What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-05-10 compared with 2023-11-03 · 196 added, 277 removed, 380 unchanged (55% of the section changed)

17 unchanged sentences

These risks, uncertainties and assumptions include, without limitation:

• deterioration in the financial condition of borrowers resulting in significant increases in the Company’s loan and lease losses and provisions for those losses and other adverse impacts to results of operations and financial condition;

• deterioration in the financial condition of borrowers resulting in significant increases in the Company’s provision for credit losses and other adverse impacts to results of operations and financial condition;

• changes in Small Business Administration (“SBA”) rules, regulations and loan products, including specifically the Section 7(a) program, changes in SBA standard operating procedures or changes to the status of Live Oak Banking Company (the “Bank”) as an SBA Preferred Lender;

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• changes in interest rates that affect the level and composition of deposits, loan demand and the values of loan collateral, securities, and interest sensitive assets and liabilities;

• the failure of assumptions underlying the establishment of reserves for possible loan and lease losses;

• the failure of assumptions underlying the establishment of reserves for possible credit losses;

• changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments;

• recent adverse developments in the banking industry highlighted by high-profile bank failures and the potential impact of such developments on customer confidence, liquidity, and regulatory responses to these developments;

• adverse developments in the banking industry highlighted by high-profile bank failures and the potential impact of such developments on customer confidence, liquidity, and regulatory responses to these developments;

• the impacts of global health crises and pandemics, such as the Coronavirus Disease 2019 (“COVID-19”) pandemic, on trade (including supply chains and export levels), travel, employee productivity and other economic activities that may have a destabilizing and negative effect on financial markets, economic activity and customer behavior;

• a reduction in or the termination of the Company’s ability to use the technology-based platform that is critical to the success of the Company’s business model or to develop a next-generation banking platform, including a failure in or a breach of the Company’s operational or security systems or those of its third party service providers;

• technological risks and developments, including cyber threats, attacks, or events;

• changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts operations, including reductions in rates of business formation and growth, demand for the Company’s products and services, commercial and residential real estate development and prices, premiums paid in the secondary market for the sale of loans, and valuation of servicing rights;

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Performance Summary

Three months ended September 30, 2023 compared with three months ended September 30, 2022

For the three months ended September 30, 2023, the Company reported net income of $39.8 million, or $0.88 per diluted share, compared to net income of $42.9 million, or $0.96 per diluted share, for the third quarter of 2022.

The decrease in net income was principally due to the lower equity method investment income of $30.2 million, largely driven by the third quarter of 2022 gain of $28.4 million related to the Company's sale of its investment in Payrailz, LLC (“Payrailz”).

To a lesser extent, the decrease was also influenced by a $5.0 million negative change in net loss on loans accounted for under the fair value option.

Key factors partially offsetting the decrease in net income for the third quarter of 2023 were:

• Increase in net interest income of $5.5 million, or 6.6%, 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;

• Decreased provision for loan and lease credit losses of $3.9 million to $10.3 million, compared to $14.2 million for the third quarter of 2022.

The provision expense in the third quarter of 2023 was primarily the result of continued growth of the loan and lease portfolio combined with specific reserve changes on individually evaluated loans and charge-off related impacts;

• On July 1, 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.

All comparative balances and changes between periods discussed herein related to the servicing asset and loans measured at fair value are inclusive of these one-time adjustments.

During the third quarter of 2023, the net gain on loan servicing asset revaluation increased by $12.7 million (inclusive of the one-time adjustment discussed above), to $11.3 million for the quarter, compared to a net loss of $1.3 million in the third quarter of 2022.

• Increased net gains on sales of loans of $3.4 million, or 36.7%, principally the result of a higher volume of loan sales in the third quarter of 2023;

• Decreased impairment charges of $7.7 million, arising from a third quarter of 2022 renewable energy tax credit investment.

Nine months ended September 30, 2023 compared with nine months ended September 30, 2022

For the nine months ended September 30, 2023, the Company reported net income of $57.7 million, or $1.28 per diluted share, compared to net income of $174.4 million, or $3.88 per diluted share, for the nine months ended September 30, 2022.

The decrease in net income was largely due to the following items:

• Decrease in equity method investment income of $152.1 million, principally a product of the above discussed Payrailz gain combined with the second quarter of 2022 gain of $120.5 million related to the Company's sale of its investment in Finxact, Inc.

• Provision for loan and lease credit losses increased by $21.1 million, to $42.3 million, compared to $21.3 million for the first nine months of 2022.

The level of provision expense in the first nine months of 2023 was primarily the result of continued growth of the loan and lease portfolio combined with specific reserve changes on individually evaluated loans and charge-off related impacts;

• The net loss on loans accounted for under the fair value option of $3.4 million, increased by $3.8 million (inclusive of the one-time adjustment discussed above) from a net gain of $475 thousand in the first nine months of 2022, principally the result of negative market trends;

• Increased levels of noninterest expense related to advertising and marketing up $3.4 million, or 51.2%, technology expense up $3.9 million, or 19.8%, and FDIC insurance expense up $5.7 million, or 84.1%.

Key factors partially offsetting the decrease in net income for the first nine months of 2023 were:

• Increase in net interest income of $14.1 million, or 5.8%, principally the result of the above discussed drivers of the quarter over quarter increase;

• A net gain on loan servicing asset revaluation of $8.9 million (inclusive of the one-time adjustment discussed above) compared to a net loss of $11.6 million in the first nine months of 2022, resulting in a positive change of $20.4 million.

This increase was principally driven by the above discussed third quarter of 2023 change in estimate;

• Decreased levels of noninterest expense related to professional services expense down $4.6 million, or 49.5%, combined with declines in renewable energy tax credit investment impairment of $7.7 million and contributions and donations expense of $6.4 million;

• Decreased income tax expense of $27.6 million, or 78.4%, principally related to above discussed decrease in net income.

Three months ended March 31, 2024 compared with three months ended March 31, 2023

For the three months ended March 31, 2024, the Company reported net income of $27.6 million, or $0.60 per diluted share, compared to net income of $398 thousand, or $0.01 per diluted share, for the first quarter of 2023.

The increase in net income was principally due to the following items:

• Increase in net interest income of $8.1 million, or 9.9%, driven by increases in loan volumes, partially mitigated by a decrease in net interest margin arising from an increase in interest-bearing deposits combined with the increase in average cost of funds outpacing the average yield on interest-earning assets;

• Provision for loan and lease credit losses decreased by $2.7 million to $16.4 million, compared to $19.0 million for the first quarter of 2023;

• A $4.3 million decrease in the net loss on loans accounted for under the fair value option;

• Increased other noninterest income of $5.7 million, or 140.1%, largely related to a gain arising from increased fair value of equity warrant assets associated with the Company’s wine & craft beverage vertical.

