses", for the estimated termination costs associated with the Company's pension plan which we anticipate exiting during the fourth quarter of 2023.
• Increases in the first quarter of 2023 for data processing, professional fees, software expense, and advertising, as well as FDIC insurance, travel and training (all included in "other operating expenses") related to the GrandSouth acquisition, including the transition of new customers and overlapping pre-conversion costs associated with the core processing system prior to the full system integration late in the quarter.
Income Taxes
We recorded income tax expense of $4.2 million for the three months ended March 31, 2023 and $8.7 million for the three months ended March 31, 2022. Our effective tax rate increased to 21.6% from 20.4% for the three months ended March 31, 2023 and 2022, respectively. The increase in effective tax rate between quarterly periods was attributable primarily to the merger and acquisition expenses which were non-deductible for tax purposes, thus increasing our federal taxable income in the current period.
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FINANCIAL CONDITION
Total assets at March 31, 2023 amounted to $12.4 billion, a $1.7 billion, or 16.4%, increase from December 31, 2022 due in large part to the GrandSouth acquisition, combined with organic loan and deposit growth during the quarter.
Total loans at March 31, 2023 amounted to $7.8 billion, a $1.1 billion, or 17.0%, increase from December 31, 2022 related primarily to the GrandSouth acquisition which contributed $1.02 billion to the increase. Organic growth (exclusive of acquired loans) amounted to $113.7 million for the first quarter of 2023 or an annualized growth rate of 5.9%. The mix of our loan portfolio remained substantially the same at March 31, 2023 compared to December 31, 2022. 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. We have no notable concentrations in geographies or industries, including in office or hospitality categories.
The composition of our investment portfolio remained substantially the same as at December 31, 2022, and continues to reflect our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits. Total investment securities decreased $26.1 million from December 31, 2022 to total $2.8 billion at March 31, 2023 due in large part to the utilization of cash flows from amortizing securities to fund loan growth. Unrealized losses on available for sale securities improved $35.3 million during the quarter ended March 31, 2023. 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 March 31, 2023 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.
Total deposits amounted to $10.4 billion at March 31, 2023, an increase of $1.1 billion, or 12.4%, from December 31, 2022. The primary driver of this increase was the GrandSouth acquisition, which contributed $1.05 billion to the growth. Organic growth (exclusive of acquired loans) amounted to $95.2 million for the first quarter of 2023 or an annualized growth rate of 3.7%. We continue to have a diversified and granular deposit base which has remained stable with continued growth in core deposits, primarily noninterest-bearing checking accounts and money market accounts. As of March 31, 2023, the estimated total insured or collateralized deposits were approximately 69% of our total deposits.
Our deposit mix has remained fairly consistent historically and has not significantly changed with the addition of GrandSouth as presented in the table below. There has been no notable shift in deposits from noninterest-bearing to interest-bearing during the quarter other than from the acquired deposits driving a moderate change in mix.
