Live Oak Bancshares, Inc. 10-K

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following presents management’s discussion and analysis (“MD&A”) of the more significant factors that affected the Company's financial condition and results of operations for the year ended December 31, 2023 as compared to December 31, 2022. For a comparison of 2022 results to 2021 and other 2021 information not included herein, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II, Item 7 of the 2022 Form 10-K filed with the SEC on February 23, 2023 . This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this Report on Form 10-K. Results of operations for the periods included in this review are not necessarily indicative of results to be obtained during any future period. Dollar amounts in tables are stated in thousands, except for per share amounts. Nature of Operations Live Oak Bancshares, Inc. (collectively with its subsidiaries including Live Oak Banking Company, the “Company”) is a financial holding company and a bank holding company headquartered in Wilmington, North Carolina, incorporated under the laws of North Carolina in December 2008. The Company conducts business operations primarily through its commercial bank subsidiary, Live Oak Banking Company (the “Bank”). The Bank was incorporated in February 2008 as a North Carolina-chartered commercial bank. The Bank specializes in providing lending and deposit related services to small businesses nationwide. A significant portion of the loans originated by the Bank are partially guaranteed by the U.S. Small Business Administration (“SBA”) under the 7(a) Loan program and the U.S. Department of Agriculture (“USDA”) Rural Energy for America Program (“REAP”), Water and Environmental Program (“WEP”), Business & Industry (“B&I”) and Community Facilities loan programs. 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”). GLS is a management and technology consulting firm that advises and offers solutions and services to participants in the government guaranteed lending sector. 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 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. 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. holds properties foreclosed on by the Bank. LOCEF provides financing to entities for renewable energy applications. Live Oak Private Wealth provides high-net-worth individuals and families with strategic wealth and investment management services. During the first quarter of 2022, Jolley Asset Management, LLC (“JAM”) was merged into Live Oak Private Wealth. JAM was previously a wholly owned subsidiary of Live Oak Private Wealth. 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. Income from the sale of loans is comprised of loan servicing revenue and revaluation of related servicing assets along with net gains on sales of loans. Offsetting these revenues are the cost of funding sources, provision for loan and lease credit losses, any costs related to foreclosed assets and other operating costs such as salaries and employee benefits, travel, professional services, advertising and marketing and tax expense. The Company also has less routinely generated gains and losses arising from its financial technology investments predominantly in its fintech segment, as discussed more fully later in this section under the caption “Results of Segment Operations.” 41 Table of Contents Executive Summary The table below sets forth selected consolidated financial data as of the dates or for the periods indicated. As of and for the Year Ended December 31, 2023 2022 2021 Income Statement Data Net income $ 73,898 $ 176,208 $ 166,995 Per Common Share Net income, diluted $ 1.64 $ 3.92 $ 3.71 Dividends declared 0.12 0.12 0.12 Book value 20.23 18.41 16.39 Tangible book value (1) 20.15 18.32 16.31 Performance Ratios Return on average assets 0.69 % 1.96 % 2.03 % Return on average equity 8.66 21.92 25.58 Net interest margin 3.35 3.87 3.86 Efficiency ratio (1) 70.65 55.57 50.55 Noninterest income to total revenue 24.45 42.09 35.06 Dividend payout ratio 7.20 2.99 3.10 Selected Loan Metrics Loans and leases originated $ 3,946,873 $ 4,007,621 $ 4,480,725 Outstanding balance of sold loans serviced 4,238,328 3,481,885 3,298,828 Asset Quality Ratios Allowance for credit losses to loans and leases held for investment (2) 1.53 % 1.41 % 1.30 % Net charge-offs (2) $ 21,373 $ 7,961 $ 3,932 Net charge-offs to average loans and leases held for investment (2) (3) 0.28 % 0.14 % 0.08 % Nonperforming loans and leases at historical cost (2) Unguaranteed $ 39,285 $ 18,784 $ 15,987 Guaranteed 95,678 54,608 26,546 Total 134,963 73,392 42,533 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) Unguaranteed $ 7,230 $ 6,678 $ 4,791 Guaranteed 41,244 38,212 33,471 Total 48,474 44,890 38,262 Unguaranteed nonperforming fair value loans to loans held for investment (4) 1.86 % 1.35 % 0.74 % Consolidated Capital Ratios Common equity tier 1 capital (to risk-weighted assets) 11.73 % 12.47 % 12.38 % Tier 1 leverage capital (to average assets) 8.58 9.26 8.87 (1) See "Non-GAAP Measures" presented at the conclusion of this Item 7 for more information and a reconciliation to the most closely related GAAP measure. (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, at amortized cost. (4) Loans accounted for under the fair value option only (excludes loans and leases carried at historical cost). 42 Table of Contents The following is a summary of the Company's financial highlights and events for 2023: • Loans and leases held for sale and investment increased by $1.12 billion, or 14.2%. 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. Business Outlook Below is a discussion of management’s current expectations regarding Company performance over the near-term based on market conditions, the regulatory environment and business strategies as of the time the Company filed this Report. Actual outcomes and results may differ materially from what is expressed or forecasted in these forward-looking statements. See “Important Note Regarding Forward-Looking Statements” in this Report for more information on forward-looking statements. 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 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. 43 Table of Contents Non-GAAP Financial Measures Statements included in this management's discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The reconciliation of non-GAAP measures is presented at the conclusion of this Item 7. Management believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company without regard to certain transactional activities. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as reported under GAAP, and investors should consider the Company's performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. 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 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. 