• Decrease in income tax expense of $8.7 million, from $3.2 million in the first quarter of 2023, to an income tax benefit of $5.5 million for the first quarter of 2024.

This decrease was largely the result of an additional $10.6 million in investment tax credits related to the Company's fourth quarter of 2023 renewable energy investment that became eligible for an extra 10% in tax credits in the first quarter of 2024.

Key factors partially offsetting the increase in net income for the first quarter of 2024 were decreased loan servicing asset revaluation income of $3.1 million, increased equity method investment losses of $2.1 million and increased salaries and employee benefits of $2.5 million.

Net Interest Income and Margin

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

Three months ended September 30, 2023 compared with three months ended September 30, 2022

For the three months ended September 30, 2023, net interest income increased $5.5 million, or 6.6%, to $89.4 million compared to $83.9 million for the three months ended September 30, 2022.

This increase was principally due to the 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 $6.6 million.

Average interest-earning assets increased by $1.85 billion, or 21.4%, to $10.52 billion for the third quarter of 2023, compared to $8.66 billion for the third quarter of 2022, while the yield on average interest-earning assets increased 150 basis points to 6.81%.

The cost of funds on interest-bearing liabilities for the third quarter of 2023 increased 217 basis points to 3.72%, and the average balance of interest-bearing liabilities increased by $1.58 billion, or 19.3%, over the third quarter of 2022.

As indicated in the rate/volume table below, the overall increase discussed above is reflected in increased interest income of $64.8 million outpacing growth in interest expense of $59.3 million for the third quarter of 2023 compared to the third quarter of 2022.

The net interest margin decreased from 3.84% for the third quarter of 2022 to 3.37% for the third quarter of 2023.

Nine months ended September 30, 2023 compared with nine months ended September 30, 2022

For the nine months ended September 30, 2023, net interest income increased $14.1 million, or 5.8%, to $255.7 million compared to $241.6 million for the nine months ended September 30, 2022.

Three months ended March 31, 2024 compared with three months ended March 31, 2023

For the three months ended March 31, 2024, net interest income increased $8.1 million, or 9.9%, to $90.1 million compared to $82.0 million for the three months ended March 31, 2023.

Average interest-earning assets increased by $1.91 billion, or 23.2%, to $10.17 billion for the nine months ended September 30, 2023, compared to $8.26 billion for the nine months ended September 30, 2022, while the yield on average interest-earning assets increased 161 basis points to 6.60%.

The cost of funds on interest-bearing liabilities for the nine months ended September 30, 2023 increased 236 basis points to 3.49%, and the average balance of interest-bearing liabilities increased by $1.60 billion, or 20.4%, over the nine months ended September 30, 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.

This increase was muted by a $78.0 million reduction in average borrowings largely related to Paycheck Protection Program Liquidity Facility, or PPPLF, repayments in 2022.

As indicated in the rate/volume table below, the overall increase discussed above is reflected in increased interest income of $193.9 million outpacing growth in interest expense of $179.7 million for the first nine months of 2023 compared to the first nine months of 2022.

The net interest margin decreased from 3.91% for the nine months ended September 30, 2022 to 3.36% for the nine months ended September 30, 2023.

During the nine months ended September 30, 2023, the Federal Reserve increased the federal funds upper target rate by 100 basis points.

In September 2023, the Federal Reserve released its most current federal funds target rate midpoint projections which implied an increase of the median Federal Funds rate to 5.6% by the end of 2023 and a decrease of approximately 50 basis points to 5.1% by the end of 2024.

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

Average interest-earning assets increased by $1.28 billion, or 13.4%, to $10.89 billion for the first quarter of 2024, compared to $9.61 billion for the first quarter of 2023, while the yield on average interest-earning assets increased 72 basis points to 7.11%.

The cost of funds on interest-bearing liabilities for the first quarter of 2024 increased 96 basis points to 4.07% and the average balance of interest-bearing liabilities increased by $1.06 billion, or 11.8%, over the first quarter of 2023.

As indicated in the rate/volume table below, the overall increase discussed above is reflected in increased interest income of $41.0 million outpacing growth in interest expense of $32.9 million for the first quarter of 2024 compared to the first quarter of 2023.

The net interest margin decreased from 3.46% for the first quarter of 2023 to 3.33% for the first quarter of 2024.

During the three months ended March 31, 2024, the Federal Reserve decided to maintain the federal funds upper target rate at 5.5%.

In March 2024, the Federal Reserve released its most current federal funds target rate midpoint projections which maintained a median Federal Funds rate of 4.6% by the end of 2024 and a decrease of approximately 70 basis points to 3.9% 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.

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

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Loan fees are included in interest income on loans.

Three Months Ended September 30,

Three Months Ended March 31,

Balance Interest Average

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(1) Average loan and lease balances include non-accruing loans and leases.

Nine Months Ended September 30,

Interest Average

Interest-earning assets:

Interest-earning balances in other banks $ 579,962 $ 21,228 4.89 % $ 259,212 $ 2,402 1.24 %

Federal funds sold 46,165 1,624 4.70 92,127 1,275 1.85

Investment securities 1,232,737 24,751 2.68 950,787 12,951 1.82

Loans held for sale 559,770 37,410 8.94 1,078,743 47,308 5.86

Loans and leases held for investment (1)

7,751,863 416,726 7.19 5,876,078 243,927 5.55

Total interest-earning assets 10,170,497 501,739 6.60 8,256,947 307,863 4.99

Allowance for credit losses on loans and leases

(107,686) (63,613)

Noninterest-earning assets 497,795 610,330

Total assets $ 10,560,606 $ 8,803,664

Interest-bearing liabilities:

Interest-bearing checking $ 208,278 $ 8,456 5.43 % $ — $ — — %

Savings 4,359,136 123,959 3.80 3,838,150 29,153 1.02

Money market accounts 124,198 523 0.56 94,901 182 0.26

Certificates of deposit 4,668,087 110,574 3.17 3,749,894 35,343 1.26

Total deposits 9,359,699 243,512 3.48 7,682,945 64,678 1.13

Borrowings 74,163 2,498 4.50 152,157 1,586 1.39

Total interest-bearing liabilities 9,433,862 246,010 3.49 7,835,102 66,264 1.13

Noninterest-bearing deposits 207,009 105,629

Noninterest-bearing liabilities 74,645 64,205

Shareholders' equity 845,090 798,728

Total liabilities and shareholders' equity

$ 10,560,606 $ 8,803,664

Net interest income and interest rate spread

$ 255,729 3.11 % $ 241,599 3.86 %

Net interest margin 3.36 % 3.91 %

Ratio of average interest-earning assets to average interest-bearing liabilities

107.81 % 105.38 %

(1) Average loan and lease balances include non-accruing loans and leases.

