Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report.
The following discussion, analysis and comparisons generally focus on the operating results for the years ended December 31, 2022 and 2021. Discussion, analysis and comparisons of the years ended December 31, 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021. This discussion and analysis includes certain forward-looking statements that involve risks, uncertainties and assumptions. You should review the “Risk Factors” section of this report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by such forward-looking statements. See also the “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.
Costs Associated with Exit Activities
Due to the steep decline in consumer mortgage volumes and the negative outlook for consumer mortgage lending over the next several years, the Company decided to exit its consumer mortgage business during the first quarter of 2023. This includes its nationwide digital direct-to-consumer mortgage platform that originates residential loans for sale in the secondary market, as well as its local traditional consumer mortgage and construction-to-permanent business. The Company’s commercial construction and land development business will not be affected by this decision and will remain an important part of the Company’s lending strategy.
This action is expected to reduce total annual noninterest expense by approximately $6.8 million and increase annualized pre-tax income by approximately $2.7 million, with 80% of the benefit realized in 2023 and 100% thereafter. The Company estimates that it will incur total pre-tax expense of approximately $3.3 million in the first and second quarters of 2023 associated with exiting this line of business.
Results of Operations
During the twelve months ended December 31, 2022, net income was $35.5 million, or $3.70 per diluted share, compared to net income of $48.1 million, or $4.82 per diluted share, for the twelve months ended December 31, 2021 and net income of $29.5 million, or $2.99 per diluted share, for the twelve months ended December 31, 2020.
The $12.6 million decrease in net income for the twelve months ended December 31, 2022 compared to the twelve months ended December 31, 2021 was due primarily to an $11.6 million decrease in noninterest income, an $11.5 million increase in noninterest expense and a $3.9 million increase in provision for loan losses, partially offset by a $10.5 million increase in net interest income and a $3.9 million decrease in income tax expense.
The increase in net income of $18.7 million for the twelve months ended December 31, 2021 compared to the twelve months ended December 31, 2020 was due primarily to a $22.0 million increase in net interest income and an $8.3 million decrease in provision for loan losses, partially offset by a $4.1 million increase in noninterest expense, a $4.0 million increase in income tax expense and a $3.5 million decrease in noninterest income.
During the twelve months ended December 31, 2022, return on average assets was 0.85%, compared to 1.14% for the twelve months ended December 31, 2021. During the twelve months ended December 31, 2022, return on average shareholders’ equity was 9.53%, compared to 13.44% for the twelve months ended December 31, 2021. Additionally, for the twelve months ended December 31, 2022, return on average tangible common equity was 9.65% compared to 13.61% for the twelve months ended December 31, 2021. These profitability ratios declined during 2022 due primarily to the decrease in net income. Refer to the “Reconciliation of Non-GAAP Financial Measures” section of Item 7 of Part II of this report, Management's Discussion and Analysis of Financial Condition and Results of Operations for additional information.
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Consolidated Average Balance Sheets and Net Interest Income Analyses
For the periods presented, the following tables provide the average balances of interest-earning assets and interest-bearing liabilities and the related yields and cost of funds. The tables do not reflect any effect of income taxes. Balances are based on the average of daily balances. Nonaccrual loans are included in average loan balances.
Twelve Months Ended
December 31, 2022 December 31, 2021 December 31, 2020
(dollars in thousands) Average Balance Interest/Dividends Yield/Cost Average Balance Interest/Dividends Yield/Cost Average Balance Interest/Dividends Yield/Cost
Assets
Interest-earning assets
Loans, including loans held-for-sale $ 3,142,166 $ 140,600 4.47 % $ 2,999,232 $ 123,467 4.12 % $ 3,025,989 $ 120,628 3.99 %
Securities - taxable 537,921 10,711 1.99 % 544,613 7,970 1.46 % 530,849 11,123 2.10 %
Securities - non-taxable 75,382 1,767 2.34 % 84,482 1,017 1.20 % 95,173 1,728 1.82 %
Other earning assets 278,073 3,830 1.38 % 466,608 1,429 0.31 % 523,788 3,380 0.65 %
Total interest-earning assets 4,033,542 156,908 3.89 % 4,094,935 133,883 3.27 % 4,175,799 136,859 3.28 %
Allowance for loan losses (29,143) (29,068) (24,660)
Noninterest earning-assets 166,127 140,059 112,659
Total assets $ 4,170,526 $ 4,205,926 $ 4,263,798
Liabilities
Interest-bearing liabilities
Interest-bearing demand deposits $ 333,737 $ 2,056 0.62 % $ 195,699 $ 583 0.30 % $ 145,207 $ 840 0.58 %
Savings accounts 58,156 336 0.58 % 56,967 203 0.36 % 40,593 303 0.75 %
Money market accounts 1,423,185 18,513 1.30 % 1,434,829 5,892 0.41 % 1,156,084 11,381 0.98 %
BaaS - brokered deposits 60,699 1,033 1.70 % — — 0.00 % — — 0.00 %
Certificates and brokered deposits 1,147,017 19,894 1.73 % 1,411,211 23,144 1.64 % 1,882,773 43,452 2.31 %
Total interest-bearing deposits 3,022,794 41,832 1.38 % 3,098,706 29,822 0.96 % 3,224,657 55,976 1.74 %
Other borrowed funds 638,526 17,983 2.82 % 600,035 17,505 2.92 % 586,372 16,342 2.79 %
Total interest-bearing liabilities 3,661,320 59,815 1.63 % 3,698,741 47,327 1.28 % 3,811,029 72,318 1.90 %
Noninterest-bearing deposits 120,325 101,825 74,277
Other noninterest-bearing liabilities 16,037 47,255 64,729
Total liabilities 3,797,682 3,847,821 3,950,035
Shareholders' equity 372,844 358,105 313,763
Total liabilities and shareholders' equity $ 4,170,526 $ 4,205,926 $ 4,263,798
Net interest income $ 97,093 $ 86,556 $ 64,541
Interest rate spread 1
2.26 % 1.99 % 1.38 %
Net interest margin 2
2.41 % 2.11 % 1.55 %
Net interest margin - FTE 3
2.54 % 2.25 % 1.68 %
1 Yield on total interest-earning assets minus cost of total interest-bearing liabilities
2 Net interest income divided by average interest-earning assets
3 On a fully-taxable equivalent (“FTE”) basis assuming a 21% tax rate. Refer to the “Reconciliation of Non-GAAP Financial Measures” section of Item 7 of Part II of this report, Management's Discussion and Analysis of Financial Condition and Results of Operations
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Rate/Volume Analysis
The following table illustrates the impact of changes in the volume of interest-earning assets and interest-bearing liabilities and interest rates on net interest income for the periods indicated. The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.