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; and • A decrease in income tax expense of $25.2 million, or 73.8%, primarily related to decreased pretax income. Net Interest Income and Margin Net interest income represents the difference between the income that the Company earns on interest-earning assets and the cost of interest-bearing liabilities. The Company’s net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates that the Company earns or pays on them, respectively. 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 competitive with other digital deposit product offerings. 44 Table of Contents 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 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. 45 Table of Contents Average Balances and Yields. 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. Loan fees are included in interest income on loans. 2023 2022 2021 Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate Interest-earning assets: Interest-earning balances in other banks $ 584,691 $ 29,487 5.04 % $ 228,866 $ 3,465 1.51 % $ 407,474 $ 920 0.23 % Federal funds sold 34,529 1,624 4.70 109,473 2,796 2.55 18,714 22 0.12 Investment securities 1,237,458 33,497 2.71 995,481 19,667 1.98 797,426 12,533 1.57 Loans held for sale 539,197 48,235 8.95 952,606 58,943 6.19 1,111,216 60,044 5.40 Loans and leases held for investment (1) 7,905,875 575,432 7.28 6,174,763 359,602 5.82 5,350,055 287,694 5.38 Total interest-earning assets 10,301,750 688,275 6.68 8,461,189 444,473 5.25 7,684,885 361,213 4.70 Less: Allowance for credit losses on loans and leases (110,855) (67,234) (54,975) Noninterest-earning assets 493,968 576,524 592,237 Total assets $ 10,684,863 $ 8,970,479 $ 8,222,147 Interest-bearing liabilities: Interest-bearing checking $ 231,413 $ 12,718 5.50 % $ — $ — — % $ 76,714 $ 442 0.58 % Savings 4,428,306 171,151 3.86 3,903,151 57,740 1.48 3,077,933 16,667 0.54 Money market accounts 125,279 721 0.58 100,684 303 0.30 103,078 300 0.29 Certificates of deposit 4,695,161 155,617 3.31 3,849,203 56,992 1.48 3,181,591 42,331 1.33 Total deposits 9,480,159 340,207 3.59 7,853,038 115,035 1.46 6,439,316 59,740 0.92 Other borrowings 61,743 2,763 4.48 122,946 1,937 1.58 1,007,596 4,688 0.47 Total interest-bearing liabilities 9,541,902 342,970 3.59 7,975,984 116,972 1.47 7,446,912 64,428 0.87 Noninterest-bearing deposits 215,327 125,062 77,104 Noninterest-bearing liabilities 74,046 65,619 45,424 Shareholders' equity 853,588 803,814 652,707 Total liabilities and shareholders' equity $ 10,684,863 $ 8,970,479 $ 8,222,147 Net interest income and interest rate spread $ 345,305 3.09 % $ 327,501 3.78 % $ 296,785 3.83 % Net interest margin 3.35 % 3.87 % 3.86 % Ratio of average interest-earning assets to average interest-bearing liabilities 107.96 % 106.08 % 103.20 % (1) Average loan and lease balances include non-accruing loans and leases. 46 Table of Contents Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior period volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior period rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume. 2023 vs. 2022 2022 vs. 2021 Increase (Decrease) Due to Increase (Decrease) Due to Rate Volume Total Rate Volume Total Interest income: Interest-earning balances in other banks $ 14,356 $ 11,666 $ 26,022 $ 4,099 $ (1,554) $ 2,545 Federal funds sold 1,547 (2,719) (1,172) 1,562 1,212 2,774 Investment securities 8,165 5,665 13,830 3,621 3,513 7,134 Loans held for sale 20,573 (31,281) (10,708) 8,091 (9,192) (1,101) Loans and leases held for investment 102,422 113,408 215,830 25,720 46,188 71,908 Total interest income 147,063 96,739 243,802 43,093 40,167 83,260 Interest expense: Interest-bearing checking — 12,718 12,718 — (442) (442) Savings 99,378 14,033 113,411 32,735 8,338 41,073 Money market accounts 310 108 418 10 (7) 3 Certificates of deposit 78,343 20,282 98,625 5,277 9,384 14,661 Other borrowings 2,678 (1,852) 826 6,276 (9,027) (2,751) Total interest expense 180,709 45,289 225,998 44,298 8,246 52,544 Net interest income $ (33,646) $ 51,450 $ 17,804 $ (1,205) $ 31,921 $ 30,716 Provision for Loan and Lease Credit Losses The provision for loan and lease credit losses represents the amount necessary to be charged against the current period’s earnings to maintain the allowance for credit losses (“ACL”) on loans and leases at a level that the Company believes is appropriate in relation to the estimated losses inherent in the loan and lease portfolio. Losses inherent in loan relationships are mitigated if a portion of the loan is guaranteed by the SBA or USDA. Typical SBA 7(a) and USDA guarantees range from 50% to 90% depending on loan size and type, which serve to reduce the risk profile of these loans. The Company believes that its focus on compliance with regulations and guidance from the SBA and USDA are key factors to managing this risk. 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 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. 47 Table of Contents Noninterest Income Noninterest income is principally comprised of net gains from the sale of SBA and USDA-guaranteed loans along with servicing revenue and related revaluation of the servicing asset . 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 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. The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented. Years Ended December 31, 2022/2023 Increase (Decrease) 2021/2022 Increase (Decrease) 2023 2022 2021 Amount Percent Amount Percent Noninterest income Loan servicing revenue $ 27,399 $ 25,359 $ 25,219 $ 2,040 8.0 % $ 140 0.6 % Loan servicing asset revaluation 4,886 (16,577) (11,726) 21,463 129.5 (4,851) (41.4) Net gains on sales of loans 46,545 43,244 67,280 3,301 7.6 (24,036) (35.7) 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) Management fee income 13,324 10,090 6,378 3,234 32.1 3,712 58.2 Other noninterest income 20,074 17,141 15,493 2,933 17.1 1,648 10.6 Total noninterest income $ 111,733 $ 237,992 $ 160,200 $ (126,259) (53.1) % $ 77,792 48.6 % Years ended December 31, 2023 vs. 2022 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. These components are key drivers of the Company's noninterest income. Three months ended December 31, Three months ended September 30, Three months ended June 30, Three months ended March 31, 2023 2022 2023 2022 2023 2022 2023 2022 Amount of loans and leases originated $ 981,703 $ 1,177,688 $ 1,073,255 $ 1,005,235 $ 861,033 $ 959,635 $ 1,030,882 $ 865,063 Guaranteed portions of loans sold 239,066 144,258 225,585 148,110 245,074 68,818 167,826 219,703 Outstanding balance of guaranteed loans sold (1) 2,986,959 2,668,110 2,909,343 2,671,705 2,808,200 2,681,079 2,695,757 2,786,403 48 Table of Contents Years ended December 31, 2023 2022 2021 2020 2019 Amount of loans and leases originated $ 3,946,873 $ 4,007,621 $ 4,480,725 $ 4,450,198 $ 2,001,886 Guaranteed portions of loans sold 877,551 580,889 668,462 542,596 340,374 Outstanding balance of guaranteed loans sold (1) 2,986,959 2,668,110 2,756,915 2,819,625 2,746,480 (1) This represents the outstanding principal balance of guaranteed loans serviced, as of the last day of the applicable period, which have been sold into the secondary market. Changes in various components of noninterest income are discussed in more detail below. Loan Servicing Asset Revaluation: 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, 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 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 Noninterest expense comprises all operating costs of the Company, such as employee-related costs, travel, professional services, advertising and marketing expenses, exclusive of interest and income tax expense. 