Rate/Volume Analysis.

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For purposes of this table, increases or decreases 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.

Three Months Ended September 30, Nine Months Ended September 30,

2022 2023 vs.

Increase (Decrease) Due to Increase (Decrease) Due to

Rate Volume Total Rate Volume Total

Three Months Ended March 31,

Increase (Decrease) Due to

Rate Volume Total

Interest income:

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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 the third quarter of 2023, there was a provision for loan and lease credit losses of $10.3 million compared to $14.2 million for the same period in 2022, a decrease of $3.9 million.

For the nine months ended September 30, 2023, there was a provision for loan and lease credit losses of $42.3 million compared to $21.3 million for the same period in 2022, an increase of $21.1 million.

The increase in provision expense as compared to the third quarter of 2022 and the nine months ended September 30, 2022 was primarily the result of loan growth, combined with specific reserve changes on individually evaluated loans and charge-off related impacts.

Loans and leases held for investment at historical cost were $7.79 billion as of September 30, 2023, increasing by $1.45 billion, or 22.9%, compared to September 30, 2022.

Net charge-offs for loans and leases carried at historical cost were $9.1 million, or 0.48% of average quarterly loans and leases held for investment, carried at historical cost, on an annualized basis, for the three months ended September 30, 2023, compared to net charge-offs of $1.7 million, or 0.12%, for the three months ended September 30, 2022.

The increase in net charge-offs was primarily related to a single borrower relationship of which a significant portion was reserved for in the second quarter of 2023.

For the nine months ended September 30, 2023 , net charge-offs totaled $16.9 million compared to $6.6 million for the nine months ended September 30, 2022 , an increase of $10.4 million, or 158.1%.

The increase in net charge-offs for the first nine-months of 2023 was primarily isolated to two relationships.

For the first quarter of 2024, there was a provision for loan and lease credit losses of $16.4 million compared to $19.0 million for the same period in 2023, a decrease of $2.7 million.

The decrease in provision expense as compared to the first quarter of 2023 was primarily the result of moderating effects arising from the combination of lower comparative levels of loan growth and charge-off impacts.

Loans and leases held for investment at historical cost were $8.53 billion as of March 31, 2024, increasing by $1.31 billion, or 18.2%, compared to March 31, 2023.

Net charge-offs for loans and leases carried at historical cost were $3.2 million, or 0.15% of average quarterly loans and leases held for investment, carried at historical cost, on an annualized basis, for the three months ended March 31, 2024, compared to net charge-offs of $6.7 million, or 0.38%, for the three months ended March 31, 2023.

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

In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $6.5 million and $2.7 million accounted for under the fair value option at September 30, 2023 and 2022, respectively, totaled $33.3 million, which was 0.43% of the held for investment loan and lease portfolio carried at historical cost at September 30, 2023, compared to $14.3 million, or 0.23% of loans and leases held for investment carried at historical cost at September 30, 2022.

The increase in total nonperforming loans and leases not guaranteed and carried at historical cost was largely comprised of one large relationship.

In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $7.9 million and $8.2 million accounted for under the fair value option at March 31, 2024 and 2023, respectively, totaled $43.1 million, which was 0.51% of the held for investment loan and lease portfolio carried at historical cost at March 31, 2024, compared to $22.0 million, or 0.30% of loans and leases held for investment carried at historical cost at March 31, 2023.

Noninterest Income

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The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.

Three Months Ended September 30, 2023/2022 Increase (Decrease)

2023 2022 Amount Percent

Noninterest income

Loan servicing revenue $ 6,990 $ 6,230 $ 760 12.2 %

Loan servicing asset revaluation 11,335 (1,324) 12,659 956.1

Net gains on sales of loans 12,675 9,275 3,400 36.7

Net (loss) gain on loans accounted for under the fair value option (568) 4,420 (4,988) (112.9)

Equity method investments (loss) income (1,034) 29,136 (30,170) (103.5)

Equity security investments (losses) gains, net (783) 876 (1,659) (189.4)

Lease income 2,498 2,516 (18) (0.7)

Management fee income 3,277 2,844 433 15.2

Other noninterest income 3,501 3,751 (250) (6.7)

Total noninterest income $ 37,891 $ 57,724 $ (19,833) (34.4) %

Nine Months Ended September 30, 2023/2022 Increase (Decrease)

Three Months Ended March 31, 2024/2023 Increase (Decrease)

2024 2023 Amount Percent

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Net gains on sales of loans 11,502 10,175 1,327 13.0

Net (loss) gain on loans accounted for under the fair value option (3,369) 475 (3,844) (809.3)

Net loss on loans accounted for under the fair value option (219) (4,529) 4,310 95.2

Equity method investments (loss) income (5,022) (2,952) (2,070) (70.1)

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Total noninterest income $ 26,097 $ 19,579 $ 6,518 33.3 %

As mentioned earlier, balances herein for the three and nine-month periods ended September 30, 2023 are inclusive of positive one-time change in estimate adjustments of $13.7 million for the loan servicing asset revaluation and $1.3 million for the net loss on loans accounted for under the fair value option

For the three months ended September 30, 2023, noninterest income decreased by $19.8 million, or 34.4%, compared to the three months ended September 30, 2022.

The decrease over the prior year is primarily a result of the $28.4 million Payrailz gain included in equity method investment income in the third quarter of 2022.

To a lesser extent, the decrease was also influenced by a $5.0 million negative change in net losses on loans accounted for under the fair value option.

Partially offsetting the decrease over the third quarter of 2022 was a $12.7 million incremental net gain related to the servicing asset revaluation and an increase in net gains on sales of loans of $3.4 million.

For the nine months ended September 30, 2023, noninterest income decreased by $137.3 million, or 62.7%, compared to the nine months ended September 30, 2022.

The decrease over the prior year is primarily a result of the aggregate $148.9 million in Finxact and Payrailz gains included in equity method investments income in the first nine months of 2022.

To a lesser extent, the decrease was also influenced by a $3.8 million negative change in net losses on loans accounted for under the fair value option, decreased net gains on loan sales of $2.2 million and decreased equity security investments gains of $3.1 million.

Partially offsetting the decrease over the prior year to date period was an increased net gain of $20.4 million related to the servicing asset revaluation combined with a $3.1 million increase in management fee income generated by Canapi Advisors.

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

For the three months ended March 31, 2024, noninterest income increased by $6.5 million, or 33.3%, compared to the three months ended March 31, 2023.

The increase over the prior year is primarily a result of a $4.3 million decrease in the net loss on loans accounted for under the fair value option combined with increased other noninterest income of $5.7 million, largely related to a gain arising from increased fair value of equity warrant assets associated with the Company’s wine & craft beverage vertical.