Rate/Volume Analysis of Net Interest Income
Twelve Months Ended December 31, 2022 vs. December 31, 2021 Due to Changes in Twelve Months Ended December 31, 2021 vs. December 31, 2020 Due to Changes in
(amounts in thousands) Volume Rate Net Volume Rate Net
Interest income
Loans, including loans held-for-sale $ 6,157 $ 10,976 $ 17,133 $ (1,074) $ 3,913 $ 2,839
Securities – taxable (100) 2,841 2,741 285 (3,438) (3,153)
Securities – non-taxable (120) 870 750 (177) (534) (711)
Other earning assets (794) 3,195 2,401 (337) (1,614) (1,951)
Total 5,143 17,882 23,025 (1,303) (1,673) (2,976)
Interest expense
Interest-bearing deposits (744) 12,754 12,010 (2,097) (24,057) (26,154)
Other borrowed funds 1,094 (616) 478 388 775 1,163
Total 350 12,138 12,488 (1,709) (23,282) (24,991)
Increase in net interest income $ 4,793 $ 5,744 $ 10,537 $ 406 $ 21,609 $ 22,015
Net interest income for the twelve months ended December 31, 2022 was $97.1 million, an increase of $10.5 million, or 12.2%, compared to $86.6 million for the twelve months ended December 31, 2021. The increase in net interest income was the result of a $23.0 million, or 17.2%, increase in total interest income to $156.9 million for the twelve months ended December 31, 2022 compared to $133.9 million for the twelve months ended December 31, 2021. This increase in total interest income was partially offset by a $12.5 million, or 26.4%, increase in total interest expense to $59.8 million for the twelve months ended December 31, 2022 compared to $47.3 million for the twelve months ended December 31, 2021.
The increase in total interest income was due to increases in interest earned on loans, including loans held-for-sale, securities and other earning assets. Interest income earned on loans, including loans held-for-sale, increased by $17.1 million as a result of the yield on the loan portfolio increasing by 35 bps, as well as the average balance of loans increasing by $142.9 million, or 4.8%. The increase in average loan balances was due primarily to increases in both the commercial (with the exception of healthcare finance) and consumer loan portfolios. Interest income earned on securities increased $3.5 million, or 38.8%, due to an increase of 60 bps in the yield earned on securities, partially offset by a decrease of $15.8 million, or 2.5%, in the average balance of securities. Interest income earned on other earning assets increased $2.4 million, or 168.0%, due to an increase of 107 bps in the yield earned on these assets, partially offset by a decrease of $188.5 million, or 40.4%, in the average balance of other earning assets. The decrease in the average balance of other earning assets was due primarily to lower cash balances. The increase in the yields earned on loans, securities and other earning assets was due primarily to the rise in interest rates throughout 2022.
The increase in total interest expense was driven primarily by increases in interest expense related to money market accounts, interest-bearing demand deposits and BaaS – brokered deposits, but partially offset by a decrease in interest expense related to certificates and brokered deposits. The increase in interest expense related to money market accounts of $12.6 million, or 214.2%, was driven by an increase of 89 bps in the cost of these deposits, partially offset by a decrease of $11.6 million, or 0.8%, in the average balance of these deposits. The increase in interest expense related to interest-bearing demand deposits of $1.5 million, or 252.7%, was due primarily to an increase of $138.0 million, or 70.5%, in the average balance of these deposits and an increase of 32 bps in the cost of these deposits. The increase in BaaS – brokered deposit expense was due to a $60.7 million increase in the average balance of deposits. The decrease in interest expense in certificates and brokered deposits of $3.3 million, or 14.0%, was due primarily to a $264.2 million, or 18.7%, decrease in the average balance of these deposits, partially offset by an increase of 9 bps in the cost of these deposits. The decrease in certificates and brokered deposit balances was driven by our pricing strategy to reduce the level of these higher cost deposits. The increase in the cost of total interest-bearing deposits, reflects the increase in interest rates throughout 2022.
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Net interest margin (“NIM”) was 2.41% for the twelve months ended December 31, 2022 compared to 2.11% for the twelve months ended December 31, 2021. On a fully-taxable equivalent (“FTE”) basis, NIM was 2.54% for the twelve months ended December 31, 2022 compared to 2.25% for the twelve months ended December 31, 2021, an increase of 29 bps. The increase in NIM and FTE NIM compared to the twelve months ended December 31, 2021 was due primarily to an increase in the yield earned on interest-earning assets, partially offset by an increase in the cost of interest-bearing liabilities. The increase in the yield on interest-earning assets and cost of interest-bearing deposits was driven primarily by the increase in interest rates throughout 2022.
Noninterest Income
The following table presents noninterest income for the three most recent years.
Twelve Months Ended December 31,
(amounts in thousands) 2022 2021 2020
Service charges and fees $ 1,071 $ 1,114 $ 824
Loan servicing revenue 2.573 1,934 1,159
Loan servicing asset revaluation (1,639) (1,069) (432)
Mortgage banking activities 5,464 15,050 24,693
Gain on sale of loans 11,372 11,598 8,298
Gain on sale of securities — — 139
Gain on sale of premises and equipment — 2,523 —
Other 2,416 1,694 1,655
Total noninterest income $ 21,257 $ 32,844 $ 36,336
During the twelve months ended December 31, 2022, noninterest income totaled $21.3 million, representing a decrease of $11.6 million, or 35.3%, compared to $32.8 million for the twelve months ended December 31, 2021. The decrease in noninterest income was driven primarily by a decrease in revenue from mortgage banking activities, no gain on sale of premises and equipment in 2022 and a $0.6 million decrease in loan servicing asset revaluation, which was partially offset by an increase in other noninterest income. The decrease in mortgage banking revenue was due mainly to decreases in interest rate locks, sold loan volumes and gain-on-sale margins driven by the increase in interest rates throughout 2022. The increase in other noninterest income was due primarily to distributions received on certain Small Business Investment Company and venture capital fund investments. Net loan servicing revenue was relatively stable as growth in the balance of the Company’s SBA 7(a) servicing portfolio was offset by the negative impact of prepayment speeds on the servicing asset revaluation.
Noninterest Expense
The following table presents noninterest expense for the three most recent years.
