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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2023-02-24 compared with 2022-02-25 · 9 added, 177 removed, 0 unchanged (100% of the section changed)

Quantitative and Qualitative Disclosure about Market Risk

RISK MANAGEMENT

Risk is inherent in any business.

BancShares has defined a moderate risk appetite, a balanced approach to risk taking, with a philosophy which does not preclude higher risk business activities balanced with acceptable returns while meeting regulatory objectives.

Through the comprehensive Risk Management Framework and Risk Appetite Framework, senior management has primary responsibility for day-to-day management of the risks we face with accountability of and support from all associates.

Senior management applies various strategies to reduce the risks to which BancShares may be exposed, with effective challenge and oversight by management committees.

In addition, our Board of Directors (the “Board”) strives to ensure the business culture is integrated with the Risk Management program and policies, procedures and metrics for identifying, assessing, monitoring and managing risk are part of the decision-making process.

The Board’s role in risk oversight is an integral part of our overall Risk Management Framework and Risk Appetite Framework.

The Board administers its risk oversight function primarily through the Board Risk Committee.

The Board Risk Committee structure is designed to allow for information flow, effective challenge and timely escalation of risk-related issues.

The Board Risk Committee is directed to monitor and advise the full Board regarding risk exposures, including Credit, Market, Capital, Liquidity, Operational, Compliance, Asset, Strategic and Reputational risks;

review, approve, and monitor adherence to the Risk Appetite Statement and supporting risk tolerance levels via a series of established metrics;

and evaluate, monitor and oversee the adequacy and effectiveness of the Risk Management Framework and Risk Appetite Framework.

The Board Risk Committee also reviews:

reports of examination by and communications from regulatory agencies;

the results of internal and third party testing and qualitative and quantitative assessments related to risk management;

and any other matters within the scope of the Board Risk Committee’s oversight responsibilities.

The Board Risk Committee monitors management’s response to certain risk-related regulatory and audit issues.

In addition, the Board Risk Committee may coordinate with the Audit Committee and the Compensation, Nominations and Governance Committee for the review of financial statements and related risks, compensation risk management and other areas of joint responsibility.

In combination with other risk management and monitoring practices, enterprise-wide stress testing activities are part of the Risk Management Framework and conducted within a defined framework.

Stress tests are performed for various risks to ensure the financial institution can support continued operations during stressed periods.

Enactment of the EGRRCPA significantly altered several provisions of the Dodd-Frank Act, including how stress tests are run.

BancShares will continue to monitor and stress test its capital and liquidity consistent with the safety and soundness expectations of the federal regulators.

Refer to the “Regulatory Considerations” section of Item 1.

Business included in this Annual Report on Form 10-K for further discussion.

Credit risk management

Credit risk is the risk of not collecting payments pursuant to the contractual terms of loans, leases and certain investment securities.

Loans and leases we originate are underwritten in accordance with our credit policies and procedures and are subject to periodic ongoing reviews.

Acquired loans, regardless of whether PCD or non-PCD, are recorded at fair value as of the acquisition date and are subject to periodic reviews to identify any further credit deterioration.

Our independent credit review function conducts risk reviews and analyses of both originated and acquired loans to ensure compliance with credit policies and to monitor asset quality trends and borrower financial strength.

These reviews include portfolio analysis by geographic location, industry, collateral type and product.

We strive to identify potential problem loans as early as possible, to record charge-offs or write-downs as appropriate and to maintain an appropriate ACL that accounts for expected credit losses in the loan and lease portfolio.

Our ACL estimate as of December 31, 2021, included extensive reviews of the changes in credit risk associated with the uncertainties around economic forecasts and the overall economic impact of COVID-19.

Expected loss estimates within each portfolio considered the potential impact of economic activity, as well as potential mitigating impact from the government stimulus and loan modification programs.

These loss estimates additionally considered BancShares industry risk, historically strong credit quality and actual net losses incurred during prior periods of economic stress, as well as recent credit trends, which have not seen significant deterioration as of December 31, 2021.