Partially offsetting the increase over the first quarter of 2023 was a $3.1 million incremental net loss related to the loan servicing asset revaluation combined with increased equity method investment losses of $2.1 million, principally related to heightened levels of underlying losses in several of the Company’s equity method investees.

The following table reflects loan and lease production, sales of guaranteed loans and the aggregate balance in guaranteed loans sold.

These components are key drivers of the Company's noninterest income.

Three months ended September 30, Three months ended June 30, Three months ended March 31,

2023 2022 2023 2022 2023 2022

Amount of loans and leases originated $ 1,073,255 $ 1,005,235 $ 861,033 $ 959,635 $ 1,030,882 $ 865,063

Guaranteed portions of loans sold 225,585 148,110 245,074 68,818 167,826 219,703

Outstanding balance of guaranteed loans sold (1)

2,909,343 2,671,705 2,808,200 2,681,079 2,695,757 2,786,403

Nine Months Ended September 30, For years ended December 31,

Three Months Ended March 31, For years ended December 31,

2024 2023 2023 2022 2021 2020

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The Company revalues its serviced loan portfolio at least quarterly.

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

For the three months ended September 30, 2023, there was a net gain on loan servicing asset revaluation of $11.3 million, compared to a net loss of $1.3 million for the three months ended September 30, 2022, resulting in a positive comparative quarter change of $12.7 million.

For the nine months ended September 30, 2023, there was a net gain on loan servicing asset revaluation of $8.9 million compared to a net loss of $11.6 million for the nine months ended September 30, 2022, resulting in a positive change of $20.4 million, or 176.6%.

The increase in the valuation of the servicing asset compared to the three and nine months ended September 30, 2022 was principally the result of the previously discussed 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 the three months ended September 30, 2023, net gains on sales of loans increased $3.4 million, or 36.7%, compared to the three months ended September 30, 2022.

The volume of guaranteed loans sold increased $77.5 million, or 52.3%, for the three months ended September 30, 2023 to $225.6 million from $148.1 million in the three months ended September 30, 2022.

For the nine months ended September 30, 2023, net gains on sales of loans decreased $2.2 million, or 6.2%, compared to the nine months ended September 30, 2022.

For the nine months ended September 30, 2023, the volume of guaranteed loans sold increased $201.9 million, or 46.2%, to $638.5 million from $436.6 million for the nine months ended September 30, 2022.

The average net gain on loan sale premium decreased from 108% to 105% in the third quarters of 2022 and 2023, respectively, and decreased from 109% to 106% in the first nine months of 2022 and 2023, respectively.

The increase in net gains on sales of loans over the third quarter of 2022 was principally the result of higher loan sale volume while the decrease over the first nine months of 2022 was principally related to the effect of weaker premiums outpacing heightened levels of sales volume.

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

For the three months ended September 30, 2023, the Company had a net loss on loans accounted for under the fair value option of $568 thousand compared to a net gain of $4.4 million for the third quarter of 2022, a negative change of $5.0 million, or 112.9%.

For the nine months ended September 30, 2023, the Company had a net loss on loans accounted for under the fair value option of $3.4 million compared to a net gain of $475 thousand for the same period of 2022, a negative change of $3.8 million, or 809.3%.

The carrying amount of loans accounted for under the fair value option at September 30, 2023 and 2022 was $410.1 million (all classified as held for investment) and $512.2 million (all classified as held for investment), respectively, a decrease of $102.1 million, or 19.9%.

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.

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 speeds and default rates and losses, with prepayment speed and discount rate being the most sensitive assumptions.

For the three months ended March 31, 2024, there was a net loss on loan servicing asset revaluation of $2.7 million, compared to a net gain of $356 thousand for the three months ended March 31, 2023, resulting in a negative comparative quarter change of $3.1 million.

The decrease in the valuation of the servicing asset compared to the three months ended March 31, 2023 was principally the result of increasing market prepayment speeds in the first quarter of 2024 while the net gain in the first quarter of 2023 was the result of positive movements in market premiums.

In the third-quarter of 2023, the Company changed its valuation techniques in the estimation of fair value for servicing assets and loans accounted for under the fair value option.

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

For the three months ended March 31, 2024, the Company had a net loss on loans accounted for under the fair value option of $219 thousand compared to a net loss of $4.5 million for the first quarter of 2023, a positive change of $4.3 million, or 95.2%.

The carrying amount of loans accounted for under the fair value option at March 31, 2024 and 2023 was $379.2 million (all classified as held for investment) and $467.0 million (all classified as held for investment), respectively, a decrease of $87.7 million, or 18.8%.

The net loss in the valuation of loans accounted for under the fair value option in the first quarter of 2024 was largely the result of the above discussed increased levels of market prepayment speeds while the net loss in the first quarter of 2023 was the result of negative market impacts related to rising interest rates.

Noninterest Expense

1 unchanged sentence

The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods presented.

Three Months Ended September 30, 2023/2022 Increase (Decrease)

2023 2022 Amount Percent

Noninterest expense

Salaries and employee benefits $ 42,947 $ 43,479 $ (532) (1.2) %

Non-employee expenses:

Travel expense 2,197 2,372 (175) (7.4)

Professional services expense 1,762 2,505 (743) (29.7)

Advertising and marketing expense 3,446 2,621 825 31.5

Occupancy expense 2,129 2,519 (390) (15.5)

Technology expense 7,722 7,770 (48) (0.6)

Equipment expense 3,676 3,761 (85) (2.3)

Other loan origination and maintenance expense 3,498 3,376 122 3.6

Renewable energy tax credit investment impairment — 7,721 (7,721) (100.0)

FDIC insurance 4,115 2,697 1,418 52.6

Contributions and donations — 191 (191) (100.0)

Other expense 2,770 4,036 (1,266) (31.4)

Total non-employee expenses 31,315 39,569 (8,254) (20.9)

Total noninterest expense $ 74,262 $ 83,048 $ (8,786) (10.6) %

Nine Months Ended September 30, 2023/2022 Increase (Decrease)

Three Months Ended March 31, 2024/2023 Increase (Decrease)

2024 2023 Amount Percent

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Other loan origination and maintenance expense 3,911 3,927 (16) (0.4)

Renewable energy tax credit investment impairment 69 7,771 (7,702) (99.1)

Renewable energy tax credit investment (recovery) impairment (927) 69 (996) (1,443.5)

FDIC insurance 3,200 3,403 (203) (6.0)

Contributions and donations — 6,429 (6,429) (100.0)

Other expense 3,226 6,385 (3,159) (49.5)

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Total noninterest expense $ 77,737 $ 78,962 $ (1,225) (1.6) %

Total noninterest expense for the three and nine months ended September 30, 2023, decreased $8.8 million, or 10.6%, and increased $40 thousand, respectively, compared to the same periods in 2022.

