Live Oak Bancshares, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following presents management’s discussion and analysis of the financial condition and results of operations of Live Oak Bancshares, Inc. (individually, “Bancshares” and collectively with its subsidiaries including Live Oak Banking Company, the “Company”). This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included elsewhere in this quarterly report on Form 10-Q and with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2023 (the “2023 Form 10-K”). Results of operations for the periods included in this quarterly report on Form 10-Q are not necessarily indicative of results to be obtained during any future period. Important Note Regarding Forward-Looking Statements This quarterly report on Form 10-Q contains statements that management believes are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to the financial condition, results of operations, plans, objectives, future performance or business of Live Oak Bancshares, Inc. (the “Company”). They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,” “projects,” “goals,” “estimates,” “will,” “may,” “should,” “could,” “would,” “continues,” “intends to,” “outlook” or “anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this Report. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements management may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to the Company at the time. Management undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements contained in this Report are based on current expectations, estimates and projections about the Company’s business, management’s beliefs and assumptions made by management. These statements are not guarantees of the Company’s future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. These risks, uncertainties and assumptions include, without limitation: • 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; • changes in rules, regulations or procedures for other government loan programs, including those of the United States Department of Agriculture (“USDA”); • 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 credit losses; • changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory 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; 37 Table of Contents • 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; • changes in accounting principles, policies, and guidelines applicable to bank holding companies and banking; • fluctuations in markets for equity, fixed-income, commercial paper and other securities, which could affect availability, market liquidity levels, and pricing; • the effects of competition from other commercial banks, non-bank lenders, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and mutual funds, and other financial institutions operating in the Company’s market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone and the Internet; • the Company's ability to attract and retain key personnel; • changes in governmental monetary and fiscal policies as well as other legislative and regulatory changes, including with respect to SBA or USDA lending programs and investment tax credits; • a deterioration of the credit rating for U.S. long-term sovereign debt, actions that the U.S. government may take to avoid exceeding the debt ceiling, and uncertainties surrounding the debt ceiling and the federal budget; • changes in political and economic conditions, including any prolonged U.S. government shutdown; • the impact of heightened regulatory scrutiny of financial products and services, primarily led by the Consumer Financial Protection Bureau and various state agencies; • the Company's ability to comply with any requirements imposed on it by regulators, and the potential negative consequences that may result; • operational, compliance and other factors, including conditions in local areas in which the Company conducts business such as inclement weather or a reduction in the availability of services or products for which loan proceeds will be used, that could prevent or delay closing and funding loans before they can be sold in the secondary market; • the effect of any mergers, acquisitions or other transactions, to which the Company or the Bank may from time to time be a party, including management’s ability to successfully integrate any businesses acquired; • adverse results, including related fees and expenses, from pending or future lawsuits, government investigations or private actions; • other risk factors listed from time to time in reports that the Company files with the SEC, including those described under “Risk Factors” in this Report; and • the Company’s success at managing the risks involved in the foregoing. 38 Table of Contents Except as otherwise disclosed, forward-looking statements do not reflect: (i) the effect of any acquisitions, divestitures or similar transactions that have not been previously disclosed; (ii) any changes in laws, regulations or regulatory interpretations; or (iii) any change in current dividend or repurchase strategies, in each case after the date as of which such statements are made. All forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. Amounts in all tables in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) have been presented in thousands, except percentage, time period, stock option, share and per share data or where otherwise indicated. Nature of Operations Bancshares is a financial holding company and a bank holding company headquartered in Wilmington, North Carolina incorporated under the laws of the state 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 guaranteed by the SBA under the 7(a) Loan Program and the U.S. Department of Agriculture’s (“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. The Company’s wholly owned material subsidiaries are 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 an on-site restaurant location. Live Oak Ventures’ purpose is investing in businesses that align with the Company's strategic initiative to be a leader in financial technology. Canapi Advisors provides investment advisory services to a series of funds (the “Canapi Funds”) focused on providing venture capital to new and emerging financial technology companies. The Bank’s wholly owned subsidiaries are Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”), Live Oak Private Wealth, LLC (“Live Oak Private Wealth”) and Tiburon Land Holdings, LLC (“TLH”). 