We maintain a well-diversified loan and lease portfolio and seek to minimize the risks associated with large concentrations within specific geographic areas, collateral types or industries.

Despite our focus on diversification, several characteristics of our loan portfolio subject us to significant risk, such as our concentrations of real estate secured loans, revolving mortgage loans and medical- and dental-related loans.

We have historically carried a significant concentration of real estate secured loans, but actively mitigate exposure through underwriting policies which primarily rely on borrower cash flow rather than underlying collateral values.

When we do rely on underlying real property values, we favor financing secured by owner-occupied real property and, as a result, a large percentage of our real estate secured loans are owner occupied.

At December 31, 2021, loans secured by real estate were $24.28 billion, or 75.0%, of total loans and leases compared to $23.56 billion, or 71.8% at December 31, 2020, and $22.38 billion, or 77.5%, at December 31, 2019.

Similar to our branch footprint, the collateral of loans secured by real estate is concentrated within North Carolina and South Carolina.

At December 31, 2021, real estate located in North Carolina and South Carolina represented 35.9% and 15.6%, respectively, of all real estate used as collateral.

Table 19 provides the geographic distribution of real estate collateral by state.

GEOGRAPHIC DISTRIBUTION OF REAL ESTATE COLLATERAL

December 31, 2021

Collateral location Percent of real estate secured loans with collateral located in the state

North Carolina 35.9

South Carolina 15.6

California 11.8

Washington 3.7

Tennessee 1.5

All other locations 8.6

Among real estate secured loans, our revolving mortgage loans (“Home Equity Lines of Credit” or “HELOCs”) present a heightened risk due to long commitment periods during which the financial position of individual borrowers or collateral values may deteriorate significantly.

In addition, a large percentage of our HELOCs are secured by junior liens.

Substantial declines in collateral values could cause junior lien positions to become effectively unsecured.

HELOCs secured by real estate were $1.82 billion, or 5.6%, of total loans at December 31, 2021, compared to $2.09 billion, or 6.4%, at December 31, 2020, and $2.38 billion, or 8.2%, at December 31, 2019.

Except for loans acquired through mergers and acquisitions, we have not purchased HELOCs in the secondary market, nor have we originated these loans to customers outside of our market areas.

All originated HELOCs were underwritten by us based on our standard lending criteria.

The HELOC portfolio consists of variable rate lines of credit which allow customer draws during a specified period of the line of credit, with a portion switching to an amortizing term following the draw period.

Approximately 83.1% of the revolving mortgage portfolio relates to properties in North Carolina and South Carolina.

Approximately 36.6% of the loan balances outstanding are secured by senior collateral positions while the remaining 63.4% are secured by junior liens.

We actively monitor the portion of our HELOCs in the interest-only period and when they will mature.

Approximately 89.4% of outstanding balances at December 31, 2021, require interest-only payments, while the remaining require monthly payments equal to the greater of 1.5% of the outstanding balance, or $100.

When HELOCs switch from interest-only to fully amortizing, including principal and interest, some borrowers may not be able to afford the higher monthly payments.

We have not experienced a significant increase in defaults as a result of these increased payments.

In the normal course of business, we will work with each borrower as they approach the revolving period maturity date to discuss options for refinance or repayment.

Loans and leases to borrowers in medical, dental or related fields were $7.09 billion as of December 31, 2021, which represents 21.9% of total loans and leases, compared to $5.54 billion or 16.9% of total loans and leases at December 31, 2020, and $5.16 billion or 17.9% of total loans and leases at December 31, 2019.

The credit risk of this industry concentration is mitigated through our underwriting policies which emphasize reliance on adequate borrower cash flow rather than underlying collateral value and our preference for financing secured by owner-occupied real property.

Except for this single concentration, no other industry represented more than 10% of total loans and leases outstanding at December 31, 2021.