Twelve Months Ended December 31,
(amounts in thousands) 2022 2021 2020
Salaries and employee benefits $ 41,553 $ 38,223 $ 34,231
Marketing, advertising and promotion 3,554 3,261 1,654
Consulting and professional services 4,826 4,054 3,511
Data processing 1,989 1,649 1,528
Loan expenses 4,435 2,112 2,036
Premises and equipment 10,688 7,063 6,396
Deposit insurance premium 1,152 1,213 1,810
Write-down of other real estate owned — — 2,065
Other 5,076 4,223 4,423
Total noninterest expense $ 73,273 $ 61,798 $ 57,654
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Noninterest expense for the twelve months ended December 31, 2022 was $73.3 million, compared to $61.8 million for the twelve months ended December 31, 2021. The increase of $11.5 million, or 18.6%, compared to the twelve months ended December 31, 2021 was due primarily to increases of $3.6 million in premises and equipment, $3.3 million in salaries and employee benefits, $2.3 million in loan expenses, $0.9 million in other noninterest expense and $0.8 million in consulting and professional fees. The increase in premises and equipment was due mainly to costs associated with the Company’s new corporate headquarters, as well as investments in technology, software maintenance and a write-down of software. The higher salaries and employee benefits expense was due mainly to increased headcount, higher medical claims expense, a $0.5 million discretionary inflation bonus paid to certain employees and $0.3 million of accelerated equity compensation related to employees who retired during the year. The increase in loan expenses was due primarily to servicing fees related to tax refund advance loans and franchise finance loans. The increase in other was due to several items, none of which were individually significant. The increase in consulting and professional fees was due primarily to a $0.9 million consulting fee associated with a special project.
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Income Taxes
The following table reconciles reported income tax expense to that computed at the statutory federal tax rate for the three most recent years.
Twelve Months Ended December 31,
(amounts in thousands) 2022 2021 2020
Statutory rate times pre-tax income $ 8,421 $ 11,880 $ 7,119
(Subtract) add the tax effect of:
Income from tax-exempt securities and loans (4,190) (4,217) (4,464)
State income taxes, net of federal tax effect 592 865 1,765
Bank-owned life insurance (201) (199) (200)
Tax credits (143) (175) (178)
Other differences 80 304 403
Income tax expense $ 4,559 $ 8,458 $ 4,445
We recognized income tax expense of $4.6 million in 2022, resulting in an effective tax rate of 11.4%, compared to $8.5 million and an effective tax rate of 15.0% in 2021. Our federal statutory tax rate was 21% in 2022 and 2021. In both 2022 and 2021, the variance from the federal statutory rate was due primarily to tax-exempt income, partially offset by state income taxes. Interest income on certain loans or securities issued by governmental, municipal and not-for-profit entities, and earnings from bank-owned life insurance were the primary components of tax-exempt income. The decrease in the effective tax rate and income tax expense was due primarily to the decrease in pre-tax earnings driven by a lower proportion of taxable revenue, including decreased mortgage banking activities and no gain on sale of premises and equipment in 2022.
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Financial Condition
The following table presents summary balance sheet data as of the end of the last two years.
(amounts in thousands) December 31,
Balance Sheet Data: 2022 2021
Total assets $ 4,543,104 $ 4,210,994
Loans 3,499,401 2,887,662
Total securities 579,552 662,609
Loans held-for-sale 21,511 47,745
Noninterest-bearing deposits 175,315 117,531
Interest-bearing deposits 3,265,930 3,061,428
Total deposits 3,441,245 3,178,959
Advances from Federal Home Loan Bank 614,928 514,922
Total shareholders' equity 364,974 380,338
Total assets increased $332.1 million, or 7.9%, to $4.5 billion as of December 31, 2022 compared to $4.2 billion as of December 31, 2021. The increase in total assets was driven primarily by an increase in loan balances, partially offset by decreases in cash and securities.
As of December 31, 2022, total shareholders’ equity was $365.0 million, a decrease of $15.4 million, or 4.0%, compared to December 31, 2021, due primarily to stock repurchase activity and an increase in accumulated other comprehensive loss resulting from a decline in the value of the available-for-sale securities portfolio caused mainly by the continued rise in interest rates during the year. This was partially offset by the net income earned during the year and an increase in the value of interest rate swaps classified as cash flow hedges. Tangible common equity totaled $360.3 million as of December 31, 2022, representing a decrease of $15.4 million, or 4.1%, compared to December 31, 2021. The ratio of total shareholders’ equity to total assets decreased to 8.03% as of December 31, 2022 from 9.03% as of December 31, 2021 and the ratio of tangible common equity to tangible assets decreased to 7.94% as of December 31, 2022 from 8.93% as of December 31, 2021.
Book value per common share increased 3.3% to $40.26 as of December 30, 2022 from $38.99 as of December 31, 2021. Tangible book value per share increased 3.2% to $39.74 as of December 31, 2022 from $38.51 as of December 31, 2021. The growth in both book value per common share and tangible book value per share reflects net income earned during the year and the effect of stock repurchase activity throughout the year, partially offset by the increase in accumulated other comprehensive loss. Refer to the “Reconciliation of Non-GAAP Financial Measures” section of Item 7 of Part II of this report, Management's Discussion and Analysis of Financial Condition and Results of Operations for additional information.
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Loan Portfolio Analysis
The following table provides information regarding our loan portfolio as of the end of the last two years.
December 31,
(dollars in thousands) 2022 2021
Commercial loans
Commercial and industrial $ 126,108 3.6 % $ 96,008 3.3 %
Owner-occupied commercial real estate 61,836 1.8 % 66,732 2.3 %
Investor commercial real estate 93,121 2.7 % 28,019 1.0 %
Construction 181,966 5.2 % 136,619 4.7 %
Single tenant lease financing 939,240 26.8 % 865,854 30.0 %
Public finance 621,032 17.7 % 592,665 20.5 %
Healthcare finance 272,461 7.8 % 387,852 13.4 %
Small business lending 123,750 3.5 % 108,666 3.8 %
Franchise finance 299,835 8.6 % 81,448 2.8 %
Total commercial loans 2,719,349 77.7 % 2,363,863 81.8 %
Consumer loans
Residential mortgage 383,948 11.0 % 186,770 6.5 %
Home equity 24,712 0.7 % 17,665 0.6 %
Other consumer 324,598 9.3 % 265,478 9.2 %
Total consumer loans 733,258 21.0 % 469,913 16.3 %
Total commercial and consumer loans 3,452,607 98.7 % 2,833,776 98.1 %
Net deferred loan origination costs, premiums and discounts on purchased loans and other 1
46,794 1.3 % 53,886 1.9 %
Total loans 3,499,401 100.0 % 2,887,662 100.0 %
Allowance for loan losses (31,737) (27,841)
Net loans $ 3,467,664 $ 2,859,821
1 Includes carrying value adjustments of $32.5 million and $37.5 million related to terminated interest rate swaps associated with public finance loans as of December 31, 2022 and December 31, 2021, respectively.
Total loans were $3.5 billion as of December 31, 2022, an increase of $611.7 million, or 21.2%, compared to December 31, 2021. Total commercial loan balances were $2.7 billion, as of December 31, 2022, up $355.5 million, or 15.0%, from December 31, 2021. Total consumer loan balances were $733.3 million as of December 30, 2022, an increase of $263.3 million, or 56.0%, compared to December 31, 2021. The increase in commercial loan balances was driven primarily by growth in franchise finance, single tenant lease financing, investor commercial real estate, construction, commercial and industrial, public finance and small business lending balances. These increases were partially offset by net payoffs in healthcare finance and owner-occupied commercial real estate loans. The increase in consumer loan balances was due primarily to higher balances in the residential mortgage, recreational vehicles and trailers loan portfolios.