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 was formed in the third quarter of 2022 to hold land adjacent to the Bank's headquarters consisting of wetlands and other protected property for the use and enjoyment of the Bank's employees and customers. The Company generates revenue primarily from net interest income and secondarily through origination and sale of government guaranteed loans. 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.” 39 Table of Contents Results of Operations Performance Summary 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 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 that the Bank offers are generally above the industry average. 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. 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. 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. 40 Table of Contents 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. See Item 3. Quantitative and Qualitative Disclosures About Market Risk for information about the Company’s sensitivity to interest rates. 41 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 and dividends from average interest-earning assets, the total dollar amount of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The 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 and annualizing that result. Loan fees are included in interest income on loans. Three Months Ended March 31, 2024 2023 Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate Interest-earning assets: Interest-earning balances in other banks $ 542,243 $ 7,456 5.53 % $ 220,114 $ 3,193 5.88 % Federal funds sold — — — 140,033 1,624 4.70 Investment securities 1,240,861 8,954 2.90 1,187,377 7,547 2.58 Loans held for sale 353,476 8,354 9.51 560,155 11,986 8.68 Loans and leases held for investment (1) 8,753,232 167,656 7.70 7,497,824 127,066 6.87 Total interest-earning assets 10,889,812 192,420 7.11 9,605,503 151,416 6.39 Less: Allowance for credit losses on loans and leases (125,447) (94,283) Noninterest-earning assets 550,839 600,471 Total assets $ 11,315,204 $ 10,111,691 Interest-bearing liabilities: Interest-bearing checking $ 300,067 $ 4,183 5.61 % $ 21,668 $ 271 5.07 % Savings 4,552,390 46,171 4.08 4,207,286 36,251 3.49 Money market accounts 125,317 187 0.60 114,084 137 0.49 Certificates of deposit 5,094,553 51,457 4.06 4,535,363 30,936 2.77 Total deposits 10,072,327 101,998 4.07 8,878,401 67,595 3.09 Borrowings 26,772 311 4.67 158,508 1,804 4.62 Total interest-bearing liabilities 10,099,099 102,309 4.07 9,036,909 69,399 3.11 Noninterest-bearing deposits 213,571 177,078 Noninterest-bearing liabilities 77,942 64,409 Shareholders' equity 924,592 833,295 Total liabilities and shareholders' equity $ 11,315,204 $ 10,111,691 Net interest income and interest rate spread $ 90,111 3.04 % $ 82,017 3.28 % Net interest margin 3.33 % 3.46 % Ratio of average interest-earning assets to average interest-bearing liabilities 107.83 % 106.29 % (1) Average loan and lease balances include non-accruing loans and leases. 42 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 volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. 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 March 31, 2024 vs. 2023 Increase (Decrease) Due to Rate Volume Total Interest income: Interest-earning balances in other banks $ (288) $ 4,551 $ 4,263 Federal funds sold — (1,624) (1,624) Investment securities 1,044 363 1,407 Loans held for sale 1,022 (4,654) (3,632) Loans and leases held for investment 17,929 22,661 40,590 Total interest income 19,707 21,297 41,004 Interest expense: Interest-bearing checking 231 3,681 3,912 Savings 6,683 3,237 9,920 Money market accounts 35 15 50 Certificates of deposit 15,790 4,731 20,521 Borrowings 22 (1,515) (1,493) Total interest expense 22,761 10,149 32,910 Net interest income $ (3,054) $ 11,148 $ 8,094 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 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. 43 Table of Contents 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 Noninterest income is principally comprised of net gains from the sale of SBA and USDA-guaranteed loans along with loan 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 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. Three Months Ended March 31, 2024/2023 Increase (Decrease) 2024 2023 Amount Percent Noninterest income Loan servicing revenue $ 7,624 $ 6,380 $ 1,244 19.5 % Loan servicing asset revaluation (2,744) 356 (3,100) (870.8) Net gains on sales of loans 11,502 10,175 1,327 13.0 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) Equity security investments (losses) gains, net (529) 77 (606) (787.0) Lease income 2,453 2,535 (82) (3.2) Management fee income 3,271 3,472 (201) (5.8) Other noninterest income 9,761 4,065 5,696 140.1 Total noninterest income $ 26,097 $ 19,579 $ 6,518 33.3 % 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. 