What changed in this filing

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Item 7. Management’s Discussion and Analysis

2024-02-22 compared with 2023-02-23 · 306 added, 236 removed, 677 unchanged (44% of the section changed)

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The Bank specializes in providing lending and deposit related services to small businesses nationwide.

The Bank identifies and extends lending to credit-worthy borrowers both within specific industries, also called verticals, through expertise within those industries, and more broadly to select borrowers outside of those industries.

A significant portion of the loans originated by the Bank are partially guaranteed by the U.S.

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Department of Agriculture (“USDA”) Rural Energy for America Program (“REAP”), Water and Environmental Program (“WEP”), Business & Industry (“B&I”) and Community Facilities loan programs.

The Company’s wholly owned material subsidiaries are the Bank, Government Loan Solutions (“GLS”), Live Oak Grove, LLC (“Grove”), Live Oak Ventures, Inc.

These loans are to small businesses and professionals with what the Bank believes are lower risk characteristics.

Industries, or “verticals,” on which the Bank focuses its lending efforts are carefully selected.

The Bank also lends more broadly to select borrowers outside of those verticals.

As of December 31, 2023, the Company’s wholly owned material subsidiaries were the Bank, Government Loan Solutions (“GLS”), Live Oak Grove, LLC (“Grove”), Live Oak Ventures, Inc.

(“Live Oak Ventures”) and Canapi Advisors, LLC (“Canapi Advisors”).

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GLS primarily provides services in connection with the settlement, accounting, and securitization processes for government guaranteed loans, including loans originated under the SBA 7(a) loan programs and USDA guaranteed loans.

The Grove provides Company employees and business visitors an on-site restaurant location.

The Grove provides Company employees and business visitors with on-site dining.

Live Oak Ventures’ purpose is investing in businesses that align with the Company's strategic initiative to be a leader in financial technology.

Canapi Advisors provides investment advisory services to a series of funds (the “Canapi Funds”) focused on providing venture capital to new and emerging financial technology companies.

The Bank’s wholly owned subsidiaries are Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”), Live Oak Private Wealth, LLC (“Live Oak Private Wealth”) and Tiburon Land Holdings, LLC (“TLH”).

As of December 31, 2023, the Bank’s wholly owned subsidiaries were Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”), Live Oak Private Wealth, LLC (“Live Oak Private Wealth”) and Tiburon Land Holdings, LLC (“TLH”).

Live Oak Number One, Inc.

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JAM was previously a wholly owned subsidiary of Live Oak Private Wealth.

TLH was formed in the third quarter of 2022 to hold land adjacent to the Bank's headquarters consisting of wetlands and other protected property for the use and enjoyment of the Bank's employees and customers.

The Company generates revenue primarily from net interest income and secondarily through origination and sale of government guaranteed loans.

TLH holds land adjacent to the Bank's headquarters consisting of wetlands and other protected property for the use and enjoyment of the Bank's employees and customers.

The Company generates revenue primarily from net interest income and secondarily through the origination and sale of government guaranteed loans.

Income from the retention of loans is comprised principally of interest income.

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Tangible book value (1)

20.15 18.32 16.31

Performance Ratios

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Efficiency ratio (1)

70.65 55.57 50.55

Noninterest income to total revenue 24.45 42.09 35.06

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Net charge-offs (2)

$ 21,373 $ 7,961 $ 3,932

Net charge-offs to average loans and leases held for investment (2) (3)

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Unguaranteed nonperforming historical cost loans and leases, to loans and leases held for investment (2)

0.48 % 0.27 % 0.33 %

Nonperforming loans at fair value (4)

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Unguaranteed nonperforming fair value loans to loans held for investment (4)

1.86 % 1.35 % 0.74 %

Consolidated Capital Ratios

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(2) Loans and leases at historical cost only (excludes loans measured at fair value).

(3) Annual net charge-offs as a percentage of annual average loans and leases held for investment.

(4) The year ended December 31, 2020 excludes one $6.1 million hotel loan classified as held for sale.

(3) Annual net charge-offs as a percentage of annual average loans and leases held for investment, at amortized cost.

(4) Loans accounted for under the fair value option only (excludes loans and leases carried at historical cost).

The following is a summary of the Company's financial highlights and events for 2023:

• Total assets were $9.86 billion at December 31, 2022 and $8.21 billion at December 31, 2021, a 20.0% increase.

Asset growth was driven by significant deposit growth combined with gains from the sale of fintech investments, as discussed below, which was bolstered by substantial loan growth, investments and higher cash balances.

• Loans and leases held for sale and investment increased by $1.12 billion, or 14.2%.

Excluding PPP loans, total loans and leases increased $1.51 billion, or 23.7%, to $7.89 billion at the end of 2022.

Total loan originations in 2022 were $4.01 billion compared to $4.48 billion in 2021.

Excluding PPP loans, total 2022 originations increased by $74.4 million, or 1.9%, compared to 2021.

• Total deposits increased by $1.77 billion, or 24.9%, to $8.88 billion at the end of 2022.

• Net income increased $9.2 million, or 5.5%, from $167.0 million, or $3.71 per diluted share, to $176.2 million, or $3.92 per diluted share, with key drivers of higher levels of reported net income outlined more fully in the opening to the section titled “Results of Operations.”

• In a year of significant Federal Reserve rate increases, net interest margin remained resilient at 3.87% for 2022 as compared to 3.86% for 2021, with net interest income increasing by $30.7 million, or 10.3%.

• Income from equity method and equity security investments increased $104.6 million.

This increase was driven by equity method investment income of $149.2 million arising from gains related to the 2022 sales of the Company’s investments in Finxact, Inc.

(“Finxact”) and Payrailz, LLC (“Payrailz”).

Partially offsetting the increase in equity method income was a decrease in equity security investment gains related principally to the 2021 Greenlight Financial Technologies, Inc.

(“Greenlight”) gain of $44.1 million.

• Net gains on sales of loans decreased $24.0 million, or 35.7%.

This decrease was the result of weaker overall market conditions in 2022 making the sale of loans less profitable than retaining them for a longer period of time.

The volume of guaranteed loans sold decreased $87.6 million, or 13.1%, in 2022 as compared to 2021 while the average net gain on loan sale premium decreased from 110% to 105% in the same comparative periods, respectively.

• The provision for loan and lease losses increased $25.7 million, largely the result of significant held for investment loan growth combined with charge-off experience impacts and changes in the macroeconomic outlook.

Total nonperforming unguaranteed loans and leases as a percentage of total loans and leases held for investment decreased from 0.33% at the end of 2021 to 0.27% at the end of 2022.

Total loan originations in 2023 were $3.95 billion compared to $4.01 billion in 2022, a decrease of 1.5%.

Substantial loan production in 2023 was the primary driver of growth in total assets which increased to $11.27 billion at December 31, 2023 as compared to $9.86 billion at December 31, 2022 , for an increase of $1.42 billion, or 14.4%.

• Supporting loan growth, total deposits increased by $1.39 billion, or 15.6%, to $10.28 billion at the end of 2023.

• Net income decreased $102.3 million, or 58.1%, from $176.2 million, or $3.92 per diluted share, to $73.9 million, or $1.64 per diluted share.

This decrease was primarily the result of significant one-time gains in 2022 from the sale of two equity method investments.

A detailed overview of key drivers of year over year changes in reported net income is outlined more fully in the opening to the section titled “Results of Operations.”

• The banking crisis in the spring of 2023 temporarily drove strategically higher levels of liquidity and affected the Company’s offering of products which provide depositors with FDIC insurance in excess of $250 thousand, and heightened industry attention to uninsured deposit risk.

At December 31, 2023 the Company’s uninsured deposits were $1.46 billion, or 14.2%, of total deposits.

• In the second consecutive year of continued Federal Reserve rate increases, net interest margin declined to 3.35% for 2023 as compared to 3.87% for 2022.

This decline in net interest margin was outpaced by 2023 loan growth which largely drove an increase in net interest income of $17.8 million, or 5.4%.

• In the third quarter of 2023, the Company changed the valuation techniques used to estimate the fair value of its servicing rights and loans measured at fair value as a result of rising interest rates and their impacts on market conditions.

These revisions were made to provide estimates which the Company believes are more representative of fair value.

These estimate changes were implemented as of July 1, 2023 and resulted in one-time adjustments on that date to increase the estimated value of the servicing asset by $13.7 million and loans measured at fair value by $1.3 million, or a total impact to noninterest income of $15.0 million.

• The provision for loan and lease credit losses increased $10.4 million, largely the result of significant held for investment loan growth combined with charge-off experience impacts.

Total nonperforming unguaranteed loans and leases as a percentage of total loans and leases held for investment, both excluding loans measured at fair value, increased from 0.27% at the end of 2022 to 0.48% at the end of 2023.