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Loan Maturities and Rate Sensitivity
The following table shows the contractual maturity distribution intervals (without regard to repayment schedules) of the outstanding loans in our portfolio as of December 31, 2022.
(amounts in thousands) Within 1 Year 1-5 Years 5-15 Years Beyond 15 Years Total
Commercial loans
Commercial and industrial $ 30,741 $ 68,563 $ 26,795 $ 9 $ 126,108
Owner-occupied commercial real estate 1,836 26,249 33,751 — 61,836
Investor commercial real estate 13,571 76,774 2,776 — 93,121
Construction 63,699 118,069 198 — 181,966
Single tenant lease financing 16,708 400,089 522,443 — 939,240
Public finance 49,056 118,646 453,330 — 621,032
Healthcare finance 5 27,234 245,222 — 272,461
Small business lending 798 5,274 78,386 39,292 123,750
Franchise finance 2,910 47,703 249,222 — 299,835
Total commercial loans 179,324 888,601 1,612,123 39,301 2,719,349
Consumer loans
Residential mortgage 306 1,279 30,352 352,011 383,948
Home equity 1,759 356 5,695 16,902 24,712
Other consumer 1,250 30,835 292,513 — 324,598
Total consumer loans 3,315 32,470 328,560 368,913 733,258
Total commercial and consumer loans $ 182,639 $ 921,071 $ 1,940,683 $ 408,214 $ 3,452,607
The following table shows the rate sensitivity of the outstanding loans in our portfolio by the contractual maturity distribution intervals as of December 31, 2022.
(amounts in thousands) Within 1 Year 1-5 Years 5-15 Years Beyond 15 Years Total
Fixed rate $ 73,869 $ 681,066 $ 1,820,429 $ 304,928 $ 2,880,292
Variable rate 108,770 240,005 120,254 103,286 572,315
Total commercial and consumer loans $ 182,639 $ 921,071 $ 1,940,683 $ 408,214 $ 3,452,607
Loan Approval Procedures and Authority
Our lending activities follow written, non-discriminatory policies with loan approval limits approved by the Board of Directors of the Bank. Loan officers have underwriting and approval authorization of varying amounts based on their lending experience and product type. Additionally, based on the amount of the loan, multiple approvals may be required. Based on the Bank’s legal lending limit, the maximum it could lend to any one borrower at December 31, 2022 was $74.7 million.
Our goal is to have a well-diversified and balanced loan portfolio. In order to manage our loan portfolio risk, we establish concentration limits by borrower, product type, industry and geography. To supplement our internal loan review resources, we have engaged independent third-party loan review groups, which are a key component of our overall risk management process related to credit administration.
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Asset Quality
December 31,
(dollars in thousands) 2022 2021
Nonaccrual loans
Commercial loans:
Commercial and industrial $ 51 $ 674
Owner-occupied commercial real estate 1,570 3,419
Single tenant lease financing — 1,100
Small business lending 4,764 959
Total commercial loans 6,385 6,152
Consumer loans:
Residential mortgage 1,048 1,226
Home equity — 14
Other consumer 17 9
Total consumer loans 1,065 1,249
Total nonaccrual loans 7,450 7,401
Past Due 90 days and accruing loans
Consumer loans:
Residential mortgage 79 —
Total consumer loans 79 —
Total past due 90 days and accruing loans 79 —
Total nonperforming loans 7,529 7,401
Other real estate owned
Single tenant lease financing — 1,188
Total other real estate owned — 1,188
Other nonperforming assets 42 29
Total nonperforming assets $ 7,571 $ 8,618
Total nonperforming loans to total loans 0.22 % 0.26 %
Total nonperforming assets to total assets 0.17 % 0.20 %
Allowance for loan losses to total loans 0.91 % 0.96 %
Nonaccrual loans to total loans 0.22 % 0.26 %
Allowance for loan losses to nonaccrual loans 426.0 % 376.2 %
A loan is designated as impaired, in accordance with the impairment accounting guidance when, based on current information or events, it is probable that we will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with delays generally not exceeding 90 days outstanding are not considered impaired. Certain nonaccrual and substantially all delinquent loans more than 90 days past due may be considered to be impaired. Generally, loans are placed on nonaccrual status at 90 days past due and accrued interest is reversed against earnings, unless the loan is well secured and in the process of collection. The accrual of interest on impaired and nonaccrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.
Impaired loans include nonperforming loans and also include loans modified in troubled debt restructurings (“TDRs”) where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection.
Nonperforming loans are comprised of total nonaccrual loans and loans 90 days past due and accruing. Nonperforming assets include nonperforming loans, other real estate owned and other nonperforming assets, which consist of
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repossessed assets. Nonperforming assets can also include investments that were classified as other-than-temporarily impaired; however, we did not own any investments classified as such during the two-year period ended December 31, 2022.
The increase in nonperforming loans of $0.1 million, or 1.7%, to $7.5 million as of December 31, 2022 compared to $7.4 million as of December 31, 2021 was due primarily to SBA loans placed on nonaccrual, partially offset by upgrades and payoffs in owner-occupied commercial real estate and single tenant lease financing during 2022. Total nonperforming assets declined by $1.0 million, or 12.2%, as of December 31, 2022 compared to December 31, 2021, due primarily to the upgrades and payoffs discussed above, as well as the decline in other real estate owned (“OREO”) discussed below.
The ratio of nonperforming loans to total loans decreased to 0.22% as of December 31, 2022 compared to 0.26% as of December 31, 2021 and the ratio of nonperforming assets to total assets decreased to 0.17% as of December 31, 2022, compared to 0.20% as of December 31, 2021.
Troubled Debt Restructurings
December 31,
(amounts in thousands) 2022 2021
Troubled debt restructurings – nonaccrual $ 2,864 $ 2,492
Troubled debt restructurings – performing 2,658 1,693
Total troubled debt restructurings $ 5,522 $ 4,185
Total TDRs as of December 31, 2022 were $5.5 million, up $1.3 million from December 31, 2021. The increase was driven by two portfolio residential mortgage loans and one small business lending loan classified as new TDRs during the twelve months ended December 31, 2022 with pre-modification and post-modification balances totaling $1.6 million.
As of December 31, 2022, the Company did not own any OREO. As of December 31, 2021, we had one commercial property in OREO with a carrying value of $1.2 million. During 2022, the Company reached a settlement agreement with the guarantor, which resulted in the Company recovering $1.2 million in excess of the carrying value of OREO.
Non-TDR Loan Modifications due to COVID-19
The “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” was issued by our banking regulators on March 22, 2020. This guidance encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19.