44 Table of Contents 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 March 31, For years ended December 31, 2024 2023 2023 2022 2021 2020 Amount of loans and leases originated $ 805,129 $ 1,030,882 $ 3,946,873 $ 4,007,621 $ 4,480,725 $ 4,450,198 Guaranteed portions of loans sold 186,654 167,826 877,551 580,889 668,462 542,596 Outstanding balance of guaranteed loans sold (1) 3,057,641 2,695,757 2,986,959 2,668,110 2,756,915 2,819,625 (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 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. 45 Table of Contents 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. The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods presented. Three Months Ended March 31, 2024/2023 Increase (Decrease) 2024 2023 Amount Percent Noninterest expense Salaries and employee benefits $ 47,275 $ 44,765 $ 2,510 5.6 % Non-employee expenses: Travel expense 2,438 2,411 27 1.1 Professional services expense 1,878 927 951 102.6 Advertising and marketing expense 3,692 3,603 89 2.5 Occupancy expense 2,247 1,925 322 16.7 Technology expense 7,723 7,729 (6) (0.1) Equipment expense 3,074 3,818 (744) (19.5) Other loan origination and maintenance expense 3,911 3,927 (16) (0.4) Renewable energy tax credit investment (recovery) impairment (927) 69 (996) (1,443.5) FDIC insurance 3,200 3,403 (203) (6.0) Other expense 3,226 6,385 (3,159) (49.5) Total non-employee expenses 30,462 34,197 (3,735) (10.9) Total noninterest expense $ 77,737 $ 78,962 $ (1,225) (1.6) % 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 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. 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. 46 Table of Contents Income Tax Expense 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 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 12. Segments in the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements. Net income (loss) by operating segment is presented below: Three Months Ended March 31, 2024 2023 Banking $ 29,707 $ 2,388 Fintech (1,372) (361) Other (749) (1,629) Consolidated net income $ 27,586 $ 398 Banking 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 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 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 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 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. Fintech 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. 47 Table of Contents Discussion and Analysis of Financial Condition March 31, 2024 vs. December 31, 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. See Note 8. Borrowings in the accompanying Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of current sources of available debt capacity. 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 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. As a general matter, the Company and the Bank are not immediately subject to these additional requirements when they exceed $10 billion in assets; instead, the Company and the Bank will be subject to these various requirements over various dates, as described below. 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 became applicable to the Bank in the first quarter of 2024. Deposit Insurance Assessments. Also under the Dodd-Frank Act, the minimum ratio of net worth to insured deposits of the Deposit Insurance Fund administered by the FDIC 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. 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. 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. 48 Table of Contents 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. 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 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. 49 Table of Contents 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. 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. March 31, 2024 (1) December 31, 2023 (1) Nonaccrual loans and leases: Total nonperforming loans and leases (all on nonaccrual) $ 148,468 $ 134,963 Foreclosed assets 8,561 6,481 Total nonperforming assets $ 157,029 $ 141,444 Allowance for credit losses on loans and leases $ 139,041 $ 125,840 Total nonperforming loans and leases to total loans and leases held for investment 1.74 % 1.64 % Total nonperforming loans and leases to total assets 1.33 % 1.24 % Allowance for credit losses on loans and leases to loans and leases held for investment 1.63 % 1.53 % Allowance for credit losses on loans and leases to total nonperforming loans and leases 93.65 % 93.24 % (1) Excludes loans measured at fair value. March 31, 2024 (1) December 31, 2023 (1) Nonaccrual loans and leases guaranteed by U.S. government: Total nonperforming loans and leases guaranteed by the U.S government (all on nonaccrual) $ 105,351 $ 95,678 Foreclosed assets guaranteed by the U.S. government 5,332 3,670 Total nonperforming assets guaranteed by the U.S. government $ 110,683 $ 99,348 Allowance for credit losses on loans and leases $ 139,041 $ 125,840 Total nonperforming loans and leases not guaranteed by the U.S. government to total held for investment loans and leases 0.51 % 0.48 % Total nonperforming loans and leases not guaranteed by the U.S. government to total assets 0.39 % 0.36 % Allowance for credit losses on loans and leases to total nonperforming loans and leases not guaranteed by the U.S. government 322.47 % 320.33 % (1) Excludes loans measured at fair value. 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. 50 Table of Contents 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 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. 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 Note 3. Loans and Leases Held for Investment and Credit Quality in the Company’s 2023 Form 10-K. 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 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 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. 