49 Table of Contents The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods presented. Years Ended December 31, 2022/2023 Increase (Decrease) 2021/2022 Increase (Decrease) 2023 2022 2021 Amount Percent Amount Percent Noninterest expense Salaries and employee benefits $ 175,052 $ 170,822 $ 124,932 $ 4,230 2.5 % $ 45,890 36.7 % Non-employee expenses: Travel expense 8,922 8,499 5,809 423 5.0 2,690 46.3 Professional services expense 7,737 11,737 15,135 (4,000) (34.1) (3,398) (22.5) Advertising and marketing expense 12,559 10,543 5,002 2,016 19.1 5,541 110.8 Occupancy expense 8,490 11,088 8,423 (2,598) (23.4) 2,665 31.6 Technology expense 31,858 28,434 22,648 3,424 12.0 5,786 25.5 Equipment expense 14,997 15,120 14,869 (123) (0.8) 251 1.7 Other loan origination and maintenance expense 14,804 13,168 13,529 1,636 12.4 (361) (2.7) Renewable energy tax credit investment impairment 14,644 16,217 3,187 (1,573) (9.7) 13,030 408.8 FDIC insurance 16,670 9,756 7,070 6,914 70.9 2,686 38.0 Contributions and donations — 6,462 2,331 (6,462) (100.0) 4,131 177.2 Other expense 17,152 12,380 8,052 4,772 38.5 4,328 53.8 Total non-employee expenses 147,833 143,404 106,055 4,429 3.1 37,349 35.2 Total noninterest expense $ 322,885 $ 314,226 $ 230,987 $ 8,659 2.8 % $ 83,239 36.0 % Total noninterest expense for 2023 increased $8.7 million, or 2.8%, compared to 2022. The increase in noninterest expense was predominately driven by the following items. Salaries and employee benefits : Total personnel expense for 2023 increased by $4.2 million, or 2.5%, compared to 2022 . The increase in salaries and employee benefits was principally related to continued investment in human resources to support strategic and growth initiatives. 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. Professional services expense: Professional services expense decreased $4.0 million, or 34.1%, compared to 2022 . 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: Technology expense increased $3.4 million, or 12.0%, compared to 2022 . This increase was primarily related to enhanced investments in the Company’s technology resources. 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 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. 50 Table of Contents 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 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 The Company’s operations are managed along two primary operating segments: Banking and Fintech. A description of each segment and the methodologies used to measure financial performance is described in Note 15. Segments in the accompanying notes to the consolidated financial statements. Net income (loss) by operating segment is presented below: Years ended December 31, 2023 2022 2021 Banking $ 82,796 $ 71,937 $ 145,662 Fintech (3,156) 109,692 27,667 Other (5,742) (5,421) (6,334) Consolidated net income $ 73,898 $ 176,208 $ 166,995 Banking 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 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. Noninterest expense increased $6.8 million, or 2.3%, compared to 2022. See the analysis of these categories of noninterest expense included in the above section captioned “Noninterest Expense” for additional discussion. Income tax expense increased $9.3 million compared to 2022. This was primarily the result of a higher level of pretax income. Fintech 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. 51 Table of Contents Discussion and Analysis of Financial Condition Total assets at December 31, 2023 were $11.27 billion, an increase of $1.42 billion, or 14.4%, compared to total assets of $9.86 billion at December 31, 2022 . The growth in total assets was principally driven by the following: • 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 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 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 principally due to paying off the Company’s Fed Funds line of credit in the first quarter of 2023. See Note 8. 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 . The book value per share was $20.23 at December 31, 2023 compared to $18.41 at December 31, 2022 . 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 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 General . 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. 52 Table of Contents 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 Any loan or portion of a loan that the Company has the intent and ability to sell is classified as held for sale. The average age of the held for sale portfolio as of December 31, 2023 was 10.9 months from origination date. 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 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. Approximately 19.8% of the held for sale portfolio is aged between one and two years. As of December 31, 2023 and 2022, the cumulative total outstanding balance of loans sold since May 2007 totaled $4.24 billion and $3.48 billion, respectively. The Company generally continues to service loans after the date of sale. As of December 31, 2023 and 2022, the total outstanding balance of loans and leases, including those serviced for others, was $13.28 billion and $11.38 billion, respectively. Loan and Lease Maturity As of December 31, 2023, $10.60 billion, or 79.8%, of the total outstanding balance of loans and leases, including those at fair value and those serviced for others, were variable rate loans that adjust at specified dates based on the prime lending rate or other variable indices. As of December 31, 2023, $5.97 billion, or 45.0%, of total outstanding balance of loans and leases, including those at fair value and those serviced for others, were variable rate loans that adjust on either a calendar monthly or calendar quarterly basis using the prime lending rate or other variable indices. At December 31, 2023, 81.5%, or $7.38 billion, of the combined held for sale and held for investment loan and lease portfolio, including those at fair value, were composed of variable rate loans. 