Interest rate risk management

Interest rate risk (“IRR”) results principally from:

assets and liabilities maturing or repricing at different points in time, assets and liabilities repricing at the same point in time but in different amounts, and short-term and long-term interest rates changing in different magnitudes.

We assess our short-term IRR by forecasting net interest income over 24 months under various interest rate scenarios and comparing those results to forecasted net interest income, assuming stable rates.

IRR scenarios modeled include, but are not limited to, immediate, parallel rate shocks, interest rate ramps, changes in the shape of the yield curve and changes in the relationships of our rates to market rates.

The composition of our interest rate sensitive assets and liabilities generally results in a net asset-sensitive position, concentrated in the middle of the yield curve, mostly driven by moves in the federal funds rate, whereby our assets will reprice faster than our liabilities.

Interest rate sensitive assets generally consist of interest-bearing cash, investment securities, and commercial and consumer loans.

Approximately 27% of our commercial and consumer loans have floating contractual reference rates.

These floating rate loans are indexed to the following rates (with approximate percentages of each floating rate loan portfolio relative to the total floating rate loan portfolio included in parenthesis), Prime (41%), LIBOR (34%), Secured Overnight Financing Rate (“SOFR”) (12%) and US Treasury (13%).

Table 20 provides the impact on net interest income over 24 months resulting from various instantaneous interest rate shock scenarios as of December 31, 2021 and 2020.

NET INCOME SENSITIVITY SIMULATION ANALYSIS

Estimated (decrease) increase in net interest income

Change in interest rate (basis points) December 31, 2021 December 31, 2020

-100 (6.97) % (6.24) %

+100 6.68 8.09

+200 12.87 14.57

Net interest income sensitivity metrics at December 31, 2021 remain largely unchanged when compared to December 31, 2020.

Long-term interest rate risk exposure is measured using the economic value of equity (“EVE”) sensitivity analysis to study the impact of long-term cash flows on earnings and capital.

EVE represents the difference between the sum of the present value of all asset cash flows and the sum of the present value of the liability cash flows.

EVE sensitivity analysis involves discounting cash flows under different interest rate scenarios.

The base-case measurement and its sensitivity to shifts in the yield curve allow management to measure longer-term repricing and option risk in the balance sheet.

Table 21 presents the EVE profile as of December 31, 2021 and 2020.

ECONOMIC VALUE OF EQUITY MODELING ANALYSIS

Estimated (decrease) increase in EVE

Change in interest rate (basis points) December 31, 2021 December 31, 2020

-100 (13.68) % (21.20) %

+100 6.10 12.18

+200 5.93 15.71

The EVE metrics at December 31, 2021, compared to December 31, 2020, were primarily affected by ongoing growth in non-maturity deposits during 2021, coupled with the interest rate environment.

We do not typically utilize interest rate swaps, floors, collars or other derivative financial instruments to attempt to hedge our overall balance sheet rate sensitivity and interest rate risk.

Our simulations do not account for other business developments, including the CIT Merger, that could affect net interest income and EVE, or for management actions that could affect net interest income and EVE or that could be taken to change our risk profile.

Accordingly, we can give no assurance that actual results would not differ materially from the estimated outcomes of our simulations.

Table 22 provides loan maturity distribution information.

LOAN MATURITY DISTRIBUTION

At December 31, 2021, maturing

(Dollars in thousands) Within

One Year One to Five

Years Five to 15

Years After 15 years Total

Construction and land development $ 147,315 $ 395,055 $ 471,156 $ 98,271 $ 1,111,797

Owner occupied commercial mortgage 503,491 3,194,733 7,924,721 369,680 11,992,625

Non-owner occupied commercial mortgage 234,654 1,343,459 1,359,985 33,295 2,971,393

Commercial and industrial and leases 1,231,000 2,861,414 1,563,114 55,124 5,710,652

SBA-PPP 43,116 450,705 — — 493,821

Total commercial loans and leases 2,159,576 8,245,366 11,318,976 556,370 22,280,288