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. 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. 51 Table of Contents 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 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) Vertical $ % 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 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 $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. 52 Table of Contents Actual past due held for in vestment loans and leases, inclusive of loans measured at fair value, have increased by $28.7 million since December 31, 2023 . Total loans and leases 90 or more days past due increased $34.8 million , or 27.9%, compared to December 31, 2023 . 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 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 $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. 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 5. Loans and Leases Held for Investment and Credit Quality of the Unaudited Condensed Consolidated Financial Statements in this report. 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 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, 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 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. In March 2024, the Company entered into a $100.0 million term loan agreement with a third party correspondent bank. See Note 8. 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. 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. 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. Commitments and Contingencies in the accompanying notes to Unaudited Condensed Consolidated Financial Statements. 53 Table of Contents 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 the repricing differences, or interest rate gaps, between interest-earning assets and interest-bearing liabilities, across various time periods. 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. Quantitative and Qualitative Disclosures About Market Risk. The interest rate gap method, however, addresses only the magnitude of asset and liability repricing timing differences as of the report date and does not address earnings, market value, changes in account behaviors based on the interest rate environment, or growth. 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 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. Quantitative and Qualitative Disclosures About Market Risk. An asset-sensitive position means that net interest income will generally move in the same direction as interest rates. For instance, if interest rates increase, net interest income can be expected to increase, and if interest rates decrease, net interest income can be expected to decrease. The Company attempts to mitigate interest rate risk by match funding assets and liabilities with similar rate instruments. Asset/liability sensitivity is primarily derived from the prime-based loans that adjust as the prime interest rate changes, rates on cash accounts that adjust as the federal funds rate changes and the longer duration of indeterminate term deposits. Note that the Company regularly models various forecasted rate projections with non-parallel shifts that are reflective of potential current rate environment outcomes. Under these scenarios, the Company’s interest rate risk profile may increase in asset sensitivity, decrease in asset sensitivity, or depending on the scenario and timing of anticipated rate changes, may transition to a liability-sensitive interest rate risk profile. The Company believes that regular modeling of various interest rate outcomes allows it to assess and manage potential risks from various rate shifts. 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 the following: to provide adequate capital to support the Company’s risk profile consistent with the risk appetite approved by the Board of Directors; to provide financial flexibility to support future growth and client needs; to comply with relevant laws, regulations, and supervisory guidance; to achieve optimal ratings for the Company and its subsidiaries; and to 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. 54 Table of Contents Capital amounts and ratios as of March 31, 2024, and December 31, 2023, 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 - March 31, 2024 Common Equity Tier 1 (to Risk-Weighted Assets) $ 991,314 11.89 % $ 375,207 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) 1,096,039 13.15 667,035 8.00 N/A N/A Tier 1 Capital (to Risk-Weighted Assets) 991,314 11.89 500,276 6.00 N/A N/A Tier 1 Capital (to Average Assets) 991,314 8.69 456,405 4.00 N/A N/A Bank - March 31, 2024 Common Equity Tier 1 (to Risk-Weighted Assets) $ 954,351 11.86 % $ 362,054 4.50 % $ 522,967 6.50 % Total Capital (to Risk-Weighted Assets) 1,055,468 13.12 643,651 8.00 804,564 10.00 Tier 1 Capital (to Risk-Weighted Assets) 954,351 11.86 482,738 6.00 643,651 8.00 Tier 1 Capital (to Average Assets) 954,351 8.42 453,363 4.00 566,704 5.00 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 (1) Prompt corrective action provisions are not applicable at the bank holding company level. 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. 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. The Company’s most critical accounting policies and 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; • Valuation of loans accounted for under the fair value option; 55 Table of Contents • Valuation of servicing assets; and • 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, could have a material impact on the Company’s financial position, results of operations or liquidity.