53 Table of Contents At December 31, 2023, $2.70 billion, or 31.2%, of loans held for investment, including those at fair value, matures in less than five years. Loans and leases maturing in greater than five years total $5.96 billion of the total $8.66 billion. The variable rate portion of the total held for investment loans and leases, excluding PPP loans, is 81.4%, which reflects the Company’s strategy to minimize interest rate risk through the use of variable rate products. At December 31, 2023 Remaining Contractual Maturity of Total Held for Investment Loans and Leases One Year or Less After One Year and Through Five Years After Five Years and Through Fifteen Years After Fifteen Years Total (1) Fixed rate loans and leases: Commercial & Industrial Small Business Banking $ 2,213 $ 154,221 $ 217,652 $ 2,925 $ 377,011 Specialty Lending 11,377 321,002 5,213 3,783 341,375 Energy & Infrastructure 19,057 10,249 69,164 111,982 210,452 Paycheck Protection Program — 4,853 742 — 5,595 Total 32,647 490,325 292,771 118,690 934,433 Construction & Development 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 Commercial Real Estate Small Business Banking 6,500 70,563 30,491 141,115 248,669 Specialty Lending — 83,439 1,398 5,549 90,386 Energy & Infrastructure — 14,742 — 116 14,858 Total 6,500 168,744 31,889 146,780 353,913 Commercial Land Small Business Banking 9,504 186,912 75,820 35,441 307,677 Total 9,504 186,912 75,820 35,441 307,677 Total fixed rate loans and leases 48,796 856,226 400,488 311,228 1,616,738 Variable rate loans and leases: Commercial & Industrial Small Business Banking 8,996 148,099 1,657,019 85,926 1,900,040 Specialty Lending 109,294 620,555 67,536 562 797,947 Energy & Infrastructure 186,128 30,222 156,533 312,608 685,491 Total 304,418 798,876 1,881,088 399,096 3,383,478 Construction & Development Small Business Banking 6,167 11,103 23,518 358,846 399,634 Specialty Lending — 42,163 — — 42,163 Energy & Infrastructure — 7,541 — — 7,541 Total 6,167 60,807 23,518 358,846 449,338 Commercial Real Estate Small Business Banking 30,437 77,903 342,783 1,893,143 2,344,266 Specialty Lending 88,019 340,231 5,109 — 433,359 Energy & Infrastructure — 56,416 32,023 76,138 164,577 Total 118,456 474,550 379,915 1,969,281 2,942,202 Commercial Land Small Business Banking 4,172 27,165 99,278 133,494 264,109 Total 4,172 27,165 99,278 133,494 264,109 Total variable rate loans and leases 433,213 1,361,398 2,383,799 2,860,717 7,039,127 Total held for investment loans and leases $ 482,009 $ 2,217,624 $ 2,784,287 $ 3,171,945 $ 8,655,865 (1) Excludes retained loan discount and net deferred costs. 54 Table of Contents 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 Management considers asset quality to be of primary importance. A formal loan review function, independent of loan origination, is used to identify and monitor problem loans. This function reports directly to the Audit Committee of the Board of Directors. Nonperforming Assets The Bank places loans and leases on nonaccrual status when they become 90 days past due as to principal or interest payments, or prior to that if management has determined based upon current information available to them that the timely collection of principal or interest is not probable. When a loan or lease is placed on nonaccrual status, any interest previously accrued as income but not actually collected is reversed and recorded as a reduction of loan or lease interest and fee income. 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. 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. See Note 1. 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. 55 Table of Contents 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, excluding loans measured at fair value, at the dates indicated. 2023 (1) 2022 (1) Nonaccrual loans and leases: Total nonperforming loans and leases (all on nonaccrual) $ 134,963 $ 73,392 Foreclosed assets 6,481 — Total nonperforming assets $ 141,444 $ 73,392 Allowance for credit losses on loans and leases $ 125,840 $ 96,566 Total nonperforming loans and leases to total loans and leases held for investment 1.64 % 1.07 % Total nonperforming loans and leases to total assets 1.24 % 0.78 % Allowance for credit losses on loans and leases to loans and leases held for investment 1.53 % 1.41 % Allowance for credit losses on loans and leases to total nonperforming loans and leases 93.24 % 131.58 % (1) Excludes loans measured at fair value. 2023 (1) 2022 (1) Nonaccrual loans and leases guaranteed by U.S. government: Total nonperforming loans and leases guaranteed by the U.S. government (all on nonaccrual) $ 95,678 $ 54,608 Foreclosed assets guaranteed by the U.S. government 3,670 — Total nonperforming assets guaranteed by the U.S. government $ 99,348 $ 54,608 Allowance for credit losses on loans and leases $ 125,840 $ 96,566 Total nonperforming loans and leases not guaranteed by the U.S. government to total held for investment loans and leases 0.48 % 0.27 % Total nonperforming loans and leases not guaranteed by the U.S. government to total assets 0.36 % 0.20 % 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. 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, 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. 56 Table of Contents 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. The following is a discussion of these loans and leases. Risk Grades 5 through 8 represent the spectrum of criticized and classified loans and leases. 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, 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, 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 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. Loans and leases that experience insignificant payment delays and payment shortfalls are generally not individually evaluated for the purpose of estimating the allowance for credit losses. The Bank generally considers an “insignificant period of time” from payment delays to be a period of 90 days or less. The Bank would consider a modification for a customer experiencing what is expected to be a short-term event that has temporarily impacted cash flow. This could be due, among other reasons, to illness, weather, impact from a one-time expense, slower than expected start-up, construction issues or other short-term issues. 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, 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, 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. 57 Table of Contents 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) Vertical $ % 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. While the level of nonperforming assets fluctuates in response to changing economic and market conditions, in light of the relative size and composition of the loan and lease portfolio and management’s degree of success in resolving problem assets, management believes that a proactive approach to early iden tification and intervention is critical to successfully managing a small business loan portfolio. As government payment assistance began to expire toward the end of 2020, borrowers with continuing difficulties arising from the pandemic were provided additional relief through payment deferrals. At December 31, 2023, the Company had $11.0 million in unguaranteed loans on SBA payment assistance. Allowance for Credit Losses on Loans and Leases The ACL of $96.6 million at December 31, 2022 , increased by $29.3 million, or 30.3%, to $125.8 million at December 31, 2023 . 