Additionally, Section 4013 of the CARES Act further provided that loan modifications due to the impact of COVID-19 that would otherwise be classified as TDRs under GAAP will not be so classified. Modifications within the scope of this relief were in effect from the period beginning March 1, 2020 until January 1, 2022.
In accordance with this guidance, we offered modifications to borrowers who were both impacted by COVID-19 and current on all principal and interest payments. As of December 31, 2022, the Company had no loans as non-TDR loan modifications due to COVID-19.
U.S. Small Business Administration Paycheck Protection Program
Section 1102 of the CARES Act created the Paycheck Protection Program (“PPP”), which is jointly administered by the SBA and the Department of the Treasury. The PPP is designed to provide a direct incentive to small businesses to retain employees on their payroll during COVID-19 as well as to help cover certain utility costs and rent payments. These loans may be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. In 2020, as a preferred SBA lender, we assisted our clients in participating in the PPP to help them maintain their workforce in an uncertain and challenging environment. The loans originated in 2020 bear an interest rate of 1.00%, and we received gross origination fees of approximately $2.3 million. The Company received this fee revenue from the SBA in late June 2020, and it was deferred over the life of the PPP loans and recognized as interest income. The Company began processing applications for forgiveness from this round beginning in December 2020 and 100% of loan balances had been forgiven as of December 31, 2021.
On December 27, 2020, $285 billion in additional funding was allocated to the PPP through the passage of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act. The Company began offering PPP loans again in 2021 and continued until the program’s funds were depleted. These loans may be forgiven if certain conditions are satisfied and
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are fully guaranteed by the SBA. The loans originated during 2021 bear an interest rate of 1.00% and the Company received gross origination fees of approximately $1.3 million. The Company received this fee revenue from the SBA during 2021, and it was deferred over the life of the PPP loans and recognized as interest income. The Company began processing applications for forgiveness from this round beginning in May 2021 and 100% of loan balances had been forgiven as of December 31, 2022.
The following table provides a rollforward of the activity of PPP loans through December 31, 2022.
(dollars in thousands)
Number of Loans Principal Balance Net Deferred Fees
Originated 447 $ 58,336 $ 1,851
Principal repaid (71) (7,184)
Net deferred fees recognized (1,253)
Balance, December 31, 2020 376 51,152 598
Originated 281 27,377 1,125
Principal repaid (634) (75,377)
Net deferred fees recognized (1,624)
Balance, December 31, 2021 23 3,152 99
Originated
Principal repaid (23) (3,152)
Net deferred fees recognized (99)
Balance, December 31, 2022 — $ — $ —
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Allowance for Loan Losses
The following table provides a rollforward of the allowance for loan losses for the twelve months ended December 31, 2022 and 2021.
December 31,
(amounts in thousands) 2022 2021
Balance, beginning of period $ 27,841 $ 29,484
Provision charged to expense 4,977 1,030
Losses charged off
Commercial and industrial — (28)
Single tenant lease financing — (2,391)
Small business lending (402) (222)
Residential mortgage — (6)
Home equity — (51)
Other consumer (2,358) (529)
Total losses charged off (2,760) (3,227)
Recoveries
Commercial and industrial 5 89
Single tenant lease financing 1,231 —
Small business lending 29 80
Residential mortgage 4 63
Home equity 139 7
Other consumer 271 315
Total recoveries 1,679 554
Balance, end of period $ 31,737 $ 27,841
Net charge-offs $ 1,081 $ 2,673
Net charge-offs (recoveries) to average loans (annualized)
Commercial and industrial (0.01) % (0.08) %
Single tenant lease financing (0.14) % 0.26 %
Small business lending 0.32 % 0.11 %
Total commercial net charge-offs (recoveries) (0.03) % 0.10 %
Residential mortgage — % (0.03) %
Home equity (0.68) % 0.24 %
Other consumer 0.43 % 0.29 %
Total consumer net charge-offs (recoveries) 0.32 % 0.04 %
Net charge-offs to average loans 0.03 % 0.09 %
The determination of the allowance for loan losses and the related provision for loan losses are components of our significant accounting policies as discussed within Note 1 to our consolidated financial statements. The adequacy of the allowance for loan losses and the provision are based on the review and evaluation of the loan portfolio and reflect management’s assessment of the risks and potential losses within the portfolio. This evaluation considers historical loss experience as well as qualitative factors such as economic and business conditions, portfolio growth, concentrations of credit in the portfolio, trends in risk grades, delinquencies within the portfolio and changes in our lending policies and practices.
Management actively monitors asset quality and, when appropriate, charges off loans against the allowance for loan losses. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from those in the assumptions used to determine the size of the allowance for loan losses.
The allowance for loan losses was $31.7 million as of December 31, 2022, compared to $27.8 million as of December 31, 2021. The increase in the allowance for loan losses compared to December 31, 2021 was due primarily to the growth in the overall loan portfolio, partially offset by a reduction in specific reserves. The decrease in the specific reserves was due to positive developments on certain monitored loans.
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The allowance for loan losses as a percentage of total loans, including and excluding PPP loans, was 0.91% as of December 31, 2022, compared to 0.96% and 0.97%, respectively, as of December 31, 2021. The allowance for loan losses as a percentage of nonperforming loans increased to 421.5% as of December 31, 2022, up from to 376.2% as of December 31, 2021. The provision for loans losses was $5.0 million for the twelve months ended December 31, 2022 compared to $1.0 million for the twelve months ended December 31, 2021. The increase in the provision for loan losses was due primarily to the increase in loan balances during the year. During 2022, we recorded net charge-offs of $1.1 million, compared to $2.7 million during 2021. The decrease in net charge-offs was due primarily to charge-offs that occurred during 2021 related to single tenant lease financing loans and a commercial and industrial relationship.
Investment Securities Portfolio
In managing our investment securities portfolio, management focuses on providing an adequate level of liquidity and managing long-term interest rate risk, while earning an adequate level of investment income without taking undue risk. Investment securities that are acquired and held principally for the purpose of selling them in the near term with the objective of generating economic profits on short-term differences in market characteristics are classified as “trading securities.” We did not classify any securities as trading securities as of December 31, 2022 and 2021. Securities that we intend to hold until maturity are classified as “held-to-maturity” securities, and all other investment securities are classified as “available-for-sale.” The carrying values of available-for-sale investment securities are adjusted for unrealized gains or losses as a valuation allowance and any gain or loss is reported on an after-tax basis as a component of other comprehensive income (loss).
We periodically evaluate each security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary. As of December 31, 2022, the unrealized losses in our investment securities portfolio were due primarily to interest rate changes. We have the ability and intent to hold all investment securities in an unrealized loss position resulting from interest rate changes to the earlier of the forecasted recovery or the maturity of the underlying investment security. As of December 31, 2022, we did not have any investment securities of a single issuer that exceeded 10% of shareholders’ equity. The term “issuer” excludes the U.S. Government and its sponsored agencies and corporations.