Net charge-offs as a percentage of average held for investment loans and leases carried at historical cost, for the years ended December 31, 2023 and 2022 , were 0.28% and 0.14%, respectively.

• Salaries and employee benefits increased by $45.9 million, or 36.7%, during 2022.

Excluding special bonus accruals for fintech investment gains in 2022 and 2021, as discussed above, the year-over-year increase was $39.4 million, or 32.6%.

This increase was principally related to continued investment in human resources to support strategic and long term growth initiatives.

Business Outlook

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See “Important Note Regarding Forward-Looking Statements” in this Report for more information on forward-looking statements.

The Company's results for 2022 demonstrated a continuation of solid growth momentum in building predictable long-term earnings, proactive credit risk management and continued investment into growth initiatives.

In 2022, the Company recognized $149.2 million in cash gains from fintech investments and $95.9 million in additional capital to support future growth.

The Company's results for 2023 demonstrated a continuation of solid growth momentum in building predictable long-term core earnings, proactive credit risk management and a resilient business model.

Management continues to focus on building recurring revenue streams, promoting change within the financial technology industry, and building out selected existing verticals while adding new verticals to the Company's business model.

Management anticipates that the Company's held-for-sale and held-for-investment loan portfolios will continue to grow as a result of healthy origination volumes and higher levels of loan retention that are intended to continue to promote long-term recurring revenue and profitability, including the continued pursuit of potential opportunities in conventional lending outside of SBA or other government guarantee programs.

Management anticipates that the Company's loan and lease portfolios will continue to grow as a result of its proven customer first focus combined with the continued pursuit of expanded small business lending within the SBA and other government programs as well as conventional lending.

Non-GAAP Financial Measures

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Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company's results or financial condition as reported under GAAP.

Management’s non-GAAP measures are not necessarily comparable to similar named measures represented by other companies, as they may be calculated differently.

Management’s non-GAAP measures are not necessarily comparable to similarly named measures represented by other companies, as they may be calculated differently.

Results of Operations

The Company reported net income of $73.9 million, or $1.64 per diluted share, for 2023 compared to $176.2 million, or $3.92 per diluted share, for 2022.

This increase in net income was primarily attributable to the following items:

• Equity method investments income increased $146.0 million, due to a $120.8 million gain related to the Company’s sale of its investment in Finxact combined with a $28.4 million gain related to the Company’s sale of its investment in Payrailz in the second and third quarters of 2022, respectively;

• Increase in net interest income of $30.7 million, or 10.3%, largely from increases in volume for the held for investment loan and lease portfolio.

The growth in net interest income was mitigated by rising average cost of funds outpacing the average yield on interest earning assets combined with growth in interest bearing liabilities.

• A decrease in income tax expense of $9.7 million, or 22.1%, primarily related to a higher level of tax credits in 2022.

Key factors partially offsetting the year-over-year increase in net income were:

• Decreased equity security investment gains of $41.4 million, largely due to the Company’s $44.1 million second quarter of 2021 fair value gain from its investment in Greenlight;

• Provision for loan and lease credit losses increased $25.7 million, or 169.2%, to $40.9 million for 2022, compared to $15.2 million for 2021.

The level of provision expense in 2022 was primarily the result of loan growth, charge-off experience impacts, increased levels of loans classified as held for investment and changes in the macroeconomic outlook;

• Decreased net gains on sales of loans of $24.0 million, or 35.7%, principally the result of weaker overall market conditions in 2022;

• An increase in noninterest expense of $83.2 million, or 36.0%, comprised principally of increased salaries and employee benefits up $45.9 million, or 36.7%, advertising and marketing expense up $5.5 million, or 110.8%, technology expense up $5.8 million, or 25.5%, contributions and donations up $4.1 million, or 177.2%;

and increased impairment charges $13.0 million related to renewable energy tax credits.

The decrease in net income was principally due to the decrease in equity method investment income of $150.2 million, primarily a result of the aggregate $149.2 million gains included in equity method investments income in 2022 related to the sales of the Company’s investments in Finxact, Inc.

(“Finxact”) and Payrailz, LLC (“Payrailz”).

To a lesser extent, the decrease was also influenced by a $10.4 million increase in the provision for loan and lease credit losses, which was primarily the result of loan growth and charge-off related impacts.

Key factors partially offsetting the year-over-year decrease in net income were:

• Increase in net interest income of $17.8 million, or 5.4%, driven by increases in loan volumes, partially mitigated by a decrease in net interest margin arising from an increase in interest-bearing liabilities combined with average cost of funds outpacing the average yield on interest-earning assets;

• Increase in the loan servicing asset revaluation income of $21.5 million, principally due to the third quarter of 2023 change in valuation techniques used to estimate the fair value of servicing rights;

• A decrease in income tax expense of $25.2 million, or 73.8%, primarily related to decreased pretax income.

Net Interest Income and Margin

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Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume changes.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as “rate changes.” As a bank without a branch network, the Bank gathers deposits over the Internet and in the community in which it is headquartered.

Due to the nature of a branchless bank and the relatively low overhead required for deposit gathering, the rates the Bank offers are generally above the industry average.

Due to the nature of a branchless bank and the relatively low overhead required for deposit gathering, the rates the Bank offers are generally competitive with other digital deposit product offerings.

For 2023, net interest income increased $17.8 million, or 5.4%, to $345.3 million compared to $327.5 million for 2022.

This increase was principally due to the significant growth in the held for investment loan and lease portfolio outpacing moderate growth in interest-bearing liabilities combined with an increase in average cost of funds which exceeded the increase in average yield on interest-earning assets.

Excluding PPP loan impacts of $7.0 million, comprised of amortization of net deferred fees combined with a 1% annualized interest rate less the related interest expense from funding activity, net interest income increased by $75.1 million.

Average interest-earning assets increased by $776.3 million, or 10.1%, to $8.46 billion for 2022, compared to $7.68 billion for 2021, while the yield on average interest-earning assets increased fifty-five basis points to 5.25%.

The cost of funds on interest-bearing liabilities for 2022 increased sixty basis points to 1.47%, and the average balance of interest-bearing liabilities increased by $529.1 million, or 7.1%, over 2021.

The increase in average interest-bearing liabilities was also largely driven by funding for significant loan originations and growth.

This increase was muted by a $884.7 million reduction in average borrowings largely related to Paycheck Protection Program Liquidity Facility, or PPPLF, repayments in 2022.

As indicated in the rate/volume table below, the overall increase discussed above is reflected in increased interest income of $83.2 million as compared to an increase in interest expense of $52.5 million for 2022 compared to 2021.

For 2021 compared to 2022, net interest margin increased from 3.86% to 3.87%.

During 2022 and through February of 2023, the Federal Reserve increased the federal funds upper target rate by 425 basis points and 25 basis points, respectively, to 4.75%.

In the Federal Reserve’s February 2023 press release it stated that it anticipates that ongoing increases to target range will be appropriate.

In December 2022, the Federal Reserve released its most current federal funds target rate midpoint projections which implied an increase of the median Federal Funds rate to 5.1% by the end of 2023 and a decrease of approximately 100 basis points to 4.1% by the end of 2024.

There can be no assurance that any further increases in the federal funds rate will occur, and if they do, the amount and timing of actual increases are subject to change.

Quantitative and Qualitative Disclosures About Market Risk for information about the Company’s sensitivity to interest rates.

This increase was principally due to the significant growth in the held for investment loan and lease portfolio outpacing growth in interest-bearing liabilities offset by an increase in average cost of funds which exceeded the increase in average yield on interest-earning assets.

Excluding PPP loan impacts, comprised of amortization of net deferred fees combined with a 1% annualized interest rate less the related interest expense from funding activity, net interest income increased by $24.3 million.

Average interest-earning assets increased by $1.84 billion, or 21.8%, to $10.30 billion for 2023 , compared to $8.46 billion for 2022, while the yield on average interest-earning assets increased 143 basis points to 6.68%.

The cost of funds on interest-bearing liabilities for 2023 increased 212 basis points to 3.59%, and the average balance of interest-bearing liabilities increased by $1.57 billion, or 19.6%, over 2022.

The increase in average interest-bearing liabilities was largely driven by funding for significant loan originations and growth as well as maintenance of the Company's target liquidity profile.

As indicated in the rate/volume table below, the overall increase discussed above is reflected in increased interest income of $243.8 million outpacing growth in interest expense of $226.0 million for 2023 compared to 2022.

The net interest margin decreased from 3.87% for 2022 to 3.35% for 2023 .

During 2023, the Federal Reserve increased the federal funds upper target rate by 100 basis points to 5.5%.

In December 2023, the Federal Reserve released its most current federal funds target rate midpoint projections which implied a decrease of the median Federal Funds rate to 4.6% by the end of 2024 and a decrease of approximately 100 basis points to 3.6% by the end of 2025.

There can be no assurance that any further increases or decreases in the Federal Funds rate will occur, and if they do, the amount and timing of actual adjustments are subject to change.