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 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.” 58 Table of Contents 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 $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 $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 $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 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. 2023 2022 Allowance Total Loans and Leases (1) % of Total Allowance % of Total Loans and Leases (1) Allowance Total Loans and Leases (1) % of Total Allowance % of Total Loans and Leases (1) Commercial & Industrial Small Business Banking $ 49,120 $ 2,125,163 39.0 % 25.7 % $ 41,481 $ 2,025,983 43.0 % 29.6 % Specialty Lending 25,807 1,131,493 20.5 13.7 17,216 754,271 17.8 11.0 Energy & Infrastructure 12,646 849,757 10.0 10.3 6,278 423,529 6.5 6.2 Paycheck Protection Program 8 5,595 — 0.1 20 13,134 — 0.2 Total 87,581 4,112,008 69.6 49.7 64,995 3,216,917 67.3 47.0 Construction & Development Small Business Banking 3,320 415,094 2.6 5.0 2,860 472,743 3.0 6.9 Specialty Lending 1,207 47,419 1.0 0.6 2,038 104,069 2.1 1.5 Energy & Infrastructure 190 7,541 0.2 0.1 203 13,753 0.2 0.2 Total 4,717 470,054 3.7 5.7 5,101 590,565 5.3 8.6 Commercial Real Estate Small Business Banking 14,743 2,465,576 11.7 29.8 14,608 2,167,515 15.1 31.6 Specialty Lending 10,754 523,744 8.5 6.3 4,233 306,785 4.4 4.5 Energy & Infrastructure 3,367 161,685 2.7 2.0 4,060 139,778 4.2 2.0 Total 28,864 3,151,005 22.9 38.1 22,901 2,614,078 23.7 38.1 Commercial Land Small Business Banking 4,678 534,762 3.7 6.5 3,569 432,594 3.7 6.3 Total 4,678 534,762 3.7 6.5 3,569 432,594 3.7 6.3 Total $ 125,840 $ 8,267,829 100.0 % 100.0 % $ 96,566 $ 6,854,154 100.0 % 100.0 % (1) Excludes loans measured at fair value. 59 Table of Contents Analysis of Loan and Lease Loss Experience. The following table sets forth an analysis of net charge-offs for loans and leases carried at historical cost to average total loans and leases, carried at historical cost, by category for the years indicated. 2023 2022 2021 Net Charge-offs (1) Average Total Loans & Leases (1)(2) % of Average Total Loans & Leases (1)(2) Net Charge-offs (1) Average Total Loans & Leases (1)(2) % of Average Total Loans & Leases (1)(2) Net Charge-offs (1) Average Total Loans & Leases (1)(2) % of Average Total Loans & Leases (1)(2) Commercial & Industrial Small Business Banking $ 13,705 $ 2,086,469 0.7 % $ 5,423 $ 1,634,074 0.3 % $ 2,740 $ 1,073,328 0.3 % Specialty Lending 7,966 1,002,418 0.8 1,383 580,940 0.2 — 247,856 — Energy & Infrastructure — 564,070 — 411 350,910 0.1 — 167,521 — Paycheck Protection Program — 8,283 — 5 81,250 — — 939,205 — Total 21,671 3,661,240 0.6 7,222 2,647,174 0.3 2,740 2,427,910 0.1 Construction & Development Small Business Banking — 274,777 — (3) 271,596 — 262 169,530 0.2 Specialty Lending — 41,230 — — 72,996 — — 19,120 — Energy & Infrastructure — 6,914 — — 12,751 — — 45,639 — Total — 322,921 — (3) 357,343 — 262 234,289 0.1 Commercial Real Estate Small Business Banking 1,416 2,463,238 0.1 489 1,904,876 — 664 1,403,403 — Specialty Lending — 448,958 — — 214,760 — 254 92,888 0.3 Energy & Infrastructure (1,714) 134,959 (1.3) (388) 120,783 (0.3) — 127,456 — Total (298) 3,047,155 — 101 2,240,419 — 918 1,623,747 0.1 Commercial Land Small Business Banking — 505,692 — 641 422,886 0.2 12 377,967 — Total — 505,692 — 641 422,886 0.2 12 377,967 — Total $ 21,373 $ 7,537,008 0.3 % $ 7,961 $ 5,667,822 0.1 % $ 3,932 $ 4,663,913 0.1 % (1) Excludes loans measured at fair value. (2) Average loans and leases held for investment, at amortized cost. Investment Securities 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. This also included purchases of $206.9 million in mortgage-backed securities, including $14.7 million for purposes of complying with the Community Reinvestment Act and purchases of $32.1 million in collateralized mortgage obligations to increase yield and duration. The investment securities portfolio consists entirely of available-for-sale securities. The Company purchases securities for the investment securities portfolio to manage interest rate risk, ensure a stable source of liquidity and to provide a steady source of income in excess of cost of funds. At December 31, 2023, the modified duration of the overall available-for-sale securities portfolio was approximately 6.45 years. 60 Table of Contents The following table sets forth the stated maturities and weighted average yields of investment securities at December 31, 2023. Certain mortgage related securities have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the tables below. Total Amortized Cost Within One Year After One to Five Years After Five to Ten Years After Ten Years Amortized Cost Average Yield Amortized Cost Average Yield Amortized Cost Average Yield Amortized Cost Average Yield U.S. 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 Municipal bonds 3,200 — — — — 3,103 4.50 97 5.22 Other debt securities — — — — — — — — — Total securities $ 1,237,633 $ 15,358 4.62 % $ 192,170 2.67 % $ 246,147 2.82 % $ 783,958 2.70 % 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. Deposits The following table sets forth the composition of deposits. 2023 2022 2021 Total Percent Total Percent Total Percent Period end: Noninterest-bearing demand deposits $ 259,270 2.5 % $ 194,100 2.2 % $ 89,279 1.3 % Interest-bearing deposits: Interest-bearing checking 301,006 2.9 — — — — Money market 135,551 1.3 128,443 1.4 105,628 1.5 Savings 4,497,376 43.8 4,096,576 46.1 3,507,354 49.3 Time deposits 5,081,816 49.5 4,465,809 50.3 3,409,783 47.9 Total 10,015,749 97.5 8,690,828 97.8 7,022,765 98.7 Total period end deposits $ 10,275,019 100.0 % $ 8,884,928 100.0 % $ 7,112,044 100.0 % Total uninsured deposits $ 1,457,800 14.2 % $ 1,563,189 17.6 % $ 1,197,057 16.8 % 2023 2022 2021 Total Percent Average Rate Total Percent Average Rate Total Percent Average Rate Average: Noninterest-bearing demand deposits $ 215,327 2.2 % — % $ 125,062 1.6 % — % $ 77,104 1.2 % — % Interest-bearing deposits: Interest-bearing checking 231,413 2.4 5.50 — — — 76,714 1.2 0.58 Money market 125,279 1.3 0.58 100,684 1.3 0.30 103,078 1.6 0.29 Savings 4,428,306 45.7 3.86 3,903,151 48.9 1.48 3,077,933 47.2 0.54 Time deposits 4,695,161 48.4 3.31 3,849,203 48.2 1.48 $ 3,181,591 100.0 % 1.33 Total average deposits $ 9,695,486 100.0 % 3.59 % $ 7,978,100 100.0 % 1.46 % $ 6,516,420 100.0 % 0.92 % 61 Table of Contents Deposits increased to $10.28 billion at December 31, 2023 from $8.88 billion at December 31, 2022, an increase of $1.39 billion, or 15.6%. This increase was primarily due to the growth of the Company’s customer base in the savings and time deposit products, enhanced by a nationwide marketing campaign with attractive rates and additional wholesale funding, to support the significant loan growth in 2023. 