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The following tables present the amortized cost and approximate fair value of our investment securities portfolio by security type as of the end of the last two years.
(amounts in thousands) December 31,
Amortized Cost 2022 2021
Securities available-for-sale
U.S. Government-sponsored agencies $ 35,606 $ 50,013
Municipal securities 68,958 75,158
Agency mortgage-backed securities - residential 252,066 377,928
Agency mortgage-backed securities - commercial 17,142 36,024
Private label mortgage-backed securities - residential 11,777 15,902
Asset-backed securities 5,000 5,000
Corporate securities 45,634 46,482
Total securities available-for-sale 436,183 606,507
Securities held-to-maturity
Municipal securities 13,946 13,992
Agency mortgage-backed securities - residential 121,853 —
Agency mortgage-backed securities - commercial 5,818 —
Corporate securities 47,551 45,573
Total securities held-to-maturity 189,168 59,565
Total securities $ 625,351 $ 666,072
December 31,
Approximate Fair Value 2022 2021
Securities available-for-sale
U.S. Government-sponsored agencies $ 33,809 $ 49,040
Municipal securities 67,276 77,033
Agency mortgage-backed securities - residential 215,092 373,236
Agency mortgage-backed securities - commercial 15,840 36,326
Private label mortgage-backed securities - residential 10,455 16,021
Asset-backed securities 4,960 5,004
Corporate securities 42,952 46,384
Total securities available-for-sale 390,384 603,044
Securities held-to-maturity
Municipal securities 12,832 14,709
Agency mortgage-backed securities - residential 106,741 —
Agency mortgage-backed securities - commercial 4,552 —
Corporate securities 44,358 46,759
Total securities held-to-maturity 168,483 61,468
Total securities $ 558,867 $ 664,512
The approximate fair value of investment securities available-for-sale decreased $212.7 million, or 35.3%, to $390.4 million as of December 31, 2022 compared to $603.0 million as of December 31, 2021. The decrease was due primarily to a decrease of $158.1 million in agency mortgage-backed securities - residential, $20.5 million in agency mortgage-backed securities - commercial, $15.2 million in U.S. Government-sponsored agencies securities, $9.8 million in municipal securities, and $5.6 million in private label mortgage-backed securities - residential. The decrease in agency mortgage-backed securities - residential and agency mortgage-backed securities - commercial was due primarily to the transfer of $96.2 million of these securities from available-for-sale to held-to-maturity in the first quarter 2022, a decline in fair value resulting from the continued rise in interest rates, as well as net paydown activity. The decreases in other securities types were also driven by a decline in value resulting from the continued rise in interest rates, as well as net paydown activity.
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Investment Maturities
The following table summarizes the contractual maturity schedule of our investment securities at their amortized cost and their weighted average yields at December 31, 2022.
1 year or less More than 1 year
to 5 years More than 5 years
to 10 years More than 10 years Total
(dollars in thousands) Amortized
Cost Wtd.
Avg.
Yield Amortized
Cost Wtd.
Avg.
Yield Amortized
Cost Wtd.
Avg.
Yield Amortized
Cost Wtd.
Avg.
Yield Amortized
Cost Wtd.
Avg.
Yield
Securities:
U.S. Government-sponsored agencies
$ — 0.00 % $ 1,386 2.63 % $ 20,543 2.98 % $ 13,677 2.39 % $ 35,606 2.74 %
Municipal securities — 0.00 % 9,522 2.90 % 13,290 2.78 % 60,092 2.68 % 82,904 2.72 %
Agency mortgage-backed securities - residential — 0.00 % — 0.00 % 5,273 2.70 % 368,646 1.82 % 373,919 1.83 %
Agency mortgage-backed securities - commercial — 0.00 % 4,950 2.24 % 705 4.49 % 17,305 2.23 % 22,960 1.46 %
Private-label mortgage-backed securities - residential — 0.00 % — 0.00 % — 0.00 % 11,777 3.14 % 11,777 3.14 %
Asset-backed securities
— 0.00 % — 0.00 % 5,000 6.21 % — 0.00 % 5,000 6.21 %
Corporate securities — 0.00 % 35,066 5.39 % 58,119 4.51 % — 0.00 % 93,185 4.84 %
Total securities $ — 0.00 % $ 50,924 4.54 % $ 102,930 3.97 % $ 471,497 1.99 % $ 625,351 2.49 %
Accrued Income and Other Assets
Accrued income and other assets decreased $2.0 million, or 4.2%, to $44.9 million at December 31, 2022 compared to $46.9 million at December 31, 2021.
Deposits
The following table presents the composition of our deposit base as of the end of the last two years.
December 31,
(dollars in thousands) 2022 2021
Noninterest-bearing deposits $ 175,315 5.1 % $ 117,531 3.7 %
Interest-bearing demand deposits 335,611 9.8 % 247,967 7.8 %
Savings accounts 44,819 1.3 % 59,998 1.9 %
Money market accounts 1,418,599 41.2 % 1,483,936 46.7 %
BaaS - brokered deposits 13,607 0.4 % — — %
Certificates of deposits 874,490 25.4 % 970,107 30.5 %
Brokered deposits 578,804 16.8 % 299,420 9.4 %
Total $ 3,441,245 100.0 % $ 3,178,959 100.0 %
Total deposits increased $262.3 million, or 8.3%, to $3.4 billion as of December 31, 2022 compared to $3.2 billion as of December 31, 2021. This increase was due primarily to increases of $279.4 million, or 93.3%, in brokered deposits, $87.6 million, or 35.3%, in interest-bearing demand deposits, $57.8 million, or 49.2%, in noninterest-bearing deposits and $13.6 million in BaaS - brokered deposits partially offset by a decline of $95.6 million, or 9.9% in certificates of deposits, $65.3 million, or 4.4%, in money market accounts, and $15.2 million, or 25.3%, in savings accounts. The increase in brokered deposits was due to accessing certain deposit channels during the third and fourth quarters 2022 to support balance sheet liquidity and manage interest rate risk. The increase in the balance of interest-bearing demand deposits was due primarily to a new customer relationship with approximately $100.0 million in deposits with a contractual term of five years and a fixed rate of 1.15%. The increase in the balance of noninterest-bearing demand deposits was driven primarily by deposits associated with our commercial real estate construction and development lending, as well as an increase in non-brokered BaaS deposits. BaaS - brokered deposits increased due to certain fintech relationships being on-boarded during the fourth quarter 2022, which resulted in deposit inflows of $13.6 million at year end 2022. The decrease in the balance of certificates of deposits was due to the maturity of higher-cost balances and reduced pricing strategies designed to limit the volume of new production. The decrease in money market accounts was due primarily to certain customer activity that can be periodically volatile.