The changes in noninterest expense for the comparable three and nine month periods were largely driven by various components, as discussed below.

Total noninterest expense for the three months ended March 31, 2024, decreased $1.2 million, or 1.6%, compared to the three months ended March 31, 2023.

The decrease in noninterest expense for the comparable three month period was largely driven by various components, as discussed below.

Salaries and employee benefits :

Total personnel expense for the nine months ended September 30, 2023 increased $2.5 million, or 2.0%, respectively, compared to the same period in 2022.

The increase over the first nine months of 2022 is principally related to continued investment in human resources to support strategic and growth initiatives.

Total full-time equivalent employees increased from 940 at September 30, 2022, to 956 at September 30, 2023.

Salaries and employee benefits expense included $12.7 million of stock-based compensation for the nine months ended September 30, 2023, compared to $15.1 million for the nine months ended September 30, 2022.

Total personnel expense for the three months ended March 31, 2024 increased $2.5 million, or 5.6%, compared to the same period in 2023.

The increase over the first three months of 2023 is principally related to continued investment in human resources to support strategic and growth initiatives.

Total full-time equivalent employees decreased from 968 at March 31, 2023, to 962 at March 31, 2024.

Salaries and employee benefits expense included $6.4 million of stock-based compensation for the three months ended March 31, 2024, compared to $6.2 million for the three months ended March 31, 2023.

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:

For the nine months ended September 30, 2023, professional services expense decreased $4.6 million, or 49.5%, compared to the same period in 2022 .

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

Advertising and marketing expense :

For the nine months ended September 30, 2023, advertising and marketing expense increased $3.4 million, or 51.2%, compared to the same period in 2022.

The increase over the first nine months of 2022 was largely driven by continued investment in the Company’s lending and deposit market growth.

Technology expense :

For the nine months ended September 30, 2023, technology expense increased $3.9 million, or 19.8%, compared to the same period in 2022.

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

Renewable energy tax credit investment impairment:

For the three and nine months ended September 30, 2023, impairment charges decreased by $7.7 million, compared to the same periods in 2022.

This decrease was the result of a new renewable energy tax credit investment in the third quarter of 2022.

FDIC insurance:

For the nine months ended September 30, 2023, FDIC insurance increased $5.7 million, or 84.1%, compared to the same period in 2022.

This increase is largely the result of rate increases effective in 2023 combined with the ongoing growth of Live Oak Banking Company.

Contributions and donations:

For the nine months ended September 30, 2023, contributions and donations decreased $6.4 million, compared to the same period in 2022.

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

Other expense :

For the three months ended March 31, 2024, other expense decreased $3.2 million, or 49.5%, compared to the same period in 2023, largely related to $1.8 million in higher levels of reserves on unfunded commitments in the three months ended March 31, 2023.

This increase in the reserve for unfunded commitments in the first quarter of 2023 was largely a result of refinements to the estimation assumptions.

Income Tax Expense

For the three months ended September 30, 2023, income tax expense was $3.0 million compared to $1.5 million for the three months ended September 30, 2022, and the Company’s effective tax rates were 6.9% and 3.4%, respectively.

For the nine months ended September 30, 2023, income tax expense was $7.6 million compared to $35.2 million for the nine months ended September 30, 2022, and the Company’s effective tax rates were 11.6% and 16.8%, respectively.

The higher level of income tax expense for the third quarter of 2023 as compared to the third quarter of 2022 was was primarily the result of higher than anticipated investment tax credits in the third quarter of 2022 related to renewable energy investments, arising from the impacts of the passage of the Inflation Reduction Act of 2022 combined with higher than expected costs at that time, as a result of the inflationary environment.

The decrease in income tax expense for first nine months of 2023 compared to the same period in 2022 was primarily due to decreased pretax income during the current period.

For the three months ended March 31, 2024, income tax benefit was $5.5 million compared to income tax expense of $3.2 million in the first quarter of 2023, and the Company’s effective tax rates were (24.8%) and 89.0%, respectively.

The lower level of income tax expense for the first quarter of 2024 as compared to the first quarter of 2023 was largely the result of an additional $10.6 million in investment tax credits related to the Company's fourth quarter of 2023 renewable energy investment that became eligible for an extra 10% in tax credits in the first quarter of 2024.

The trigger for this first quarter 2024 additional eligibility was the result of the March 22, 2024 Internal Revenue Service (“IRS”) Notice 2024-30, which expanded the list of geographic areas which qualify for increased investment tax credit levels.

The location of the underlying renewable energy project was an addition to the recent IRS Notice.

Partially offsetting this decrease was increased pretax income during the current period.

Results of Segment Operations

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Net income (loss) by operating segment is presented below:

Three Months Ended September 30, Nine Months Ended September 30,

2023 2022 2023 2022

Three Months Ended March 31,

Banking $ 29,707 $ 2,388

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Consolidated net income $ 27,586 $ 398

For the three and nine months ended September 30, 2023, net income increased $24.9 million and $5.3 million, respectively, compared to the same periods of 2022.

For the three months ended March 31, 2024, net income increased $27.3 million compared to the same period of 2023.

Key factors influencing these changes are discussed below.

For the three and nine months ended September 30, 2023, net interest income increased $5.3 million, or 6.2%, and $13.4 million, or 5.5%, respectively, compared to the same periods of 2022.

For the three months ended March 31, 2024, net interest income increased $8.1 million, or 9.8% compared to the same period of 2023.

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 the three and nine months ended September 30, 2023, decreased $3.9 million, and increased $21.1 million, respectively, compared to the same periods of 2022.

The provision for loan and lease credit losses for the three months ended March 31, 2024, decreased $2.7 million.

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.

For the three and nine months ended September 30, 2023, noninterest income increased $8.5 million, or 31.0%, and $9.8 million, or 15.3%, respectively, compared to the same periods of 2022.

The increase for the three and nine month comparative periods was principally driven by an incremental net gain on the loan servicing asset revaluation.

Also contributing to the increase over the third quarter of 2022 was higher net gains on sale of loans.

Partially offsetting these three and nine month contributors to increased noninterest income was incremental net losses on loans accounted for under the fair value option.

For the three months ended March 31, 2024, noninterest income increased $8.2 million, or 48.0%, compared to the same period of 2023.

The increase for the three month comparative period was principally driven by an incremental decline in the net loss on loans accounted for at fair value of $4.3 million combined with the previously discussed gain of $5.7 million included in other noninterest income arising from increased fair value of equity warrant assets.

Partially offsetting these three month contributors to increased noninterest income was incremental net losses on the loan servicing asset revaluation of $3.1 million.

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

For the three months ended September 30, 2023, noninterest expense decreased $9.0 million, or 11.5%, compared to same period of 2022.

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

For the three and nine months ended September 30, 2023, income tax expense increased $1.7 million and decreased $2.4 million, respectively, compared to the same periods of 2022.