Residential mortgage 84,375 391,917 1,543,399 3,660,228 5,679,919

Revolving mortgage 113,575 211,084 91,455 1,378,891 1,795,005

Construction and land development 16,623 104,655 18,104 260,188 399,570

Consumer auto 9,784 625,953 695,651 — 1,331,388

Consumer other 305,972 121,327 74,655 45,774 547,728

Total consumer loans 530,329 1,454,936 2,423,264 5,345,081 9,753,610

PCD loans 32,719 95,715 139,102 70,088 337,624

Total loans and leases $ 2,722,624 $ 9,796,017 $ 13,881,342 $ 5,971,539 $ 32,371,522

Table 23 provides information regarding the sensitivity of loans and leases to changes in interest rates.

LOAN INTEREST RATE SENSITIVITY

Loans maturing after one year with

(Dollars in thousands) Fixed interest rates Variable interest rates

Construction and land development $ 575,787 $ 388,695

Owner occupied commercial mortgage 10,638,067 851,067

Non-owner occupied commercial mortgage 2,369,125 367,614

Commercial and industrial and leases 3,844,074 635,578

SBA-PPP 450,705 —

Total commercial loans and leases 17,877,758 2,242,954

Residential mortgage 2,761,276 2,834,268

Revolving mortgage 32,766 1,648,664

Construction and land development 103,947 279,000

Consumer auto 1,321,604 —

Consumer other 194,726 47,030

Total consumer loans 4,414,319 4,808,962

PCD loans 138,614 166,291

Total loans and leases $ 22,430,691 $ 7,218,207

Liquidity risk management

Liquidity risk is the risk an institution is unable to generate or obtain sufficient cash or its equivalents on a cost-effective basis to meet commitments as they fall due.

The most common sources of liquidity risk arise from mismatches in the timing and value of on-balance sheet and off-balance sheet cash inflows and outflows.

In general, on-balance sheet mismatches generate liquidity risk when the effective maturity of assets exceeds the effective maturity of liabilities.

A commonly cited example of a balance sheet liquidity mismatch is when long-term loans (assets) are funded with short-term borrowings (liabilities).

Other forms of liquidity risk include market constraints on the ability to convert assets into cash at expected levels, an inability to access funding sources at sufficient levels at a reasonable cost and changes in economic conditions or exposure to credit, market, operational, legal and reputation risks affecting an institution’s liquidity risk profile.

We utilize various limit-based measures to monitor, measure and control liquidity risk across three different types of liquidity:

• Tactical - Measures the risk of a negative cash flow position whereby cash outflows exceed cash inflows over a short-term horizon out to nine weeks;

• Structural - Measures the amount by which illiquid assets are supported by long-term funding;

• Contingent - Measures the risk of having insufficient liquidity sources to support cash needs under potential future stressed market conditions or having an inability to access wholesale funding sources in a timely and cost effective manner.

We aim to maintain a diverse mix of liquidity sources to support the liquidity management function, while aiming to avoid funding concentrations by diversifying our external funding with respect to maturities, counterparties and nature.

Our primary source of liquidity is our branch-generated deposit portfolio due to the generally stable balances and low cost.

Additional sources include cash at the Federal Reserve Bank and various other correspondent bank accounts and unencumbered securities, which totaled $16.41 billion at December 31, 2021, compared to $9.63 billion at December 31, 2020.

Another source of available funds is advances from the FHLB of Atlanta.

Outstanding FHLB advances were $644.7 million as of December 31, 2021, and we had sufficient collateral pledged to secure $8.92 billion of additional borrowings.

Further, in the current year, $4.81 billion in non-PCD loans with a lendable collateral value of $3.95 billion were used to create additional borrowing capacity at the Federal Reserve Bank.

We also maintain Federal Funds and other credit lines, which had $556.0 million of available capacity at December 31, 2021.