Average Balances and Yields.

The following table presents information regarding average balances for assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amount of interest expense on average interest-bearing liabilities, and the resulting average yields and costs.

The following table presents information regarding average balances for assets and liabilities, the total dollar amounts of interest income from average interest-earning assets, the total dollar amount of interest expense on average interest-bearing liabilities, and the resulting average yields and costs.

The yields and costs for the periods indicated are derived by dividing the income or expense by the average balances for assets or liabilities, respectively, for the periods presented.

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For 2023, the provision for loan and lease credit losses was $51.3 million compared to $40.9 million in 2022, an increase of $10.4 million.

The 2022 increase in provision was primarily the result of loan growth, charge-off experience impacts, increased levels of loans classified as held for investment and changes in the macroeconomic outlook.

Loans and leases held for investment at historical cost were $6.85 billion as of December 31, 2022, an increase of $1.97 billion, or 40.5%, compared to December 31, 2021.

Excluding PPP loans and net unearned fees on those loans, the balance in loans and leases held for investment at historical cost was $6.84 billion at December 31, 2022, an increase of $2.22 billion, or 48.2%, over December 31, 2021.

Net charge-offs for loans and leases carried at historical cost were $8.0 million, or 0.14% of average loans and leases held for investment, carried at hist orical cost, for 2022, compared to net charge-offs of $3.9 million, or 0.08%, for 2021, an increase of $4.0 million, or 102.5%.

The increase in net charge-offs for 2022 was anticipated following the expiration of government subsidies and the return to expected losses consistent with pre-Covid historical experience.

Net charg e-offs are a key element of historical experience in the Company's estimation of the allowance for credit losses on loans and leases.

The 2023 increase in provision was primarily the result of loan growth and charge-off related impacts.

Loans and leases held for investment at historical cost were $8.25 billion as of De cember 31, 2023, an increase of $1.40 billion , or 20.4%, c ompared to December 31, 2022.

Net charge-offs for loans and leases carried at historical cost were $21.4 million, or 0.28% of average loans and leases held for investment at amortized cost, excluding loans measured at fair value, for 2023, compared to net charge-offs of $8.0 million, or 0.14%, for 2022, an increase of $13.4 million, or 168.5%.

The increase in net charge-offs for 2023 was primarily isolated to six relationships.

Net charge-offs are a key element of historical experience in the Company's estimation of the allowance for credit lo sses on loans and leases.

In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $7.2 million and $6.7 million accounted for under the fair value option at December 31, 2023 and 2022, respectively, totaled $39.3 million, which was 0.48% of the held for investment loan and lease portfolio carried at historical cost at December 31, 2023, compared to $18.8 million, or 0.27% of loans and leases held for investment carried at historical cost at December 31, 2022.

Nonperforming loans and leases carried at historical cost which are not guaranteed by the SBA or USDA were 0.27% and 0.35% of the historical cost portion of the held for investment loan and lease portfolio, excluding PPP loans, at December 31, 2022 and 2021, respectively.

Noninterest Income

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Revenue from the sale of loans depends upon the volume, maturity structure and rates of underlying loans as well as the pricing and availability of funds in the secondary markets prevailing in the period between completed loan funding and closing of sale.

In addition, the loan servicing revaluation is significantly impacted by changes in market rates and other underlying assumptions such as prepayment speeds and default rates.

Net gain (loss) on loans accounted for under the fair value option is also significantly impacted by changes in market rates, prepayment speeds and inherent credit risk.

In addition, the loan servicing asset revaluation is significantly impacted by changes in market rates and other underlying assumptions such as prepayment speeds and default rates.

Net (loss) gain on loans accounted for under the fair value option is also significantly impacted by changes in market rates, prepayment speeds and inherent credit risk.

Other less consistent elements of noninterest income include gains and losses on investments.

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Net gains on sales of loans 46,545 43,244 67,280 3,301 7.6 (24,036) (35.7)

Net gain (loss) on loans accounted for under the fair value option 1,046 4,257 (13,083) (3,211) (75.43) 17,340 132.54

Equity method investments income (loss) 144,250 (1,716) (14,691) 145,966 8,506.18 12,975 88.32

Equity security investments gains (losses), net 3,355 44,752 14,909 (41,397) (92.50) 29,843 200.17

Gain on sale of investment securities available-for-sale, net — — 1,880 — — (1,880) (100.00)

Net (loss) gain on loans accounted for under the fair value option (3,539) 1,046 4,257 (4,585) (438.3) (3,211) (75.4)

Equity method investments (loss) income (5,994) 144,250 (1,716) (150,244) (104.2) 145,966 8,506.2

Equity security investments (losses) gains, net (969) 3,355 44,752 (4,324) (128.9) (41,397) (92.5)

Lease income 10,007 10,084 10,263 (77) (0.8) (179) (1.7)

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Years ended December 31, 2023 vs.

For 2022 , noninterest income increased by $77.8 million, or 48.6%, compared to 2021 .

The increase from the prior year is primarily the result of an increase in equity method investment income of $146.0 million, due to a $120.8 million gain related to the Company’s sale of its investment in Finxact combined with a $28.4 million gain related to the Company’s sale of its investment in Payrailz in the second and third quarters of 2022, respectively.

Partially offsetting this increase is d ecreased equity security investment gains, largely due to the Company’s $44.1 million second quarter 2021 fair value gain from its investment in Greenlight combined with decreased net gains on sales of loans of $24.0 million and higher losses on loan servicing asset revaluation of $4.9 million.

For 2023 , noninterest income decreased by $126.3 million, or 53.1%, compared to 2022 .

The decrease over the prior year is primarily a result of the aggregate $149.2 million in Finxact and Payrailz gains included in equity method investments income in 2022.

To a lesser extent, the decrease was also influenced by a $4.6 million negative change in net losses on loans accounted for under the fair value option and decreased equity security investments gains of $4.3 million.

Partially offsetting the decrease over 2022 was an increased net gain of $21.5 million related to the loan servicing asset revaluation combined with increased net gains on sales of loans of $3.3 million and a $3.2 million increase in management fee income generated by Canapi Advisors.

Canapi Advisors is included in the Company's Fintech segment.

The tables below reflect loan and lease production, sales of guaranteed loans and the aggregate balance in guaranteed loans sold that are being serviced.

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The Company revalues its serviced loan portfolio at least quarterly.

The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as adequate compensation for servicing, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.

For 2022, there was a negative loan servicing revaluation adjustment of $16.6 million compared to $11.7 million for 2021, an increase in expense of $4.9 million, or 41.4%.

The decrease in the valuation of the servicing asset was principally due to negative market conditions in 2022.

In consideration of the sensitivity of servicing rights as discussed above and in Note 5 to the accompanying audited consolidated financial statements, the following table is provided to reflect the effect on fair value as of December 31, 2022 due to hypothetical changes in yield curve rates.

Change in Yield Curve Assumption Incremental Increase (Decrease) in Value

+300 basis point ($2,649)

+200 basis point (1,833)

+100 basis point (954)

- 100 basis point 1,038

The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as adequate compensation for servicing, the discount rate, the custodial earnings rate, ancillary income, prepayment speeds and default rates and losses, with the prepayment speed and discount rate being the most sensitive assumptions.

For 2023, there was a net gain on loan servicing asset revaluation of $4.9 million compared to a net loss of $16.6 million for 2022, resulting in a positive change of $21.5 million, or 129.5%.

The increase in the valuation of the servicing asset compared to 2022 was principally the result of the third quarter of 2023 change in valuation techniques used to estimate the fair value of servicing rights with a one-time positive adjustment of $13.7 million as a result of rising interest rates and their impacts on market conditions.

Net Gains on Sales of Loans:

For 2022, net gains on sales of loans decreased $24.0 million, or 35.7%, compared to 2021.

The volume of guaranteed loans sold decreased $87.6 million, or 13.1%, to $580.9 million from $668.5 million in 2021.

The average net gain on loan sale premium decreased from 110% to 105% in 2021 and 2022, respectively.

The decrease in net gains on sales of loans was principally the result of lower loan sales volume combined with negative market conditions beginning to materialize in 2022, as discussed above.

Accordingly, these market trends influenced the Company's appetite for loan sales during periods of weaker premiums in the current year.

Net Gain (Loss) on Loans Accounted for Under the Fair Value Option :

F or 2022 , the net gain on loans accounted for under the fair value option decreased $3.2 million, or 75.4%, compared to 2021 .

The carrying amount of loans accounted for under the fair value option at December 31, 2022 and 2021 was $494.5 million (all classified as held for investment) and $670.5 million ($25.3 million classified as held for sale and $645.2 million classified as held for investment), respectively, a decrease of $176.1 million, or 26.3%.

The lower net gain on loans accounted for under the fair value option during 2022 was principally the result o f the earlier discussed negative market conditions combined with the continued amortization of the underlying loan portfolio.