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. 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: Maturity Period Three months or less More than three months to six months More than six months to twelve months More than twelve months Amount of time deposits in uninsured accounts $ 67,828 $ 97,527 $ 84,245 $ 6,204 Borrowings Total borrowings decreased $59.8 million at December 31, 2023 from December 31, 2022 as a result of the following: In March 2021, the Company entered into a 60-month term loan agreement of $50.0 million with a third party correspondent bank. The loan accrues interest at a fixed rate of 2.95% with a monthly payment sufficient to fully amortize the loan, with all remaining unpaid principal and interest due at maturity on March 30, 2026. The Company paid the Lender a non-refundable $325 thousand loan origination fee upon signing of the Note that is presented as a direct deduction from the carrying amount of the loan and will be amortized into interest expense over the life of the loan. In April 2020, the Company entered into the Federal Reserve Bank's PPPLF. Under the PPPLF, advances must be secured by pledges of loans to small businesses originated by the Company under the U.S. Small Business Administration's 7(a) loan program titled the Paycheck Protection Program. The PPPLF accrues interest at thirty-five basis points and matures at various dates equal to the maturity date of the PPPLF collateral pledged to secure the advance, and will be accelerated on and to the extent of any 7(a) loan forgiveness reimbursement by the SBA for any PPPLF collateral or the date of purchase by the SBA from the borrower of any PPPLF collateral. On the maturity date of each advance, the Company repays the advance plus accrued interest. This borrowing was paid in full at September 30, 2022. In September 2020, the Company renewed a $50.0 million revolving line of credit originally issued in 2017 with a third party correspondent bank. 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. 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 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 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. 62 Table of Contents Liquidity Management Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Company’s customers. Liquidity is immediately available from four major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) the market value of unpledged investment securities; 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. Loans and other assets are funded primarily by loan sales, wholesale deposits and core deposits. 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, Federal Reserve Bank Term Funding Program, 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. At December 31, 2023, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $1.13 billion available to be pledged as collateral. Contractual Obligations The Company has entered into significant fixed and determinable contractual obligations for future payments. See the accompanying notes to the consolidated financial statements for expected timing of payments as of December 31, 2023. These include operating leases (Note 4. Leases), time deposits with stated maturity dates (Note 7. Deposits) and borrowings (Note 8. Borrowings). 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 In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in the consolidated financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. 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 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. Commitments and Contingencies in the accompanying notes to the consolidated financial statements. Asset/Liability Management and Interest Rate Sensitivity One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps. This method, however, addresses only the magnitude of timing differences and does not address earnings or market value. Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to more accurately measure interest rate risk. For more information, see Item 7A of this Report. 63 Table of Contents Capital The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. The Company’s principal goals related to the maintenance of capital are to provide adequate capital to support the Company’s risk profile consistent with the risk appetite approved by the Board of Directors; provide financial flexibility to support future growth and client needs; comply with relevant laws, regulations, and supervisory guidance; achieve optimal credit ratings for the Company and its subsidiaries; and provide a competitive return to shareholders. Management regularly monitors the capital position of the Company on both a consolidated and Bank level basis. In this regard, management’s goal is to maintain capital at levels that are in excess of the regulatory “well capitalized” levels. Risk-based capital ratios, which include Tier 1 Capital, Total Capital and Common Equity Tier 1 Capital, are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets. Capital amounts and ratios as of December 31, 2023, 2022 and 2021 are presented in the table below. Actual Minimum Capital Requirement Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions (1) Amount Ratio Amount Ratio Amount Ratio Consolidated - December 31, 2023 Common Equity Tier 1 (to Risk-Weighted Assets) $ 960,433 11.73 % $ 368,549 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) $ 1,063,157 12.98 % $ 655,198 8.00 % N/A N/A Tier 1 Capital (to Risk-Weighted Assets) $ 960,433 11.73 % $ 491,399 6.00 % N/A N/A Tier 1 Capital (to Average Assets) $ 960,433 8.58 % $ 447,561 4.00 % N/A N/A Bank - December 31, 2023 Common Equity Tier 1 (to Risk-Weighted Assets) $ 823,478 10.40 % $ 356,426 4.50 % $ 514,837 6.50 % Total Capital (to Risk-Weighted Assets) $ 922,876 11.65 % $ 633,646 8.00 % $ 792,057 10.00 % Tier 1 Capital (to Risk-Weighted Assets) $ 823,478 10.40 % $ 475,234 6.00 % $ 633,646 8.00 % Tier 1 Capital (to Average Assets) $ 823,478 7.41 % $ 444,480 4.00 % $ 555,600 5.00 % Consolidated - December 31, 2022 Common Equity Tier 1 (to Risk-Weighted Assets) $ 888,235 12.47 % $ 320,446 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) $ 977,360 13.73 % $ 569,681 8.00 % N/A N/A Tier 1 Capital (to Risk-Weighted Assets) $ 888,235 12.47 % $ 427,261 6.00 % N/A N/A Tier 1 Capital (to Average Assets) $ 888,235 9.26 % $ 383,499 4.00 % N/A N/A Bank - December 31, 2022 Common Equity Tier 1 (to Risk-Weighted Assets) $ 730,092 10.70 % $ 307,179 4.50 % $ 443,703 6.50 % Total Capital (to Risk-Weighted Assets) $ 815,577 11.95 % $ 546,096 8.00 % $ 682,620 10.00 % Tier 1 Capital (to Risk-Weighted Assets) $ 730,092 10.70 % $ 409,572 6.00 % $ 546,096 8.00 % Tier 1 Capital (to Average Assets) $ 730,092 7.70 % $ 379,396 4.00 % $ 474,245 5.00 % Consolidated - December 31, 2021 Common Equity Tier 1 (to Risk-Weighted Assets) $ 689,367 12.38 % $ 250,619 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) $ 753,691 13.53 % $ 445,544 8.00 % N/A N/A Tier 1 Capital (to Risk-Weighted Assets) $ 689,367 12.38 % $ 334,158 6.00 % N/A N/A Tier 1 Capital (to Average Assets) $ 689,367 8.87 % $ 310,902 4.00 % N/A N/A Bank - December 31, 2021 Common Equity Tier 1 (to Risk-Weighted Assets) $ 640,652 12.05 % $ 239,201 4.50 % $ 345,512 6.50 % Total Capital (to Risk-Weighted Assets) $ 704,976 13.26 % $ 425,246 8.00 % $ 531,557 10.00 % Tier 1 Capital (to Risk-Weighted Assets) $ 640,652 12.05 % $ 318,934 6.00 % $ 425,246 8.00 % Tier 1 Capital (to Average Assets) $ 640,652 8.32 % $ 307,931 4.00 % $ 384,914 5.00 % (1) Prompt corrective action provisions are not applicable at the bank holding company level. 