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The following tables present contractual interest rates paid on time deposits, their scheduled maturities, and the scheduled maturities for time deposits greater than $250,000.
Time Deposit Maturities at December 31, 2022
Period to Maturity Percentage of Total Certificate Accounts
(dollars in thousands) Less than 1
year > 1 year
to 2 years > 2 years
to 3 years More than
3 years Total
Interest Rate:
<1.00% $ 217,897 $ 73,320 $ 96,589 $ 92,519 $ 480,325 42.5 %
1.00% – 1.99% 89,076 19,076 10,559 1,323 120,034 10.6 %
2.00% – 2.99% 144,606 80,122 7,711 48,471 280,910 24.9 %
3.00% – 3.99% 99,011 21,034 8,983 26,695 155,723 13.8 %
4.00% – 4.99% 88,411 4,360 — — 92,771 8.2 %
Total $ 639,001 $ 197,912 $ 123,842 $ 169,008 $ 1,129,763 100.0 %
Time Deposit Maturities Greater than $250,000
(dollars in thousands) December 31, 2022
Maturity Period:
3 months or less $ 37,873
Over 3 through 6 months 64,277
Over 6 through 12 months 105,853
Over 12 months 276,697
Total $ 484,700
Federal Home Loan Bank Advances
Although deposits are the primary source of funds for our lending and investment activities and for general business purposes, we may use short-term advances from the Federal Home Loan Bank of Indianapolis (the “FHLB”) to manage liquidity needs and longer-term advances to supplement deposit growth and manage interest rate risk. The following table is a summary of FHLB borrowings for the periods indicated.
At or For The Twelve Months Ended December 31,
(dollars in thousands) 2022 2021 2020
Balance outstanding at end of period $ 614,928 $ 514,922 $ 514,916
Average amount outstanding during period 534,144 514,617 514,913
Maximum outstanding at any month end during period 615,928 514,922 514,916
Weighted average interest rate at end of period 1
2.82 % 1.65 % 1.30 %
Weighted average interest rate during period 1
2.15 % 1.68 % 1.78 %
1 Excludes the impact of interest rate swaps. Refer to Note 18 to our consolidated financial statements for additional information about derivative financial instruments.
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities were $14.5 million at December 31, 2022 compared to $30.5 million at December 31, 2021. The decrease in accrued expenses and other liabilities was due primarily to a $14.3 million decrease in derivative liabilities due to changes in fair value.
Liquidity and Capital Resources
Liquidity management is the process used by the Company to manage the continuing flow of funds necessary to meet its financial commitments on a timely basis and at a reasonable cost while also maintaining safe and sound operations.
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Liquidity, represented by cash and investment securities, is a product of the Company’s operating, investing and financing activities. The primary sources of funds are deposits, principal and interest payments on loans and investment securities, maturing loans and investment securities, access to wholesale funding sources and collateralized borrowings. While scheduled payments and maturities of loans and investment securities are relatively predictable sources of funds, deposit flows are greatly influenced by interest rates, general economic conditions and competition. Therefore, the Company supplements deposit growth and enhances interest rate risk management through borrowings and wholesale funding, which are generally advances from the Federal Home Loan Bank and brokered deposits.
The Company holds cash and investment securities that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operations and meet its financial commitments. At December 31, 2022, on a consolidated basis, the Company had $0.6 billion in cash and cash equivalents and investment securities available-for-sale, and $21.5 million in loans held-for-sale that were generally available for our cash needs. The Company can also generate funds from wholesale funding sources and collateralized borrowings. At December 31, 2022, the Bank had the ability to borrow an additional $473.9 million from the FHLB, the Federal Reserve and correspondent bank Fed Funds lines of credit.
The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its common shareholders and interest and principal on outstanding debt. The Company’s primary sources of funds are cash maintained at the holding company level and dividends from the Bank, the payment of which is subject to regulatory limits. At December 31, 2022, the Company, on an unconsolidated basis, had $22.3 million in cash generally available for its cash needs, which is in excess of its current annual regular shareholder dividend and operating expenses.
The Company uses its sources of funds primarily to meet ongoing financial commitments, including withdrawals by depositors, credit commitments to borrowers, operating expenses and capital expenditures. At December 31, 2022, approved outstanding loan commitments, including unused lines of credit and standby letters of credit, amounted to $485.4 million. Certificates of deposits and brokered certificates of deposits scheduled to mature in one year or less at December 31, 2022 totaled $639.0 million.
Management is not aware of any other events or regulatory requirements that, if implemented, are likely to have a material effect on either the Company’s or the Bank’s liquidity.
The following table presents the Company’s significant contractual obligations as of December 31, 2022.
Payments Due In
(dollars in thousands) Note Reference Less than 1 year 1-3 years 3-5 years More than 5 years Total
Premises and equipment 5 $ 4,200 $ — $ — $ — $ 4,200
Deposits and brokered deposits without stated maturity 1
8 2,311,482 — — — 2,311,482
Certificates of deposits and brokered deposits 1,2
8 639,002 321,754 169,007 — 1,129,763
FHLB advances 1,2
9 145,000 235,009 110,000 124,919 614,928
Subordinated debt 1
10 — — — 107,000 107,000
Total contractual obligations $ 3,099,684 $ 556,763 $ 279,007 $ 231,919 $ 4,167,373
1 Amounts do not include associated interest payments.
2 Amounts do not include the effect of interest rate swaps used to convert short-term advances into long-term funding.
In October 2021, the Company’s Board of Directors approved a stock repurchase program authorizing the repurchase of up to $30.0 million of the Company’s outstanding common stock from time to time on the open market or in privately negotiated transactions. In October 2022, the Company’s Board of Directors increased the authorization to $35.0 million. Under this program, The Company repurchased a total of 855,956 shares at an average price of $36.31 per share under the program through December 19, 2022.
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On December 19, 2022, the Company's Board of Directors approved a new stock repurchase program authorizing the repurchase of up to $25.0 million of our outstanding common stock from time to time on the open market or in privately negotiated transactions. The stock repurchase authorization replaced the Company’s previously announced stock repurchase program and is scheduled to expire on December 31, 2023. Various factors determine the amount and timing of our share repurchases, including our capital requirements, organic growth and other strategic opportunities, economic and market conditions (including the trading price of our stock), and regulatory and legal considerations. See Part II, Item 5, of this report for information regarding recent repurchase activity and our remaining authority under the program.