For 2023, net gains on sales of loans increased $3.3 million, or 7.6%, compared to 2022.

The volume of guaranteed loans sold increased $296.7 million, or 51.1%, over 2022 while the average net gain on loan sale premium decreased from 108% to 105% in 2022 and 2023, respectively.

The increase in net gains on sales of loans over 2022 was principally the result of higher loan sale volume.

Net (Loss) Gain on Loans Accounted for Under the Fair Value Option :

For 2023, the Company had a net loss on loans accounted for under the fair value option of $3.5 million compared to a net gain of $1.0 million for 2022, a negative change of $4.6 million.

The carrying amount of loans accounted for under the fair value option at December 31, 2023 and 2022 was $388.0 million (all classified as held for investment) and $494.5 million (all classified as held for investment), respectively, a decrease of $106.4 million, or 21.5%.

The incremental net loss on loans accounted for under the fair value option compared to both prior periods was largely the result of negative market trends between the comparative periods.

Noninterest Expense

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The increase in salaries and employee benefits was principally related to continued investment in human resources to support strategic and growth initiatives.

Additional bonus accruals of $7.5 million and $3.0 million were included in both the second and third quarters of 2022 related to the earlier discussed Finxact and Payrailz gains, respectively, while the second quarter of 2021 included an additional $4.0 million bonus accrual, related to the earlier mentioned Greenlight gain.

Total full-time equivalent employees increased from 794 at December 31, 2021 to 970 at December 31, 2022.

Total full-time equivalent employees decreased from 970 at December 31, 2022 to 952 at December 31, 2023, however, average full-time equivalent employees for 2023 was 966 as compared to 887 for 2022 .

Salaries and employee benefits expense included $17.9 million of stock-based compensation for 2023 , compared to $20.3 million for 2022 .

Expenses related to the employee stock purchase program, stock grants, stock option compensation and restricted stock expense are all considered stock-based compensation.

Travel expense:

Travel expense increased $2.7 million, or 46.3%.

Travel expenses increased primarily to support the growth in loan origination volume and customer base as travel restrictions have eased combined with inflationary impacts on travel related costs.

Professional services expense:

Professional services expense decreased $4.0 million, or 34.1%, compared to 2022 .

The decrease compared to the prior period was largely driven by lower legal fees.

Advertising and marketing expense:

Advertising and marketing expense increased $5.5 million, or 110.8%, compared to 2021.

Increases were largely driven by as a continued investment in the Company’s lending and deposit market growth.

This decrease was due to lower levels of legal fees combined with an insurance recovery of $1.3 million in 2023 related to previously expensed legal fees.

Technology expense:

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This increase was primarily related to enhanced investments in the Company’s technology resources.

Renewable energy tax credit investment impairment:

The Company recognized $16.1 million in impairment charges related to new renewable energy tax credit investment transactions in 2022 as compared to $3.1 million in 2021.

I nvestments of this type generate a return primarily through the realization of income tax credits and other benefits;

accordingly, impairment of the investment amount is generally recognized in conjunction with the realization of related tax benefits.

These investments generated federal investment tax credits in 2022 and 2021 of $16.4 million and $3.4 million, respectively, which are included in the Company’s effective tax rates.

FDIC insurance:

FDIC insurance increased $6.9 million, or 70.9%, compared to 2022 .

This is largely the result of a one-time increase in insurance assessment rates effective in 2023, combined with the ongoing growth in total consolidated assets at the Company.

Contributions and donations:

For 2022, contributions and donations expense increased $4.1 million, or 177.2%, compared to 2021.

This increase was related to a special charitable donation during the second quarter of 2022 of $5.0 million made in connection with the earlier discussed Finxact gain.

For 2023 , contributions and donations expense decreased $6.5 million, or 100.0%, compared to 2022.

This decrease is principally related to a special charitable donation during the second quarter of 2022 of $5.0 million made in connection with the earlier discussed Finxact gain.

Other expense:

Other expenses increased $4.8 million, or 38.5%, compared to 2022 .

This increase is largely related to $2.5 million in increased levels of provision for unfunded commitment reserves, principally a product of refinements in estimation assumptions in the first quarter of 2023.

Income Tax Expense

Income tax expense and related effective tax rate in 2023 was $8.9 million and 10.8% compared to $34.1 million and 16.2% in 2022.

The lower effective tax rate of 16.2% for 2022 was principally due to higher levels of tax credits related to renewable energy tax credit transactions, as discussed above .

The Company's renewable energy investments generated federal investment tax credits of $16.4 million in both 2023 and 2022, which reduced its effective tax rate for both years.

The lower effective tax rate of 10.8% for 2023 was principally due lower pretax income in 2023 relative to consistent levels of renewable energy tax credits in both 2023 and 2022.

Results of Segment Operations

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Consolidated net income $ 73,898 $ 176,208 $ 166,995

Net income decreased $73.7 million, or 50.6%, compared to 2021.

Key factors influencing this decrease are discussed below.

Net income increased $10.9 million, or 15.1%, compared to 2022.

Key factors influencing these changes are discussed below.

For 2023, net interest income increased $16.9 million, or 5.1%, compared to 2022.

See above section captioned “Net Interest Income and Margin” as it is principally related to the Banking segment.

The provision for loan and lease credit losses for 2023 increased $10.4 million, or 25.4%, over 2022.

See the analysis of provision for loan and lease credit losses included in the above section captioned “Provision for Loan and Lease Credit Losses” as it is entirely related to the Banking segment.

Noninterest income decreased $33.8 million, or 29.6%, over 2021.

The decrease was principally driven by a decrease in net gains on sales of loans combined with an increase of losses in loan servicing asset revaluation and decrease in net gain arising from loans accounted for under the fair value option.

Noninterest income increased $20.5 million, or 25.4%, over 2022.

This increase was principally driven by an incremental net gain on the loan servicing asset revaluation.

Also contributing to the increase was higher net gains on sales of loans.

Partially offsetting the increased noninterest income was incremental net losses on loans accounted for under the fair value option.

See the analysis of these categories of noninterest income included in the above section captioned “Noninterest Income” for additional discussion.

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See the analysis of these categories of noninterest expense included in the above section captioned “Noninterest Expense” for additional discussion.

Partially offsetting the above elements which reduced income was an increase in net interest income of $31.1 million, or 10.4%, and lower income tax expense of $35.8 million, compared to 2021.

See the analysis of net interest income included in the above section captioned “Net Interest Income and Margin,” as it is predominantly related to the Banking segment.

The decrease in income tax expense relative to the Bank is primarily the result of a lower level of pretax income combined with higher levels of investment tax credits related to renewable energy investment transactions.

Net income increased by $82.0 million over 2021.

The increase was principally due to equity method investment gains of $28.4 million and $120.8 million from the sale of Payrailz and Finxact, respectively.

This increase was partially offset by decreased equity security investment gains of $41.4 million, largely a result of the 2021 gain of $44.1 million arising from the Company’s investment in Greenlight.

Income tax expense increased $9.3 million compared to 2022.

This increase is a product of the above discussed increase in Fintech segment income.

This was primarily the result of a higher level of pretax income.

Net income decreased by $112.8 million over 2022.

The decrease was principally due to equity method investment gains of $28.4 million and $120.8 million from the sale of Payrailz and Finxact, respectively.

Income tax expense decreased $35.0 million, compared to 2022.

This decrease is a product of the above discussed decrease in Fintech segment income.

Discussion and Analysis of Financial Condition

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• Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, combined with investment securities available-for-sale was $1.71 billion at December 31, 2023 , an increase of $277.3 million, or 19.4%, compared to $1.43 billion at December 31 , 2022.

This increase was primarily due to proceeds arising from the Payrailz and Finxact sales combined with growing deposit levels.

• Growth in total loans and leases held for investment and held for sale of $1.26 billion resulti ng from strong origination activity in 2022 and holding loans available for sale for longer periods of time before sale, as discussed more fully below.

Total originations during 2022 were $4.00 billion.

Loans held for sale decreased $561.9 million, or 50.3%, during 2022 , from $1.12 billion at December 31, 2021 , to $554.6 million at December 31, 2022 .

This decrease was primarily the result of a $754.7 million transfer of loans, including $696.6 million in guaranteed loans, from held for sale to held for investment in the third quarter of 2022.

This transfer was largely due to the impact of market conditions in a rising rate environment influencing management's intent and ability to hold these loans for the foreseeable future.

See “Results of Operations” discussion of “Net Gains on Sales of Loans” for additional information influencing managements intent to hold more loans for investment.

Loans and leases held for investment increased $1.82 billion, or 33.0%, during 2022 , from $5.52 billion at December 31, 2021 , to $7.34 billion at December 31, 2022 .

The increase was primarily the result of the above-mentioned loan originations in 2022 combined with increased levels of loans retained as held for investment.