64 Table of Contents Critical Accounting Policies and Estimates The preparation of consolidated financial statements in accordance with GAAP requires the Company to make estimates and judgments that affect reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. 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 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. The Company’s most critical accounting estimates are listed below. These estimates require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. Allowance for credit losses (ACL) The Company’s policy is to maintain the ACL at a level to absorb expected credit losses. The loan and lease portfolio is periodically reviewed by management to identify trends and to measure asset quality. Accounting policies related to the ACL on financial instruments including loans and off-balance-sheet credit exposures are considered to be critical as these policies involve considerable subjective judgment and estimation by the Company. The ACL is a valuation account that is deducted from the amortized cost basis of loans and leases to present a net amount expected to be collected over the life of the asset. The Company’s ACL on loans and leases is estimated using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts, and measured on a pooled basis where loans with similar risk characteristics (such as industry and type of collateral) are collectively evaluated for impairment. The ACL is computed using a discounted cash flow (“DCF”) methodology that utilizes inputs and assumptions that require significant judgement. The most significant assumptions used are: 1) economic forecast assumptions, 2) prepayment assumptions, and 3) application of qualitative factors, the most significant of which is related to the loan risk grading process. Sensitivities to these three areas are disclosed below to demonstrate how a change in economic forecast, prepayment assumptions and risk grades may impact the ACL. The below sensitivities only consider each variable individually in isolation as compared to the reported total of the ACL and factor in no correlated impacts to other inputs or factors of the ACL model. Economic forecast Probability of default (“PD”) and loss given default (“LGD”) rates within the DCF model are adjusted for national unemployment rates during the reasonable and supportable forecast period. The Company has determined that a reasonable and supportable forecast period is four quarters with loss rates reverting back to a historical loss rate over the subsequent four quarters on a straight-line basis. The ACL is highly sensitive to the unemployment economic forecast used. Due to the high level of uncertainty regarding significant assumptions, the Company often evaluates various economic scenarios from authoritative industry sources to assess variability of economic outlooks. At December 31, 2023, the Company utilized economic assumptions that management believed were the most likely to occur during the duration of the forecast period which had current unemployment levels remaining relatively stable during the one-year forecast period. Selecting a different forecast in the current environment could result in a significantly different ACL. The following table summarizes the impact of more severe unemployment forecast scenarios if they had been selected at December 31, 2023. 65 Table of Contents Approximate increase to ACL Scenario Forecasted Unemployment $ % Severe Current unemployment levels increase to 5.6% in the first quarter of 2024 and increase to 9.2% by the end of a one-year forecast period. At the end of the forecast period adjusted loss rates revert back to a historical rate over a one-year period. $30.9 million 24.6 % Moderate Current unemployment levels increase to 4.6% in the first quarter of 2024 and increase to 7.2% by the end of a one-year forecast period. At the end of the forecast period adjusted loss rates revert back to a historical rate over a one-year period. 17.6 million 14.0 Mild Current unemployment levels decrease to 4.1% in the first quarter of 2024 before increasing to 5.2% by the end of a one-year forecast period. At the end of the forecast period adjusted loss rates revert back to a historical rate over a one-year period. 6.2 million 4.9 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 estimate 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 ACL. To illustrate, if the weighted average prepayment assumption were decreased by 25%, the ACL as of December 31, 2023 would increase by approximately $6.0 million or 4.7%. Loan risk grade - qualitative adjustments 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 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 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. Changes to internal risk ratings, would result in a different estimated allowance for credit losses. To illustrate, if all loans in the Company’s five largest industry verticals ($2.17 billion or 41.0% of unguaranteed held for investment loans not 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 ACL as of December 31, 2023 would increase by approximately $13.9 million, or 11.0%. 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, and changes in interest rates. See Note 1. Organization and Summary of Significant Accounting Policies and Note 3. Loans and Leases Held for Investment and Credit Quality in the notes to consolidated financial statements for further details of the factors considered by the Company in estimating the necessary level of the ACL. Valuation of loans accounted for under the fair value option 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. 66 Table of Contents 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. See Note 10. 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. 