March 31, 2023 December 31, 2022
($ in thousands) Amount % of
Total Amount % of
Total
Noninterest-bearing checking accounts $ 3,763,637 36 % 3,566,003 39 %
Interest-bearing checking accounts 1,526,333 15 % 1,514,166 16 %
Money market accounts 3,126,571 30 % 2,416,146 26 %
Savings accounts 705,669 7 % 728,641 8 %
Other time deposits 624,444 6 % 464,343 5 %
Time deposits >$250,000 342,447 3 % 276,319 3 %
Total customer deposits 10,089,101 97 % 8,965,618 97 %
Brokered deposits 283,497 3 % 261,911 3 %
Total deposits $ 10,372,598 100 % 9,227,529 100 %
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Nonperforming Assets
NPAs are defined as nonaccrual loans, modifications to borrowers in financial distress, loans past due 90 or more days and still accruing interest, foreclosed real estate, and prior to the adoption of ASU 2022-02, accruing TDRs. NPAs are summarized as follows:
($ in thousands)
March 31, 2023 December 31, 2022
Nonperforming assets
Nonaccrual loans $ 28,059 28,514
Modifications to borrowers in financial distress 2,224 —
TDRs – accruing — 9,121
Total nonperforming loans 30,283 37,635
Foreclosed real estate 789 658
Total nonperforming assets $ 31,072 38,293
Asset Quality Ratios
Nonaccrual loans to total loans 0.36 % 0.43 %
Nonperforming loans to total loans 0.39 % 0.56 %
Nonperforming assets to total loans and foreclosed properties 0.40 % 0.57 %
Nonperforming assets to total assets 0.25 % 0.36 %
Allowance for credit losses to nonaccrual loans 379.19 % 319.03 %
Allowance for credit losses to nonperforming loans 351.34 % 241.71 %
As shown in the table above, NPAs decreased from December 31, 2022 to March 31, 2023. The decline was due in part to the Company's adoption of ASU 2022-02 which eliminated the accounting for TDRs and replaced it with disclosures of loan modifications for borrowers experiencing financial difficulty. At March 31, 2023, total nonaccrual loans amounted to $28.1 million, compared to $28.5 million at December 31, 2022 . " Real estate mortgage - commercial and other" is the largest category of nonaccrual loans, at $12.2 million, or 43.3%, of total nonaccrual loans, followed by "Commercial, financial, and agricultural" at $10.8 million, or 38.4%, of total nonaccrual loans. Included in those categories are nonaccrual SBA loans totaling $15.0 million at March 31, 2023, or 53.4%, of total nonaccrual loans, that have $5.8 million in guarantees from the SBA.
As reflected in Note 4 to the accompanying consolidated financial statements, total classified loans increased 5.3% to $51.1 million at March 31, 2023 compared to $48.5 million at December 31, 2022. Special mention loans increased 15.3% from $39.0 million at December 31, 2022 to $44.9 million at March 31, 2023. The majority of the increase was attributable to commercial real estate loans acquired from GrandSouth.
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 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
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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.
Fluctuations in the ACL each period are based on loan mix and growth, changes in the levels of nonperforming loans, economic forecasts impacting loss drivers, other assumptions and inputs to the CECL model, and as occurred in 2023, adjustments for acquired loan portfolios. Our ACL increased $15.4 million at March 31, 2023, as compared to year end, to a total of $106.4 million. The increase was driven by the acquisition of GrandSouth as discussed previously in the "Provision for Credit Losses" section above and in Note 4 to the accompanying consolidated financial statements. Purchase accounting adjustments included a "Day 1" ACL of $5.6 million recorded for PCD loans and an initial "Day 2" provision for loan losses of $12.2 million related to non-PCD loans in the GrandSouth portfolio. The balance of the change in the ACL was primarily a result of updated economic forecast inputs to our CECL model driving lower loss rate assumptions, primarily due to slightly improved unemployment and GDP forecasts.
For the periods indicated, the following table summarizes our balances of loans outstanding, average loans outstanding, ACL, charge-offs and recoveries, and key ratios:
Loan Ratios, Loss and Recovery Experience
($ in thousands) Three Months Ended March 31, 2023 Twelve Months
Ended December 31,
2022 Three Months Ended March 31, 2022
Loans outstanding at end of period $ 7,798,963 6,665,145 6,064,698
Average amount of loans outstanding 7,728,425 6,293,280 6,051,487
Allowance for credit losses, at period end 106,396 90,967 82,069
Total charge-offs (2,621) (4,465) (1,043)
Total recoveries 989 4,043 823
Net charge-offs $ (1,632) (422) (220)
Ratios:
Net charge-offs as a percent of average loans (annualized) 0.09 % 0.01 % 0.01 %
Allowance for credit losses as a percent of loans at end of period 1.36 % 1.36 % 1.35 %
Recoveries of loans previously charged-off as a percent of loans charged-off 37.73 % 90.55 % 78.91 %
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.