Excluding PPP loans, total loans and leases held for investment increased $2.07 billion, or 39.4%, during 2022.

All PPP loans are classified as held for investment and were $12.9 million at December 31, 2022.

This increase reflects growing deposit levels combined with maintenance of the Company's targeted liquidity profile.

• Growth in total loans and leases held for investment and held for sale of $1.12 billion resulti ng from strong origination activity in 2023 of $3.95 billion.

Total deposits were $10.28 billion at December 31, 2023 , an increase of $1.39 billion, or 15.6%, from $8.88 billion at December 31, 2022 .

The increase in deposits was largely driven by significant loan origination efforts.

The increase in total deposits from the prior period was to support growth in the loan and lease portfolio combined with strong deposit inflows.

Borrowings decreased to $23.4 million at December 31, 2023 from $83.2 million at December 31, 2022 .

This decrease was related principally to net curtailments of borrowings through the PPPLF which was paid off in the third quarter of 2022.

These PPPLF borrowings are used to help fund PPP loans.

This decrease was principally due to paying off the Company’s Fed Funds line of credit in the first quarter of 2023.

Borrowings in the accompanying notes to the consolidated financial statements for a discussion of current sources of available debt capacity.

Shareholders’ equity at December 31, 2023 was $902.7 million as compared to $811.0 million at December 31, 2022 .

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Average equity to average assets was 8.0% for the year ended December 31, 2023 compared to 9.0% for the year ended December 31, 2022 .

The increase in shareholders’ equity for 2022 was principally the result of $176.2 million in net income and stock-based compensation expense of $20.3 million, partially offset by other comprehensive loss associated with negative market impacts on the Company’s available-for-sale investment portfolio of $94.2 million.

The increase in shareholders’ equity for 2023 was principally the result of $73.9 million in net income and stock-based compensation expense of $17.9 million and other comprehensive income associated with positive market impacts on the Company’s available-for-sale investment portfolio of $7.6 million.

Regulatory Impact of Asset Growth

In the first quarter of 2023, the Company and the Bank each first exceeded $10 billion in total assets.

As of December 31, 2023, the Company and the Bank each had total assets of $11.27 billion and $11.21 billion , respectively, ending their first four consecutive quarters of reported assets in excess of $10 billion.

The Dodd-Frank Act and its implementing regulations impose various additional requirements on bank holding companies and banks with $10 billion or more in total consolidated assets.

Consumer Financial Laws.

Under the Dodd-Frank Act, the Consumer Financial Protection Bureau (CFPB) has near-exclusive supervision authority, including examination authority, to assess compliance with federal consumer financial laws for a bank and its affiliates if the bank has total assets of more than $10 billion.

This provision becomes applicable to a bank following the fourth consecutive quarter where the total assets of the bank, as reported in its quarterly Call Report, exceed $10 billion and afterwards remains applicable to the bank unless the bank has reported total assets of $10 billion or less in its quarterly Call Report for four consecutive quarters.

This provision is expected to be applicable to the Bank in the first quarter of 2024.

Deposit Insurance Assessments.

Also under the Dodd-Frank Act, the DIF reserve ratio was increased from 1.15 percent to 1.35 percent and the FDIC is required, in setting deposit insurance assessments, to offset the effect of the increase on institutions with assets of less than $10 billion, which results in institutions with assets greater than $10 billion paying higher assessments.

In addition, following the fourth consecutive quarter where the total assets of a bank exceeds $10 billion, as reported in its quarterly Call Report, the FDIC utilizes a different method for determining deposit insurance assessments.

This large bank method is based on a bank’s ability to withstand asset- and funding-related stress, its regulatory ratings, and potential losses to the FDIC in the event of the bank’s failure, subject to discretionary adjustments by the FDIC.

The Bank expects to become subject to the large bank method for determining its deposit insurance assessments in 2024.

Volcker Rule.

Under provisions of the Dodd-Frank Act referred to as the “Volcker Rule,” certain limitations are placed on the ability of insured depository institutions and their affiliates to engage in sponsoring, investing in and transacting with certain investment funds, known as “covered funds” under the rule.

There are a number of exclusions from the definition of “covered funds,” including for investments in Small Business Investment Companies, or SBICs, and certain qualifying venture capital funds.

The Volcker Rule also places restrictions on proprietary trading, which could impact certain hedging activities.

Limits on Interchange Fees.

The Durbin Amendment to the Dodd-Frank Act gave the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by a payment card issuer that, together with its affiliates, has assets of $10 billion or more, as of December 31 of the preceding calendar year, and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.

The Federal Reserve Board has adopted rules under this provision that limit the swipe fees that a debit card issuer can charge a merchant for a transaction to the sum of 21 cents and five basis points times the value of the transaction, plus up to one cent for fraud prevention costs.

The Bank exceeded $10 billion in assets at December 31, 2023.

This will trigger a reduction of annual pre-tax income from debit card interchange fees beginning July 1, 2024.

Additional information regarding the Durbin Amendment is presented in Item 1A.

Risk Factors.

Loans Held for Sale & Serviced Portfolio

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Approximately 12.1% of the current held for sale portfolio is older than two years.

The majority of held for sale loans over one year old are composed of construction loans.

The majority of held for sale loans over one year old are composed of construction loans or other loans that have yet to fully fund.

Construction loans typically have extended build out periods that inherently result in longer lead times between origination and the ultimate sale date.

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Small Business Banking 145 4,989 8 10,317 15,459

Specialty Lending — 5,256 — — 5,256

Total 145 10,245 8 10,317 20,715

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Total held for investment loans and leases $ 482,009 $ 2,217,624 $ 2,784,287 $ 3,171,945 $ 8,655,865

(1) Excludes net deferred (fees) costs

(1) Excludes retained loan discount and net deferred costs.

Commercial Real Estate

Commercial real estate loans as indicated by the FDIC include loans secured by the following:

construction, land development, multifamily property and nonfarm, nonresidential real property.

The following table provides information with respect to commercial real estate loans as of December 31, 2023.

Guaranteed Unguaranteed Total (1)

Held for Investment Loans:

Owner Occupied

Small Business Banking $ 1,145,306 $ 989,029 $ 2,134,335

Specialty Lending — 87,922 87,922

Energy & Infrastructure 9,517 20,584 30,101

Total 1,154,823 1,097,535 2,252,358

Non-Owner Occupied

Small Business Banking 370,304 380,028 750,332

Specialty Lending — 482,146 482,146

Energy & Infrastructure 35,416 122,899 158,315

Total 405,720 985,073 1,390,793

Total Held for Investment Commercial Real Estate $ 1,560,543 $ 2,082,608 $ 3,643,151

Held for Sale Loans:

Owner Occupied

Small Business Banking $ 62,242 $ — $ 62,242

Total 62,242 — 62,242

Non-Owner Occupied

Small Business Banking 121,399 — 121,399

Energy & Infrastructure 891 — 891

Total 122,290 — 122,290

Total Held for Sale Commercial Real Estate $ 184,532 $ — $ 184,532

Total Commercial Real Estate Loans $ 1,745,075 $ 2,082,608 $ 3,827,683

% of Total Commercial Real Estate Loans 45.6 % 54.4 % 100.0 %

(1) Excludes retained loan discount and net deferred costs.

Asset Quality

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A formal loan review function, independent of loan origination, is used to identify and monitor problem loans.

This function reports directly to the Audit & Risk Committee of the Board of Directors.

This function reports directly to the Audit Committee of the Board of Directors.

Nonperforming Assets

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Typically, collections of interest and principal received on a nonaccrual loan or lease are applied to the outstanding principal as determined at the time of collection of the loan or lease.

Troubled debt restructurings (“TDRs”) occur when, because of economic or legal reasons pertaining to the debtor’s financial difficulties, debtors are granted concessions that would not otherwise be considered.

Such concessions would include, but are not limited to, the transfer of assets or the issuance of equity interests by the debtor to satisfy all or part of the debt, modification of the terms of debt or the substitution or addition of debtor(s).

Nonperforming assets and TDRs, excluding loans measured at fair value, at December 31, 2022 were $134.9 million, which represented a $54.7 million, or 68.2%, increase from December 31, 2021 .

These nonperforming assets, at December 31, 2022 were comprised of $73.4 million in nonaccrual loans and leases.

At December 31, 2022, there were no foreclosed assets.

Of the $134.9 million of nonperforming assets and TDRs, $75.1 million carried an SBA guarantee, leaving an unguaranteed exposure of $59.8 million in total nonperforming assets and TDRs at December 31, 2022 .

The Company adopted ASU 2022-02 on January 1, 2023.

Accordingly, the prior period discussed below has been adjusted to exclude previously disclosed troubled debt restructurings for comparative purposes.

Organization and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements for additional information about the adoption of ASU 2022-02.