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. The fair value of servicing rights is highly sensitive to changes in underlying assumptions. Changes in prepayment speed and discount rate assumptions typically have the most significant impacts on the fair value of servicing rights. Generally, as interest rates rise on variable rate loans, loan prepayments increase due to an increase in refinance activity, which results in a decrease in the fair value of servicing assets, however, weakening economic conditions or significant declines in interest rates can also increase loan prepayment activity. The discount rate used in the estimation process is tied to a benchmark risk-free rate with a risk premium added using a build-up method. Measurement of fair value is limited to the conditions existing and the assumptions used as of a particular point in time, and those assumptions may not be appropriate if they are applied at a different time. 67 Table of Contents At December 31, 2023, the key assumptions used to determine the fair value of the Company’s servicing rights included a weighted average prepayment speed equal to 15.3% and a weighted average discount rate equal to 14.5%. The table below reflects the sensitivity of the current fair value of servicing assets to immediate changes in the above key assumptions with all other assumptions remaining static: As of December 31, 2023 Fair value of servicing rights $48,186 Incremental Increase (Decrease) in Value Prepayment Speed 20% increase ($2,815) 10% increase (1,452) 10% decrease 1,549 20% decrease 3,203 Discount Rate 200 basis point increase ($2,186) 100 basis point increase (1,117) 100 basis point decrease 1,170 200 basis point decrease 2,396 The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the servicing rights is calculated without changing any other assumption. Changes in one factor may result in changes in another. See Note 5. Servicing Assets in the notes to consolidated financial statements for further details of the factors considered by the Company in estimating the fair value of servicing assets. Income taxes The income tax provision calculation is complex and requires the use of estimates and judgment in its determination. The exercise of significant judgment arises in the interpretation of these tax laws and regulations, in various jurisdictions in which the Company operates and actual liabilities could significantly vary based upon the taxing authority’s interpretation. Specifically, significant estimates in accounting for income taxes relate to the valuation of deferred tax assets and liabilities, evaluations of the Company’s ability to realize deferred tax assets, including income tax credits and net operating loss carryforwards, and the need for a valuation allowance, the calculation of taxable income, the estimation of uncertain tax positions and the determination of temporary differences between book and tax bases. Adjustments to these items may occur due to modifications in tax rates, newly enacted laws, issuance of tax regulations, resolution of items with taxing authorities, alterations to interpretative statutory, judicial, and regulatory guidance that affects the Company’s tax positions, changes in the Company's tax accounting methods or elections, or other facts and circumstances. Management closely monitors tax developments and the potential timing of these changes in order to evaluate the effect they may have on the Company’s overall tax position and the estimates and judgments used in determining the income tax provision and records adjustments as necessary. To the extent the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. 68 Table of Contents Non-GAAP Measures Some of the financial measures included in our selected historical consolidated financial data and elsewhere in this Report are not measures of financial performance recognized by GAAP. These non-GAAP financial measures are: “tangible shareholders’ equity;” “tangible assets;” “tangible shareholders’ equity to tangible assets;” “tangible book value per share;” and “efficiency ratio.” Management uses these non-GAAP financial measures in its analysis of the Company’s performance. • “Tangible shareho lders’ equity” is total shareholders’ equity less goodwill and other intangible assets. Management has not considered loan servicing rights as an intangible asset for purposes of this calculation. • “Tangible assets” is total assets less goodwill and other intangible assets. Management has not considered loan servicing rights as an intangible asset for purposes of this calculation. • “Tangible shareholders’ equity to tangible assets” is defined as the ratio of shareholders’ equity less goodwill and other intangible assets, divided by total assets less goodwill and other intangible assets. Management believes this measure is important because it shows relative changes from period to period in equity and total assets, each exclusive of changes in intangible assets. Management has not considered loan servicing rights as an intangible asset for purposes of this calculation. • “Tangible book value per share” is defined as total equity reduced by goodwill and other intangible assets divided by total common shares outstanding. Management believes this measure is important because it shows changes from period to period in book value per share exclusive of changes in intangible assets. Management has not considered loan servicing rights as an intangible asset for purposes of this calculation. • “Efficiency ratio” is defined as total noninterest expense divided by the sum of net interest income and noninterest income. Management believes this measure is important as an indicator of productivity because it shows the amount of noninterest expense that was required to generate a dollar of revenue. While the efficiency ratio is a measure of productivity, its value reflects the unique attributes of the “high-touch business model” the Company employs. 69 Table of Contents The Company believes these non-GAAP financial measures provide useful information to management and investors that is supplementary to the financial condition, results of operations and cash flows computed in accordance with GAAP; however, the Company acknowledges that non-GAAP financial measures have a number of limitations. As such, you should not view these measures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use. The following table provides a reconciliation of these non-GAAP financial measures to the most closely related GAAP measure. Years Ended December 31, 2023 2022 2021 Total shareholders' equity $ 902,666 $ 811,033 $ 715,133 Less: Goodwill 1,797 1,797 1,797 Other intangible assets 1,721 1,873 2,026 Tangible shareholders' equity (a) $ 899,148 $ 807,363 $ 711,310 Shares outstanding (c) 44,617,673 44,061,244 43,619,070 Total assets $ 11,271,423 $ 9,855,498 $ 8,213,393 Less: Goodwill 1,797 1,797 1,797 Other intangible assets 1,721 1,873 2,026 Tangible assets (b) $ 11,267,905 $ 9,851,828 $ 8,209,570 Tangible shareholders' equity to tangible assets (a/b) 7.98% 8.20% 8.66% Tangible book value per share (a/c) $ 20.15 $ 18.32 $ 16.31 Efficiency ratio: Noninterest expense (d) $ 322,885 $ 314,226 $ 230,987 Net interest income 345,305 327,501 296,785 Noninterest income 111,733 237,992 160,200 Adjusted operating revenue (e) $ 457,038 $ 565,493 $ 456,985 Efficiency ratio (d/e) 70.65% 55.57% 50.55% 70 Table of Contents