FOURTH QUARTER ANALYSIS

For the quarter ended December 31, 2021, net income was $123.3 million compared to $138.1 million for the corresponding quarter of 2020, a decrease of $14.8 million or 10.7%.

The decrease was primarily the result of lower net interest income, lower noninterest income and higher noninterest expenses, partially offset by lower provision expense.

Earnings per share were $12.09 for the fourth quarter of 2021 compared to $13.59 for the same period a year ago.

Net interest income was $357.4 million, a decrease of $1.3 million, or 0.4%, compared to the fourth quarter of 2020.

This was primarily due to a decline in the yield on loans and a decrease in interest and fee income on SBA-PPP loans, largely offset by organic loan growth, higher investment and overnight balances and yields, as well as lower rates on interest-bearing deposits.

SBA-PPP loans contributed $26.5 million in interest and fee income for the fourth quarter of 2021 compared to $42.2 million for the same quarter in 2020.

The taxable-equivalent net interest margin for the fourth quarter of 2021 was 2.58%, a decrease of 44 basis points from 3.02% in the same quarter in the prior year.

The margin decline was primarily due to changes in earning asset mix driven by excess liquidity and higher balances in overnight investments, a decline in the yield on loans and lower income on SBA-PPP loans.

These declines were partially offset by lower rates paid on interest-bearing deposits and higher investment yields.

Income tax expense was $30.3 million in the fourth quarter of 2021, compared to $36.6 million in the fourth quarter of 2020.

The effective tax rates were 19.7% and 21.0% during each of these respective periods.

Provision for credit losses was a net benefit of $5.1 million during the fourth quarter of 2021, compared to $5.4 million in expense for the fourth quarter of 2020.

The $10.5 million decrease was favorably impacted by a $4.7 million reserve release driven primarily by continued strong credit performance, low net charge-offs and improvement in macroeconomic factors.

The net recovery ratio was 0.01% for the fourth quarter of 2021, compared to 0.06% for the fourth quarter of 2020.

Noninterest income was $114.3 million for the fourth quarter of 2021, a decrease of $12.5 million from the same period of 2020.

Contributing to the decline was a $15.9 million reduction in fair market value adjustments on marketable equity securities, a $6.0 million decrease in mortgage income due to reductions in gain on sale and production volume driven by higher mortgage rates and increased competition and a $5.3 million decline in realized gains on available for sale securities.

These declines were partially offset by a $5.3 million increase in wealth management services due to growth in assets under management resulting in higher advisory and transaction fees, a $3.6 million increase in service charges on deposit accounts, a $2.6 million increase in cardholder services, net, and a $1.2 million increase in both merchant services, net and other service charges and fees.

Noninterest expense was $323.2 million for the fourth quarter of 2021, an increase of $17.8 million from the same quarter last year.

This was primarily due to increases of $9.9 million in salaries and wages (resulting from annual merit and higher revenue-based incentives), $4.5 million in CIT merger-related expenses, $3.7 million in processing fees paid to third parties (resulting from our continued investments in digital and technology to support revenue-generating businesses and improve internal processes), and temporary personnel costs.

Quantitative and Qualitative Disclosures about Market Risk

Market risk is the potential economic loss resulting from changes in market prices and interest rates.

This risk can either result in diminished current fair values of financial instruments or reduced NII in future periods.

Changes in fair value that result from movement in market rates cannot be predicted with any degree of certainty.

Therefore, the impact that future changes in market rates will have on the fair values of financial instruments is uncertain.

As of December 31, 2022, BancShares’ market risk profile had changed since December 31, 2021, primarily due to the CIT Merger.

Market risk information is set forth in Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations within the “Risk Management” section and in Item 8.

Notes to Consolidated Financial Statements within Note 1 — Significant Accounting Policies and Basis of Presentation, Note 14 — Derivative Financial Instruments and Note 16 — Fair Value.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7A. Quantitative and Qualitative Disclosures About Market Risk