Total nonperforming assets, including loans measured at fair value, at December 31, 2023 were $192.2 million, which represented a $71.8 million, or 59.6%, increase from December 31, 2022.

These nonperforming assets, at December 31, 2023 were comprised of $185.7 million in nonaccrual loans and leases and $6.5 million in foreclosed assets.

Of the $192.2 million of nonperforming assets, $141.0 million carried a government guarantee, leaving an unguaranteed exposure of $51.2 million in total nonperforming assets at December 31, 2023.

This represents an increase of $25.1 million, or 96.6%, from an unguaranteed exposure of $26.0 million at December 31, 2022.

The following table provides information with respect to nonperforming assets and troubled debt restructurings, excluding loans measured at fair value, at the dates indicated.

The following table provides information with respect to nonperforming assets, excluding loans measured at fair value, at the dates indicated.

Nonaccrual loans and leases:

Total nonperforming loans and leases (all on nonaccrual) $ 134,963 $ 73,392

Total accruing loans and leases past due 90 days or more — —

Foreclosed assets 6,481 —

Total troubled debt restructurings 80,604 55,273

Less nonaccrual troubled debt restructurings (19,054) (18,210)

Total performing troubled debt restructuring 61,550 37,063

Total nonperforming assets and troubled debt restructurings $ 134,942 $ 80,216

Total nonperforming assets $ 141,444 $ 73,392

Allowance for credit losses on loans and leases $ 125,840 $ 96,566

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Total nonperforming loans and leases to total assets 1.24 % 0.78 %

Total nonperforming assets and troubled debt restructurings to total assets 1.44 % 1.06 %

Allowance for credit losses on loans and leases to loans and leases held for investment 1.53 % 1.41 %

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government (all on nonaccrual) $ 95,678 $ 54,608

Total accruing loans and leases past due 90 days or more guaranteed by the U.S.

government — —

Foreclosed assets guaranteed by the U.S.

government 3,670 —

Total troubled debt restructurings guaranteed by the U.S.

government 35,465 26,954

Less nonaccrual troubled debt restructurings guaranteed by the U.S.

government (14,944) (10,770)

Total performing troubled debt restructurings guaranteed by U.S.

government 20,521 16,184

Total nonperforming assets and troubled debt restructurings guaranteed by the U.S.

Total nonperforming assets guaranteed by the U.S.

government $ 99,348 $ 54,608

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government to total assets 0.36 % 0.20 %

Total nonperforming assets and troubled debt restructurings not guaranteed by the U.S.

government to total assets 0.64 % 0.49 %

Allowance for credit losses on loans and leases to total nonperforming loans and leases not guaranteed by the U.S government 320.33 % 514.09 %

(1) Excludes loans measured at fair value.

Total nonperforming assets and troubled debt restructurings, including loans measured at fair value, at December 31, 2022 were $208.3 million, which represented a $54.8 million, or 35.7%, increase from December 31, 2021.

These nonperforming assets, at December 31, 2022 were comprised of $120.4 million in nonaccrual loans and leases.

Of the $208.3 million of nonperforming assets and TDRs, $134.1 million carried an SBA guarantee, leaving an unguaranteed exposure of $74.2 million in total nonperforming assets and TDRs at December 31, 2022.

Nonperforming assets, excluding loans measured at fair value, at December 31, 2023 were $141.4 million, which represented a $68.1 million, or 92.7%, increase from December 31, 2022 .

These nonperforming assets, at December 31, 2023 were comprised of $135.0 million in nonaccrual loans and leases and $6.5 million in foreclosed assets.

Of the $141.4 million of nonperforming assets, $99.3 million carried a government guarantee, leaving an unguaranteed exposure of $42.1 million in total nonperforming assets at December 31, 2023 .

This represents an increase of $23.3 million, or 124.1%, from an unguaranteed exposure of $18.8 million at December 31, 2022 .

See the below discussion related to the change in potential problem and impaired loans and leases for management’s overall observations regarding the change in total nonperforming loans and leases.

As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 9.0% at December 31, 2022 , compared to 6.0% at December 31, 2021 .

Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management’s belief that the greater magnitude of risk resides in this portion, the ratio at both December 31, 2022 and December 31, 2021 was 2.3%.

As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, repres ented 14.6% at December 31, 2023, compared to 9.0% at December 31, 2022.

Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management’s belief that the greater magnitude of risk resides in this portion, the ratio at December 31, 2023 and 2022 was 4.3% and 2.3%, respectively.

As of December 31, 2023 , and December 31, 2022 , potential problem (also referred to as criticized) and classified loans and leases, excluding loans measured at fair value, totaled $785.2 million and $424.7 million, respectively.

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For a complete description of the risk grading system, see “Credit Quality Indicators” in Note 3 to the notes to consolidated financial statements.

At December 31, 2022, the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $195.8 million and total portfolio unguaranteed exposure risk was $228.9 million, or 5.5% of total held for investment unguaranteed exposure carried at historical cost.

At December 31, 2023 , the portion o f criticized and classified loans and leases guaranteed by the SBA or USDA totaled $344.8 million and total portfolio unguaranteed exposure risk was $440.3 million, or 8.3% of total held for investment unguaranteed exposure carried at historic al cost.

This compares to the December 31, 2022 portion of criticized and classified loans and leases guaranteed by the SBA or USDA which totaled $195.8 million and total portfolio unguaranteed exposure risk was $228.9 million, or 5.5% of total held for investment unguaranteed exposure carried at historical cost.

As of December 31, 2022, loans and leases carried at historical cost within the following verticals comprise the largest portion of the tot al potential problem and classified loans and leases:

Wine and Craft Beverage at 11.5%, G eneral Lending at 10.3%, Senior Housing at 10.2%, Sponsor Finance at 7.8%, Healthcare at 6.4%, Hotels at 5.9%, Fitness Centers at 5.1%, Agriculture at 4.5% and Senior Care at 4.0%.

As of December 31, 2021, loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases:

Educational Services at 16.1%, Wine and Craft Beverage at 13.7%, Hotels at 11.8%, Entertainment Centers at 10.4%, Healthcare at 9.0%, Fitness Centers at 5.3%, Self-Storage at 4.8%, Agriculture at 4.5% and Veterinary at 4.4%.

Of the above listed verticals, Senior Housing and Sponsor Finance is within the Company’s Specialty Lending division while Hotels are within the Energy & Infrastructure division, the remainder of the above listed verticals are within the Small Business Banking division.

The majority of the $52.0 million increase in potential problem and classified loans and leases in 2022 was comprised of several relationships that did not have a government guarantee, largely related to some of the more recently matured verticals.

As of December 31, 2023 and December 31, 2022, loans and leases carried at historical cost within the following verticals comprise the largest portion of the tot al potential problem and classified loans and leases:

As of December 31, 2023 As of December 31, 2022

Vertical % of Criticized and Classified Loans and Leases

Senior Housing 16.5% Wine & Craft Beverage 11.5%

Bioenergy 14.4% General Lending 10.3%

General Lending 12.2% Senior Housing 10.2%

Search Fund Lending 8.6% Search Fund Lending 7.8%

Wine & Craft Beverage 5.6% Healthcare 6.4%

Healthcare 3.9% Hotels 5.9%

Hotels 3.3% Fitness Centers 5.1%

Self Storage 3.3% Agriculture 4.5%

Senior Care 3.2% Senior Care 4.0%

% of Total Criticized and Classified Loans 71.0% % of Total Criticized and Classified Loans 65.7%

Of the above listed verticals, Senior Housing is within the Company’s Specialty Lending division while Hotels and Bioenergy are within the Energy & Infrastructure division, the remainder of the above listed verticals are within the Small Business Banking division.

The majority of the $360.5 million increase in potential problem and classified loans and leases in 2023 was comprised of increased levels of Risk Grade 5 loans and leases, as discussed below.

The Company believes that its underwriting and credit quality standards have remained high and continues to consider changing economic conditions in a rising interest rate environment.

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Credit personnel will review the request to determine if the customer is stressed and how the event has impacted the ability of the customer to repay the loan or lease long term.

At December 31, 2022, the Company had a total of $10.2 million in modified unguaranteed loans and leases on payment deferral with $346 thousand in accrued interest.

At December 31, 2023, the Company had a total of $37.2 million in loans modified in 2023 to borrowers experiencing financial difficulty, all of which remained current with $14.6 million on principal payment deferral.

Management endeavors to be proactive in its approach to identify and resolve problem loans and leases and is focused on working with the borrowers and guarantors of these loans and leases to provide loan and lease modifications when warranted.

Management implements a proactive approach to identifying and classifying loans and leases as special mention (also referred to as criticized), Risk Grade 5.

At December 31, 2022, and December 31, 2021, Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled $286.5 million and $267.4 million, respectively.

The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during 2022 was principally confined to five verticals:

Senior Housing ($43.4 million or 227.2%), General Lending ($20.5 million or 107.1%), Sponsor Finance ($13.8 million or 72.3%), Broadband ($12.4 million or 64.7%) and Community Facilities ($8.9 million or 46.8%).