The increase compared to the third quarter of 2022 was primarily related to higher levels of pre-tax income in third quarter of 2023 while the decrease compared to the nine months ended September 30, 2022 is principally due to higher levels of expected tax credits in the prior year.

For the three and nine months ended September 30, 2023, net income decreased by $28.5 million and $122.5 million, respectively, compared to same periods of 2022.

The primary factor influencing this decrease compared to both prior periods is the $120.5 million Finxact gain from the second quarter of 2022 and the $28.4 million Payrailz gain from the third quarter of 2022, both included in equity method investment income.

Partially offsetting the decrease over the first nine months of 2022 was a $3.1 million increase in management fee income earned by Canapi Advisors combined with lower levels of income tax expense as a result decreased pretax income in 2023.

For the three months ended March 31, 2024, income tax expense decreased $7.0 million compared to the same period of 2023.

The decrease compared to the first quarter of 2023 was largely the result of an additional $10.6 million in investment tax credits related to the Company's fourth quarter of 2023 renewable energy investment that became eligible for increased tax credits in the first quarter of 2024.

See the above section captioned “Income Tax Expense” for further discussion around the increased investment tax credits.

For the three months ended March 31, 2024, net income decreased by $1.0 million compared to same period of 2023.

This decrease was largely related to increased equity method and equity security investment losses.

Discussion and Analysis of Financial Condition

September 30, 2023 vs.

March 31, 2024 vs.

December 31, 2023

Total assets at September 30, 2023 were $10.95 billion, an increase of $1.09 billion, or 11.1%, 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 $1.63 billion at September 30, 2023, an increase of $203.3 million, or 14.2%, 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 of $858.5 million, or 11.7%, during the first nine months of 2023, from $7.34 billion at December 31, 2022, to $8.20 billion at September 30, 2023, resulting from strong origination activity during the first nine months of 2023 of $2.97 billion.

Total deposits were $10.00 billion at September 30, 2023, an increase of $1.12 billion, or 12.6%, 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.

At September 30, 2023, the Bank’s total uninsured deposits were approximately $1.48 billion, or 14.6%, of total deposits.

Borrowings decreased to $25.8 million at September 30, 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.

Total assets at March 31, 2024 were $11.51 billion, an increase of $234.1 million, or 2.1%, compared to total assets of $11.27 billion at December 31, 2023.

The growth in total assets was principally driven by the growth in total loans and leases held for investment and held for sale of $202.4 million, or 2.2%, during the first three months of 2024, from $9.02 billion at December 31, 2023, to $9.22 billion at March 31, 2024.

This growth was a result of strong origination activity during the first three months of 2024 of $805.1 million.

Total deposits were $10.38 billion at March 31, 2024, an increase of $108.3 million, or 1.1%, from $10.28 billion at December 31, 2023.

The increase in total deposits from the prior period was to support growth in the loan and lease portfolio as well as the Company's targeted liquidity levels.

At March 31, 2024, the Bank’s total uninsured deposits were approximately $1.47 billion, or 14.0%, of total deposits.

Borrowings increased to $120.2 million at March 31, 2024, from $23.4 million at December 31, 2023.

This increase was principally due to entering into a new loan agreement in the first quarter of 2024 to strategically enhance Bank capital levels in order to accommodate future growth expectations.

Borrowings in the accompanying Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of current sources of available debt capacity.

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

As of September 30, 2023, the Company and the Bank each had total assets of $10.95 billion and $10.87 billion, respectively.

As of March 31, 2024, the Company and the Bank each had total assets of $11.51 billion and $11.42 billion, respectively.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (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.

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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 became applicable to the Bank in the first quarter of 2024.

Deposit Insurance Assessments.

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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.

Additionally, the large bank method captures risk mitigants such as the Bank's unique concentration of government guaranteed loans and its impact on our perceived loss severity measure which is generally favorable to the Bank's deposit insurance assessments.

The Bank became subject to the large bank method for determining its deposit insurance assessments in the first quarter of 2024.

Volcker Rule.

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Limits on Interchange Fees.

The Bank also may be affected by the Durbin Amendment to the Dodd-Frank Act regarding limits on debit card interchange fees.

The Durbin Amendment 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 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.

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 March 31, 2024.

Guaranteed Unguaranteed Total (1)

Held for Investment Loans:

Owner Occupied

Small Business Banking $ 1,175,122 $ 1,010,572 $ 2,185,694

Specialty Lending — 94,390 94,390

Energy & Infrastructure 17,706 21,391 39,097

Total 1,192,828 1,126,353 2,319,181

Non-Owner Occupied

Small Business Banking 379,172 417,139 796,311

Specialty Lending — 499,435 499,435

Energy & Infrastructure 39,022 148,876 187,898

Total 418,194 1,065,450 1,483,644

Total Held for Investment Commercial Real Estate $ 1,611,022 $ 2,191,803 $ 3,802,825

Held for Sale Loans:

Owner Occupied

Small Business Banking $ 58,385 $ — $ 58,385

Total 58,385 — 58,385

Non-Owner Occupied

Small Business Banking 122,390 — 122,390

Total 122,390 — 122,390

Total Held for Sale Commercial Real Estate $ 180,775 $ — $ 180,775

Total Commercial Real Estate Loans $ 1,791,797 $ 2,191,803 $ 3,983,600

% of Total Commercial Real Estate Loans 45.0 % 55.0 % 100.0 %

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

Asset Quality

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

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

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

Nonperforming Assets

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

In respect to the Company's adoption of ASU No.

2022-02 on January 1, 2023, as described more fully in Note 2 in the accompanying Unaudited Condensed Consolidated Financial Statements, the prior period discussed below has been adjusted to exclude previously disclosed troubled debt restructurings for comparative purposes.

Nonperforming assets, excluding loans measured at fair value, at September 30, 2023 were $105.8 million, which represented a $32.4 million, or 44.1%, increase from December 31, 2022.

These nonperforming assets at September 30, 2023 were comprised of $99.1 million in nonaccrual loans and leases and $6.7 million in foreclosed assets.

Of the $105.8 million of nonperforming assets, $69.0 million carried a government guarantee, leaving an unguaranteed exposure of $36.8 million in total nonperforming assets at September 30, 2023.

Nonperforming assets, including loans measured at fair value, at March 31, 2024 were $215.3 million, which represented a $23.1 million, or 12.0%, increase from December 31, 2023.

These nonperforming assets at March 31, 2024 were comprised of $206.7 million in nonaccrual loans and leases and $8.6 million in foreclosed assets.

Of the $206.7 million of nonperforming assets, $158.7 million carried a government guarantee, leaving an unguaranteed exposure of $56.6 million in total nonperforming assets at March 31, 2024.