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Reconciliation of Non-GAAP Financial Measures
This Management's Discussion and Analysis contains financial information determined by methods other than in accordance with GAAP. Non-GAAP financial measures, specifically tangible common equity, tangible assets, tangible book value per common share, tangible common equity to tangible assets, average tangible common equity, return on average tangible common equity, total interest income - FTE, net interest income - FTE and net interest margin - FTE are used by the Company's management to measure the strength of its capital and analyze profitability, including its ability to generate earnings on tangible capital invested by its shareholders. The Company also believes that it is standard practice in the banking industry to present total interest income, net interest income and net interest margin on a fully-taxable equivalent basis, as those measures provide useful information for peer comparisons. Although the Company believes these non-GAAP financial measures provide a greater understanding of its business, they should not be considered a substitute for financial measures determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP financial measures that may be presented by other companies. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in the following table for the last three completed fiscal years ended on December 31.
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(dollars in thousands, except share and per share data) At or For The Twelve Months Ended December 31,
2022 2021 2020
Total equity - GAAP $ 364,974 $ 380,338 $ 330,944
Adjustments:
Goodwill (4,687) (4,687) (4,687)
Tangible common equity $ 360,287 $ 375,651 $ 326,257
Total assets - GAAP $ 4,543,104 $ 4,210,994 $ 4,246,156
Adjustments:
Goodwill (4,687) (4,687) (4,687)
Tangible assets $ 4,538,417 $ 4,206,307 $ 4,241,469
Total common shares outstanding 9,065,883 9,754,455 9,800,569
Book value per common share $ 40.26 $ 38.99 $ 33.77
Effect of goodwill (0.52) (0.48) (0.48)
Tangible book value per common share $ 39.74 $ 38.51 $ 33.29
Total shareholders’ equity to assets 8.03 % 9.03 % 7.79 %
Effect of goodwill (0.09 %) (0.10 %) (0.10 %)
Tangible common equity to tangible assets 7.94 % 8.93 % 7.69 %
Total average equity - GAAP $ 372,844 $ 358,105 $ 313,763
Adjustments:
Average goodwill (4,687) (4,687) (4,687)
Average tangible common equity $ 368,157 $ 353,418 $ 309,076
Return on average shareholders' equity 9.53 % 13.44 % 9.39 %
Effect of goodwill 0.12 % 0.17 % 0.14 %
Return on average tangible common equity 9.65 % 13.61 % 9.53 %
Total interest income $ 156,908 $ 133,883 $ 136,859
Adjustments:
Fully-taxable equivalent adjustments 1
5,355 5,453 5,796
Total interest income - FTE $ 162,263 $ 139,336 $ 142,655
Net interest income $ 97,093 $ 86,556 $ 64,541
Adjustments:
Fully-taxable equivalent adjustments 1
5,355 5,453 5,796
Net interest income - FTE $ 102,448 $ 92,009 $ 70,337
Net interest margin 2.41 % 2.11 % 1.55 %
Effect of fully-taxable equivalent adjustments 1
0.13 % 0.14 % 0.13 %
Net interest margin - FTE 2.54 % 2.25 % 1.68 %
1 Assuming a 21% tax rate
Critical Accounting Policies and Estimates
Allowance for Loan Losses. We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of our consolidated financial statements. An estimate of potential losses inherent in the loan portfolio is determined and an allowance for those losses is established by considering factors including historical loss rates, expected cash flows, estimated collateral values, and other qualitative factors. The allowance for loan losses represents management’s best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. Management evaluates the allowance for loan losses quarterly. If the underlying assumptions later prove to be inaccurate based on subsequent loss evaluations, the allowance for loan losses is adjusted.
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Management estimates the appropriate level of allowance for loan losses by separately evaluating impaired and non-impaired loans. A specific allowance is assigned to an impaired loan when expected cash flows or collateral do not justify the carrying amount of the loan. The methodology used to assign an allowance to a non-impaired loan is more subjective. Generally, the allowance assigned to non-impaired loans is determined by applying historical loss rates to existing loans with similar risk characteristics, adjusted for qualitative factors including changes in economic and business conditions, unemployment rates, concentrations of credit, changes in the nature and volume of the portfolio, terms of loans, risk grades, trends in charge-offs and recoveries, trends in delinquencies, nonaccrual loans, and impaired loans, and changes in lending policies and procedures. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is periodically assessed and adjusted when appropriate. Notwithstanding these procedures, there still exists the possibility that the assessment could prove to be significantly incorrect and that an immediate adjustment to the allowance for loan losses would be required.
Investments in Debt and Equity Securities. We classify investments in debt and equity securities as available-for-sale in accordance with Accounting Standards Codification, or ASC, Topic 320, “Accounting for Certain Investments in Debt and Equity Securities.” Securities classified as held-to-maturity would be recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. Fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of pricing sources, including Reuters/EJV, Interactive Data and Standard & Poors. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting our financial position, results of operations and cash flows. If the estimated value of investments is less than the cost or amortized cost, management evaluates whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and management determines that the impairment is other-than-temporary, a further determination is made as to the portion of impairment that is related to credit loss. The impairment of the investment that is related to the credit loss is expensed in the period in which the event or change occurred. The remainder of the impairment is recorded in other comprehensive income (loss).
Other Real Estate Owned. OREO acquired through loan foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the OREO or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation adjustment is recorded through noninterest expense. Net operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of OREO and foreclosed assets are netted and posted through noninterest income.
Impairment of Goodwill. As a result of a previous acquisition by the Company, goodwill, an intangible asset with an indefinite life, is reflected on the balance sheet. Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently.
Deferred Income Tax Assets/Liabilities. Our net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income. Deferred tax assets and liabilities are established for these items as they arise. From an accounting standpoint, deferred tax assets are reviewed to determine if they are realizable based on the historical level of taxable income, estimates of future taxable income and the reversals of deferred tax liabilities. In most cases, the realization of the deferred tax asset is based on future profitability. If we were to experience net operating losses for tax purposes in a future period, the realization of deferred tax assets would be evaluated for a potential valuation reserve.
Recent Accounting Pronouncements
Refer to Note 22 to our consolidated financial statements.
Off-Balance Sheet Arrangements
In the ordinary course of business, we may enter into financial transactions to extend credit, engage in interest rate swaps or other forms of commitments that may be considered off-balance sheet arrangements. Interest rate swaps were arranged to receive hedge accounting treatment and were classified as either fair value or cash flow hedges. Fair value hedges were purchased to convert certain fixed rate assets to floating rate. Cash flow hedges were used to convert certain variable rate liabilities into fixed rate liabilities. At December 31, 2022 and December 31, 2021, we had interest rate swaps with a notional amount of $260.0 million. Additionally, we may enter into forward contracts relating to our mortgage banking business to
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hedge the exposures we have from commitments to extend new residential mortgage loans to our customers and from our mortgage loans held-for-sale. At December 31, 2022 and December 31, 2021, we had commitments to sell residential real estate loans of $17.0 million and $72.8 million, respectively. These contracts mature in less than one year. Refer to Note 18 to our consolidated financial statements for additional information about derivative financial instruments.
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