Partially offsetting the above increases were decreases in Risk Grade 5 loans principally concentrated in four verticals:

Educational Services ($46.9 million or 245.5%), Hotels ($16.4 million or 85.9%), Entertainment Centers ($14.6 million or 76.5%) and Bioenergy ($9.4 million or 49.4%).

The increase in criticized loans in 2022 was related to a small number of loans within mature verticals.

Of the above listed verticals, Senior Housing and Sponsor Finance is within the Company’s Specialty Lending division while Community Facilities, Hotels and Bioenergy are within the Energy & Infrastructure division, the remainder of the above listed verticals are within the Small Business Banking division.

At December 31, 2023, and December 31, 2022, Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled $599.2 million and $286.5 million, respectively, for a year-over-year increase of $312.7 million.

Relative to total held for investment unguaranteed exposure carried at historical cost at December 31, 2022 and 2023, unguaranteed Risk Grade 5 loans and leases increased from 4.1% to 6.9%, respectively.

The largest year-over-year changes in Risk Grade 5 loans and leases carried at historical cost were within the foll owing verticals :

December 31, 2023 vs.

2022 Increase (Decrease)

Bioenergy $ 113,065 37.9 %

Senior Housing 73,722 24.7

General Lending 25,852 8.7

Search Fund Lending 25,004 8.4

Self Storage 16,045 5.4

Government Contracting 15,301 5.1

Asset Based Lending 14,677 4.9

Hotels 9,709 3.3

Senior Care 9,527 3.2

Health Care 8,153 2.7

Broadband (12,352) (4.1)

Wine Craft Beverage (11,927) (4.0)

Entertainment Centers (11,435) (3.8)

Total of largest changes in RG 5 loans and leases $ 275,341 92.4%

The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during 2023 was principally confined to ten verticals, as reflected above.

The increase in Risk Grade 5 loans in 2023 was largely a result of softer than expected starts for new projects in certain verticals due to delays in both construction completion and ramp up time, stemming from downstream effects of pandemic-related impacts.

Of the above listed verticals, Senior Housing, Asset-Based Lending and Government Contracting are within the Company’s Specialty Lending division while Hotels and Bioenergy are within the Energy & Infrastructure division, the remainder of the above listed verticals are within the Small Business Banking division.

At December 31, 2023 , approximately 99.3% of loans and leases classified as Risk Grade 5 are performing with no relationships having payments past due more than 30 days.

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At December 31, 2023, the Company had $11.0 million in unguaranteed loans on SBA payment assistance.

Management monitors these borrowers closely and has observed financial conditions continuing to improve.

Allowance for Credit Losses on Loans and Leases

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The ACL as a percentage of loans and leases held for investment at historical cost amounted to 1.5% and 1.4% at December 31, 2023 and 2022 , respectively.

The increase in the ACL during 2022 was primarily due to significant loan growth, charge-off experience impacts, increased levels of loans classified as held for investment and changes in the macroeconomic outlook, as addressed more fully in the above section captioned “Provision for Loan and Lease Credit Losses” in “Results of Operations.”

Actual past due held for investment loans and l eases, inclusive of loans measured at fair value, have increased by $24.2 million since December 31, 2021.

The increase in the ACL during 2023 was primarily due to significant loan growth combined with charge-off related impacts, as addressed more fully in the above section captioned “Provision for Loan and Lease Credit Losses” in “Results of Operations.”

Actual past due held for investment loans and leases, inclusive of loans measured at fair value, have increased by $65.7 million since December 31, 2022.

Total loans and leases 90 or more days past due increased $68.2 million, or 120.6%, compared to December 31, 2022.

This increase was comprised of a $4.2 million decrease in unguaranteed exposure combined with an offsetting $11.5 million increase in the guaranteed portion of past due loans compared to December 31, 2021.

This increase was comprised of a $24.0 million increase in unguaranteed exposure combined with a $44.2 million increase in the guaranteed portion of past due loans compared to December 31, 2022.

At December 31, 2023 and December 31, 2022, total held for investment unguaranteed loans and leases past due as a percentage of total held for investment unguaranteed loans and leases, inclusive of loans measured at fair value, was 0.8% and 0.7%, respectively.

Total unguaranteed loans and leases past due were comprised of $21.2 million carried at historical cost, an increase of $4.6 million, an d $9.6 million measured at fair value, an increase of $4.5 million, as of December 31, 2022 compared to December 31, 2021.

The 2022 increase in past dues was largely related to sixteen loans spread across seven mature verticals.

Total unguaranteed loans and leases past due were comprised of $37.6 million carried at historical cost, an increase of $16.4 million, and $9.8 million measured at fair value, an increase of $237 thousand, as of December 31, 2023 compared to December 31, 2022.

Management continues to actively monitor and work to improve asset quality.

Management believes the ACL of $96.6 million at Dec ember 31, 2022 is appropriate in light of the risk inherent in the loan and lease portfolio.

Management’s judgments are based on numerous assumptions about current and expected events that it believes to be reasonable, but which may or may not be valid.

Management believes the ACL of $125.8 million at December 31, 2023 is appropriate in light of the risk inherent in the loan and lease portfolio.

Management’s judgments are based on numerous assumptions about current and expected events that it believes to be reasonable, but which may or may not prove to be accurate.

Accordingly, no assurance can be given that management’s ongoing evaluation of the loan and lease portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the ACL, thus adversely affecting the Company’s operating results.

Additional information on the ACL is presented in Note 3.

Loans and Leases Held for Investment and Credit Quality of the condensed consolidated financial statements in this Report.

Loans and Leases Held for Investment and Credit Quality of the consolidated financial statements in this report.

The following table sets forth the breakdown of the allowance for credit losses on loans and leases carried at historical cost by category at the dates indicated.

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Charge-offs (1)

Average Total Loans &

Average Total Loans & Leases (1)(2)

% of Average Total

Loans & Leases (1)(2)

Charge-offs (1)

Average Total Loans &

Average Total Loans & Leases (1)(2)

% of Average Total

Loans & Leases (1)(2)

Charge-offs (1)

Average Total Loans &

Average Total Loans & Leases (1)(2)

% of Average Total

Loans & Leases (1)(2)

Commercial & Industrial

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(1) Excludes loans measured at fair value.

(2) Average loans and leases held for investment, at amortized cost.

Investment Securities

Investment securities totaled $1.01 billion at December 31, 2022, an increase of $108.7 million, or 12.0%, compared to $906.1 million at December 31, 2021.

Investment securities totaled $1.13 billion at December 31, 2023, an increase of $111.4 million, or 11.0%, compared to $1.01 billion at December 31, 2022.

The increase in the investment portfolio for 2023 was to support earnings through additional yield compared to cash alternatives, continue to provide a contingent funding source and act as a mechanism to manage the Company’s interest rate risk.

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Yield Amortized

US government securities $ 16,080 $ — — % $ 12,948 3.30 % $ 3,132 3.11 % $ — — %

government securities $ 17,809 $ 3,000 3.54 % $ 12,430 3.77 % $ 2,379 3.11 % $ — — %

Mortgage-backed securities 1,216,624 12,358 4.89 179,740 2.70 240,665 2.79 783,861 2.70

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Total securities $ 1,237,633 $ 15,358 4.62 % $ 192,170 2.67 % $ 246,147 2.82 % $ 783,958 2.70 %

At December 31, 2022, the Company had 98.3% of its total investment securities portfolio in mortgage-backed securities, compared with 98.2% at December 31, 2021.

At December 31, 2023 and December 31, 2022, the Company had 98.3% of its total investment securities portfolio in mortgage-backed securities.

The Company has continued to purchase mortgage-backed securities in order to obtain a favorable yield versus cash alternatives while still maintaining a low risk profile within the investment portfolio.

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Noninterest-bearing deposits increased $65.2 million, or 33.6%, during 2023, and interest-bearing deposits increased $1.32 billion, or 15.2%, during the same period.

At December 31, 2022, the aggregate balance of uninsured time deposit accounts totaled $39.1 million.

At December 31, 2022, 81.8% of uninsured time deposit accounts were scheduled to mature within one year.

The aggregate amount of time deposits in denominations of $250 thousand or more at December 31, 2023 was approximately $695.6 million.

Of those deposits, $255.8 million was uninsured and 97.6% of the uninsured time deposit accounts were scheduled to mature within one year.

The maturity profile of uninsured time deposits at December 31, 2023 is as follows:

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Subsequently on October 20, 2021, the Company renewed and increased the revolving line of credit from $50.0 million to $100.0 million and increased the term from 12 months to 36 months.

In September 2023, the Company modified the revolving line of credit and extended the maturity 12 months to a maturity date of October 10, 2026.