This represents an increase of $5.4 million, or 10.5%, from an unguaranteed exposure of $51.2 million at December 31, 2023.

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

September 30, 2023 (1)

March 31, 2024 (1)

December 31, 2023 (1)

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(1) Excludes loans measured at fair value.

September 30, 2023 (1)

March 31, 2024 (1)

December 31, 2023 (1)

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(1) Excludes loans measured at fair value.

Total nonperforming assets, including loans measured at fair value, at September 30, 2023 were $154.0 million, which represented a $33.6 million, or 27.9%, increase from December 31, 2022.

These nonperforming assets at September 30, 2023 were comprised of $147.3 million in nonaccrual loans and leases and $6.7 million in foreclosed assets.

Of the $154.0 million of nonperforming assets, $108.8 million carried a government guarantee, leaving an unguaranteed exposure of $45.2 million in total nonperforming assets at September 30, 2023.

Nonperforming assets, excluding loans measured at fair value, at March 31, 2024 were $157.0 million, which represented a $15.6 million, or 11.0%, increase from December 31, 2023.

These nonperforming assets at March 31, 2024 were comprised of $148.5 million in nonaccrual loans and leases and $8.6 million in foreclosed assets.

Of the $157.0 million of nonperforming assets, $110.7 million carried a government guarantee, leaving an unguaranteed exposure of $46.3 million in total nonperforming assets at March 31, 2024.

This represents an increase of $4.3 million, or 10.1%, from an unguaranteed exposure of $42.1 million at December 31, 2023.

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

As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 11.0% at September 30, 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 ratios at both September 30, 2023 and December 31, 2022 were 3.7% and 2.3%, respectively.

As of September 30, 2023, and December 31, 2022, potential problem (also referred to as criticized) and classified loans and leases, excluding loans measured at fair value, totaled $567.6 million and $424.7 million, respectively.

As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 14.1% at March 31, 2024, compared to 14.6% at December 31, 2023.

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 ratios at both March 31, 2024 and December 31, 2023 were 4.1% and 4.3%, respectively.

As of March 31, 2024, and December 31, 2023, potential problem (also referred to as criticized) and classified loans and leases, excluding loans measured at fair value, totaled $908.2 million and $785.2 million, respectively.

The following is a discussion of these loans and leases.

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Loans and Leases Held for Investment and Credit Quality in the Company’s 2023 Form 10-K.

At September 30, 2023 , the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $227.0 million and total portfolio unguaranteed exposure risk was $340.6 million, or 6.8% of total held for investment unguaranteed exposure carried at historical cost.

At March 31, 2024 , the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $391.7 million and total portfolio unguaranteed exposure risk was $516.6 million , or 9.4% of total held for investment unguaranteed exposure carried at historical cost.

This compares to the December 31, 2023 portion of criticized and classified loans and leases guaranteed by the SBA or USDA which 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 historical cost .

As of September 30, 2023 , loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases:

General Lending at 13.2%, Wine and Craft Beverage at 11.2%, Senior Housing at 11.4%, Sponsor Search Fund Lending at 10.5%, Sponsor Finance at 5.0%, Hotels at 4.5%, Venture Banking at 4.1%, A griculture at 3.9%, Healthcare at 3.9%, and Senior Care at 3.9%.

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

Wine and Craft Beverage at 11.5%, General Lending at 10.3%, Senior Housing at 10.2%, Sponsor Search Fund Lending at 7.0%, Healthcare at 6.4%, Hotels at 5.9%, Fitness Centers at 5.1%, Agriculture at 4.5% and Senior Care at 4.0%.

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

The majority of the $142.9 million increase in potential problem and classified loans and leases in the first nine months of 2023 was comprised of several relationships that did not have a government guarantee.

As of March 31, 2024 and December 31, 2023 , loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases:

As of March 31, 2024 As of December 31, 2023

Vertical % of Criticized and Classified Loans and Leases

Bioenergy 14.7% Senior Housing 16.5%

Senior Housing 14.0% Bioenergy 14.4%

General Lending 11.6% General Lending 12.2%

Search Fund Lending 7.2% Search Fund Lending 8.6%

Wine & Craft Beverage 5.0% Wine & Craft Beverage 5.6%

Healthcare 4.2% Healthcare 3.9%

Self Storage 4.1% Hotels 3.3%

Senior Care 4.0% Self Storage 3.3%

Sponsor Finance 3.7% Senior Care 3.2%

% of Total Criticized and Classified Loans 68.5% % of Total Criticized and Classified Loans 71.0%

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

The majority of the $123.0 million increase in potential problem and classified loans and leases in the first three months of 2024 was comprised of increased levels of Risk Grade 5 loans and leases, as discussed below.

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

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

At September 30, 2023, the Company had a total of $37.1 million in loans modified in the first nine months of 2023 to borrowers experiencing financial difficulty, all of which remained current with $14.6 million on principal payment deferral.

During the three months ended March 31, 2024, there were no loan modifications made for borrowers experiencing financial difficult on loans held at amortized cost.

Management endeavors to be proactive in its approach to identify and resolve p roblem 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 September 30, 2023 , and December 31, 2022 , Risk Grade 5 loans and leases, excluding lo ans measured at fair value, totaled $385.1 million and $286.5 million, respectively, for a nine month increase of $84.9 million.

The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the first nine months of 2023 was principally confined to eight verticals:

Sponsor Search Fund Lending ($25.4 million or 30.0%), Sponsor Finance ($23.7 million or 23.9%), General Lending ($21.0 million or 24.7%), Venture Banking ($15.9 million or 18.7%), Asset-Based Lending ($13.7 million or 16.1%), Bioenergy ($13.4 million or 15.8%), Senior Housing ($9.0 million or 10.6%) and Wine and Craft Beverage ($7.0 million or 8.3%).

Partially offsetting the above increase were decreases in Risk Grade 5 loans principally concentrated in two verticals:

Broadband ($12.4 million or 14.5%) and Entertainment Centers ($9.0 million or 10.6%).

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

At September 30, 2023, approximately 95.4% of loans and leases classified as Risk Grade 5 are performing with no relationships having payments past due more than 30 days.

At March 31, 2024 , and December 31, 2023 , Risk Grade 5 loans and leases, excluding lo ans measured at fair value, totaled $669.2 million and $599.2 million, respectively, for a three month increase of $70.0 million.

Relative to total held for investment unguaranteed exposure carried at historical cost at March 31, 2024 and December 31, 2023, unguaranteed Risk Grade 5 loans and leases increased from 6.9% to 7.7%, respectively.

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

March 31, 2024 vs.