For the three months ended March 31, 2023, we recorded a provision for unfunded commitments of $1.1 million, which includes an initial provision of $1.9 million for the acquisition of GrandSouth and a provision reversal of $0.9 million related to fluctuations in the levels and mix of outstanding loan commitments. For the comparable period of 2022, a reversal of $1.5 million provision for unfunded commitments was required related to lower levels of unfunded commitments for the period. The allowance for unfunded commitments of $14.4 million and $13.3 million at March 31, 2023 and December 31, 2022, 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
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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 2022 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. In addition, we have available lines of credit from the FHLB and Federal Reserve, as well as federal funds lines from several correspondent banks which are summarized below.
At March 31, 2023, the Company had three sources of readily available borrowing capacity:
• An approximately $862.1 million line of credit with the FHLB (of which $506.8 million and $221.8 million were outstanding at March 31, 2023 and December 31, 2022, respectively);
• Federal funds lines with several correspondent banks totaling $265.0 million (of which none were outstanding at March 31, 2023 or December 31, 2022); and
• An approximately $166.2 million line of credit through the Federal Reserve's discount window (of which none was outstanding at March 31, 2023 or December 31, 2022).
Our overall liquidity increased slightly from December 31, 2022 with our liquidity ratio of 26.2% at March 31, 2023. We define our liquidity ratio as net liquid assets (cash, unpledged securities and other marketable assets) as a percentage of our net liabilities (unpledged deposits and borrowings). Our total liquidity ratio, including the $786.4 million in available lines of credit at quarter end was 30.5% as of March 31, 2023. We have identified approximately $980 million in commercial real estate loans which are eligible to be pledged to the FHLB and will provide us additional availability under that line of credit. Also, we have investment securities which we can pledge at either the Federal Reserve or the FHLB to increase our borrowing capacity. 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, 2022, the detail of w hich is presented in the Contractual Obligations and Other Commercial Commitments table of our 2022 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 March 31, 2023, and have no current plans to do so.
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 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
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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 risk-based capital is comprised of tier 1 capital plus qualifying subordinated debentures, and certain adjustments, the largest of which is our ACL and reserve for unfunded commitments. The Company has elected to exclude accumulated other comprehensive income ("AOCI") related primarily to available for sale securities from common equity tier 1 capital. 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 applicable to us.
At March 31, 2023, our capital ratios exceeded the regulatory minimum ratios discussed above. The decrease in total risk-based capital at March 31, 2023 as compared to year end is related primarily to asset growth and the GrandSouth acquisition. The following table presents the capital ratios for the Company and the regulatory minimums discussed above for the periods indicated:
March 31, 2023 December 31, 2022
Risk-based capital ratios:
Common equity Tier 1 to Tier 1 risk weighted assets 12.53 % 13.02 %
Minimum required Common Equity Tier 1 capital 7.00 % 7.00 %
Tier I capital to Tier 1 risk weighted assets 13.32 % 13.83 %
Minimum required Tier 1 capital 8.50 % 8.50 %
Total risk-based capital to Tier II risk weighted assets 14.88 % 15.09 %
Minimum required total risk-based capital 10.50 % 10.50 %
Leverage capital ratio:
Tier 1 capital to quarterly average total assets 10.28 % 10.51 %
Minimum required Tier 1 leverage capital 4.00 % 4.00 %
The Bank is also subject to capital requirements that do not vary materially from the Company’s capital ratios presented above. At March 31, 2023, the Bank exceeded the minimum ratios established by the regulatory authorities.
In additional the the regulatory capital requirements, we monitor the Company's tangible common equity ratio which is a non-GAAP measurement calculated as total capital less intangible assets, as a percent of total assets net of intangible assets. AOCI is included in the Company’s tangible common equity to tangible assets ratio which was 6.60% at March 31, 2023, an increase of 21 basis points from December 31, 2022. AOCI at March 31, 2023 improved $27.9 million compared to year end reflecting the reduction in unrealized loss on available for sale securities resulting from the favorable impact of interest rate changes during the first quarter.
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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.