The line of credit is unsecured and accrues interest at 30-day SOFR plus 1.25%, with an interest rate cap of 6.75% and an interest rate floor of 2.75%.

Payments are interest only with all principal and accrued interest due at maturity on October 10, 2025 .

Payments are interest only with all principal and accrued interest due at maturity.

The terms of this loan require the Company to maintain minimum capital and debt service coverage ratios.

The Company paid the Lender a non-refundable $ 750 thousand loan origination fee upon signing of the Note that will be amortized into interest expense over the life of the loan.

The Company paid the Lender a non-refundable $750 thousand loan origination fee upon signing of the Note and a non-refundable $250 thousand renewal fee in September 2023 that will be amortized into interest expense over the life of the loan.

The Company made an advance of $8.0 million on December 20, 2021 and $12.0 million on March 16, 2022.

The Company paid down this balance in full on May 20, 2022 and there is $100.0 million of available credit remaining at December 31, 2023 .

On December 30, 2022, the Company made an advance of $50.0 million on an overnight Fed Funds line of credit that is unsecured with an interest rate of 4.65% with $50.0 million of available credit remaining at December 31, 2022.

On December 30, 2022, the Company made an advance of $50.0 million on an overnight Fed Funds line of credit that was unsecured with an interest rate of 4.65% with $50.0 million of available credit remaining at December 31, 2022.

The Company paid down this balance in full on January 3, 2023 and there is $100.0 million of available credit remaining at December 31, 2023.

Liquidity Management

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and (d) availability under lines of credit, FHLB advances, and the Federal Reserve Discount Window.

A primary tool in the Company’s liquidity management process is the utilization of a Volatile Liability Coverage Ratio (“VLCR”) model to stress outflows in various scenarios with targeted days of liquidity coverage.

The VLCR model output is then used by management to ensure adequate liquidity sources are available during those future periods.

and (d) availability under lines of credit, FHLB advances, Federal Reserve Bank Term Funding Program and the Federal Reserve Discount Window.

A primary tool in the Company’s liquidity management process is the utilization of an Outflow Coverage Ratio (“OCR”) model to stress outflows in various scenarios with targeted days of liquidity coverage.

The OCR model output is then used by management to ensure adequate liquidity sources are available during those future periods.

At December 31, 2023, the total amount of these four liquidity source items was $4.26 billion, or 37.8% of total assets, a decrease of 2.9% of total assets from $4.01 billion, or 40.7% of total assets, at December 31, 2022.

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To date, an increasing retail deposit base and a stable amount of brokered deposits have been adequate to meet loan obligations, while maintaining the desired level of immediate liquidity.

The Company maintains an investment securities portfolio that is available for both immediate and secondary contingent liquidity purposes, whether via pledging to the Federal Home Loan Bank or through liquidation.

Additionally, the Company maintains a guaranteed loan portfolio that is also a contingent liquidity source, whether via pledging to the Federal Reserve Discount Window or through liquidation.

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Deposits) and borrowings (Note 8.

As of December 31, 2023, the Company also has $301.0 million in brokered deposits with $75.2 million scheduled to mature in less than a year and $225.8 million scheduled to mature within one to three years.

Off-Balance Sheet Arrangements

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Such transactions are used primarily to manage customers’ requests for funding and take the form of commitments to extend credit and standby letters of credit.

In 2022, the Company also entered into airplane purchase agreement commitments.

In 2022, the Company entered into airplane purchase agreement commitments of which one airplane was placed in service in 2023 and one airplane purchase agreement commitment is outstanding as of December 31, 2023.

The Company is also in the process of constructing a new facility to accommodate expansion of its main campus.

For more information, see Note 11.

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The Company’s accounting policies, including those for the Company’s critical accounting estimates are described in detail in Note 1.

Organization and Summary of Significant Accounting Policies in the consolidated financial statements and are an integral part of the Company’s consolidated financial statements.

Organization and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements and are an integral part of the Company’s consolidated financial statements.

A thorough understanding of these accounting policies is essential when reviewing the Company’s reported results of operations and financial position.

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Historical loss information is adjusted for differences in current risk characteristics that are not considered within the quantitative modeling process of the ACL but are relevant in assessing the expected credit losses.

These qualitative adjustments include risk grades, delinquency levels, pool age, portfolio mix & growth rates and the status of servicing efforts that may be impacted by natural disasters or health pandemics.

These qualitative adjustments include risk grades, delinquency levels, pool age, portfolio mix and growth rates and the status of servicing efforts that may be impacted by natural disasters or health pandemics.

As indicated above, the loan risk grading process generally has the most significant impact on the ACL.

Accordingly, the Company’s internal risk rating system and resulting loss estimates are highly dependent on the accuracy for the risk rating assigned to each loan and lease.

Accordingly, the Company’s resulting loss estimates are highly dependent on the accuracy for the risk rating assigned to each loan and lease.

The inherent imprecision in the risk rating system resulting from inaccuracy in assigning and/or entering risk ratings in the loan accounting system is monitored by the Company’s internal and external asset quality review functions.

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Other Considerations

While management utilizes its best judgment and information available, the ultimate adequacy of our ACL is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets.

Organization and Summary of Significant Accounting Policies and Note 3.

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Valuation of loans accounted for under the fair value option

Loans accounted for under the fair value option involve estimation for credit risk, market liquidity, and economic condition impacts using factors that are beyond management’s control.

The credit element of the loan fair value mark is estimated using the same DCF model discussed above relative to ACL calculations with key inputs requiring significant judgement and assumptions being:

1) selection of economic forecast, 2) prepayment assumptions, and 3) application of qualitative factors, the most significant of which is related to the loan risk grading process.

Economic forecast

To illustrate, absent any other changes in the model, if the Company selected the severe, moderate, or mild scenarios as described above, the credit mark for fair value loans at December 31, 2022 would have increased by approximately $2.3 million or 17.1%, $1.1 million or 8.3%, and $409 thousand or 3.0%, respectively.

If facts and circumstances supported the Company’s utilization of more severe unemployment scenario other impacts to the model would also be factored in which could result in a materially different estimated than that provided above.

Prepayment assumptions

Expected losses are calculated as the product of PD, LGD, and exposure at default (“EAD”).

Expected losses are then discounted using the loan or leases effective interest rate, adjusted for estimated prepayments.

Changes to the prepayment assumptions used would result in a different estimated fair value mark.

To illustrate, if the weighted average prepayment assumption were decreased by 25%, the fair value mark as of December 31, 2022 would increase by approximately $829 thousand, or 6.0%.

Loan risk grade - qualitative adjustments

To illustrate, if all loans in the Company’s five largest industry verticals ($103.0 million or 23.1% of unguaranteed held for investment loans accounted for under the fair value option) were adjusted down by one risk grade (e.g., RG 4 to RG 5) across all pools, the fair value mark as of December 31, 2022 would increase by $602 thousand, or 4.4%.

Market liquidity and economic condition adjustments are estimated using the sale prices of similar loans based on yield, term and asset size.

This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

Other Considerations

Fair Value of Financial Instruments in the notes to consolidated financial statements for further details of the factors considered by management in estimating the fair value of loans.

In the first quarter of 2021, the Company chose not to elect the fair value for all retained participating interests arising from new government guaranteed loan sales.

Management estimates the fair value of loans accounted for under the fair value option using a DCF methodology.

The estimate incorporates assumptions that market participants would use to estimate the fair value of similar assets such as prepayment speeds, default and severity rates, and a discount rate.

This evaluation is inherently subjective as it requires assumptions that are susceptible to significant revision as more information becomes available.

The fair value of loans accounted for under the fair value option is highly sensitive to changes in the discount rate assumption.

The discount rate used in the estimation process is tied to a benchmark risk-free rate with an additional spread based on loan maturity, size, rate structure, and credit risk.

Generally, the value of the fair value option portfolio is inversely correlated to changes in the risk-free rate.

At December 31, 2023, the weighted average discount rate of loans accounted for under the fair value option was 9.6%.

The table below reflects the sensitivity of the Company’s loans measured at fair value to immediate changes in the discount rate assumption with all other assumptions remaining static:

As of December 31, 2023

Fair value of loans accounted for under the fair value option $388,036

Incremental Increase (Decrease) in Value

Discount Rate

200 basis point increase ($19,469)

100 basis point increase (9,917)

100 basis point decrease 10,738

200 basis point decrease 21,925

All loans accounted for under the fair value option were originated prior to 2021.

Fair Value of Financial Instruments in the notes to consolidated financial statements for further details.

Valuation of servicing assets

The fair value of servicing assets is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.

Changes to these assumptions can have a material impact on the valuation of the servicing assets.

Yield curve rates are considered a significant assumption in the valuation of servicing rights and an analysis of sensitivity is reflected in the section captioned “Noninterest Income” elsewhere in this discussion.

What changed 10-K

Item 7. Management’s Discussion and Analysis