December 31, 2023 Increase (Decrease)

Bioenergy $ 19,694 28.1 %

Government Contracting 14,909 21.3

Sponsor Finance 12,016 17.2

Self Storage 11,412 16.3

Healthcare 8,012 11.4

Vet 7,464 10.7

Senior Care 6,224 8.9

Agriculture 5,239 7.5

Restoration 4,771 6.8

Professional Services 4,575 6.5

General Lending (3,317) (4.7)

Asset-Based Lending (5,191) (7.4)

Fitness Centers (5,814) (8.3)

Total of largest changes in RG 5 loans and leases $ 79,994 114.3%

The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the first three months of 2024 was principally confined to 13 verticals, as reflected above.

The underlying factor in this increase in Risk Grade 5 loans in 2024 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, Sponsor Finance, Senior Housing, Asset-Based Lending and Government Contracting are within the Company’s Specialty Lending division, Bioenergy is within the Energy & Infrastructure division and the remainder of the above listed verticals are within the Small Business Banking division.

At March 31, 2024, approximately 99.1% 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 identification 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 September 30, 2023, the Company had $10.5 million in unguaranteed loans on SBA payment assistance.

At March 31, 2024, the Company had $6.3 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 $24.7 million, or 25.6%, to $121.3 million at September 30, 2023.

The ACL as a percentage of loans and leases held for investment at historical cost amounted to 1.4% and 1.6% at December 31, 2022 and September 30, 2023, respectively.

The increase in the ACL during the first nine months of 2023 was primarily the result of loan growth, combined with specific reserve changes on individually evaluated loans and charge-off related impacts.

The ACL of $125.8 million at December 31, 2023, increased by $13.2 million, or 10.5%, to $139.0 million at March 31, 2024.

The ACL as a percentage of loans and leases held for investment at historical cost amounted to 1.5% and 1.6% at December 31, 2023 and March 31, 2024, respectively.

The increase in the ACL during the first three months of 2024 was primarily the result of specific reserve changes on individually evaluated loans.

See also the above section captioned “Provision for Loan and Lease Credit Losses” in “Results of Operations” for related information.

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This increase was comprised of a $8.0 million increase in unguaranteed exposure combined with a $26.8 million increase in the guaranteed portion of past due loans compared to December 31, 2023 .

At September 30, 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 ungu aranteed loans and leases past due were comprised of $34.5 million carried at historical cost, an increase of $13.3 million, and $8.0 million measured at fair value, a decrease of $1.6 million, as of September 30, 2023 compared to December 31, 2022 .

At March 31, 2024 and December 31, 2023 , 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 1.0% and 0.8% , respectively.

Total ungu aranteed loans and leases past due were comprised of $45.3 million carried at historical cost, an increase of $7.7 million , and $10.2 million measured at fair value, an increase of $345 thousand , as of March 31, 2024 compared to December 31, 2023 .

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

Management believes the ACL of $121.3 million at September 30, 2023 is appropriate in light of the risk inherent in the loan and lease portfolio.

Management believes the ACL of $139.0 million at March 31, 2024 is appropriate in light of the risk inherent in the loan and lease portfolio.

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

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and (d) availability under lines of credit.

At September 30, 2023, the total amount of these four items was $4.34 billion, or 39.6% of total assets compared to 40.7% of total assets, at December 31, 2022.

Loans and other assets are funded by loan sales, wholesale deposits, and customer deposits.

and (d) availability under lines of credit, FHLB advances and 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.

At March 31, 2024, the total amount of these four liquidity source items was $4.11 billion, or 35.7% of total assets, a decrease of 2.1% of total assets from $4.26 billion, or 37.8% of total assets, at December 31, 2023.

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 September 30, 2023, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $1.10 billion available to pledge as collateral.

At March 31, 2024, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $1.12 billion available to be pledged as collateral.

Contractual Obligations

The Company has entered into significant fixed and determinable contractual obligations for future payments.

Other than normal changes in the ordinary course of the Company’s operations, there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2022.

In March 2024, the Company entered into a $100.0 million term loan agreement with a third party correspondent bank.

Borrowings in the accompanying notes to Unaudited Condensed Consolidated Financial Statements for more details.

Other than the new borrowing previously mentioned and normal changes in the ordinary course of the Company’s operations, there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2023.

See the section titled “Liquidity Management” in Part II, Item 7 of the Company’s 2023 Form 10-K for additional discussion of contractual obligations.

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

As of December 31, 2023, there was one airplane purchase agreement commitment outstanding and during 2024 the airplane was placed in service.

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

For more information, see Note 10.

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One method used to manage interest rate sensitivity is to measure the repricing differences, or interest rate gaps, between interest-earning assets and interest-bearing liabilities, across various time periods.

As of September 30, 2023, the balance sheet’s total cumulative gap position was 4.7%, meaning that over the entire life of the Company's assets and liabilities, more assets will reprice than liabilities.

As of March 31, 2024, the balance sheet’s total cumulative gap position was 4.6%, meaning that over the entire life of the Company's assets and liabilities, more assets will reprice than liabilities.

For further information, see Item 3.

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Therefore, management also uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of instantaneous parallel interest rate shocks applied to a static balance sheet and non-parallel interest rate shocks applied to a dynamic balance sheet to measure interest rate risk.

As of September 30, 2023, the Company’s interest rate risk profile under the instantaneous parallel interest rate shock scenarios applied to a static balance sheet is slightly asset-sensitive.

As of March 31, 2024, the Company’s interest rate risk profile under the instantaneous parallel interest rate shock scenarios applied to a static balance sheet is slightly asset-sensitive.

For more information, see Item 3.

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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 September 30, 2023, and December 31, 2022, are presented in the table below.

Capital amounts and ratios as of March 31, 2024, and December 31, 2023, are presented in the table below.

Actual Minimum Capital

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Amount Ratio Amount Ratio Amount Ratio

Consolidated - September 30, 2023

Consolidated - March 31, 2024

Common Equity Tier 1 (to Risk-Weighted Assets) $ 991,314 11.89 % $ 375,207 4.50 % N/A N/A

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Tier 1 Capital (to Average Assets) 991,314 8.69 456,405 4.00 N/A N/A

Bank - September 30, 2023

Bank - March 31, 2024

Common Equity Tier 1 (to Risk-Weighted Assets) $ 954,351 11.86 % $ 362,054 4.50 % $ 522,967 6.50 %

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Actual results may differ from these estimates under different assumptions or conditions.

Accounting policies, as described in detail in the Notes to the Company’s Unaudited Condensed Consolidated Financial Statements in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, are an integral part of the Company’s consolidated financial statements.

Accounting policies, including those for the Company's critical accounting policies, as described in detail in the Notes to the Company’s Unaudited Condensed Consolidated Financial Statements in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023, are an integral part of the Company’s consolidated financial statements.

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

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• Income taxes

Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company’s financial position, results of operations or liquidity.

Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, could have a material impact on the Company’s financial position, results of operations or liquidity.

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis