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, 2021 (the "2021 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 loan and lease losses and provisions for those 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 loan and lease losses; • changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; • the continuing impacts of 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; 32 • changes in financial market condition s, 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 devel opment 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 service providers operating in the Company’s market area and elsewhere, including providers 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; • changes in political and economic conditions; • 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. 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. 33 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. The Bank identifies and extends lending to credit-worthy borrowers within specified industries, also called verticals, through expertise within those industries, and more broadly to select borrowers outside of those industries. A significant portion of the loans originated by the Bank are 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”) and Business & Industry ("B&I") loan programs. The Company’s wholly owned 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”). The Bank’s wholly owned subsidiaries are Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”) and Live Oak Private Wealth, LLC (“Live Oak Private Wealth”). Live Oak Number One, Inc. holds properties foreclosed on by the Bank. LOCEF provides financing to entities for renewable energy applications and became a wholly owned subsidiary of the Bank during the first quarter of 2019. 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. 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 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 net gains on sales of loans along with loan servicing revenue and revaluation of related servicing assets. 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 in its fintech segment, as discussed more fully later in this section entitled “Results of Segment Operations.” Recent Developments The COVID-19 pandemic caused complex and significant adverse impacts, all of which continue to be subject to a high degree of uncertainty. This uncertainty is magnified with the continued risk of a resurgence of the virus and new variants. Despite ongoing uncertainty, the impact has decreased, and the economy has continued to generally improve, resulting in positive impacts on the Company’s allowance for credit losses (“ACL”) on loans and leases, as discussed below in MD&A. Relative to Paycheck Protection Program (“PPP”) loans, the Company ended the first quarter of 2022 with a total outstanding balance net of deferred fees and costs of $130.8 million compared to $261.9 million at December 31, 2021. The Company’s interest income, arising from PPP loan amortization of net deferred fees combined with the 1% annualized interest rate, continues to recede from $20.7 million to $7.5 million to $4.3 million, for the first and fourth quarters of 2021 and first quarter of 2022, respectively. At March 31, 2022, $2.7 million in net deferred fees remains to be recognized into future interest income. The Company’s corresponding Paycheck Protection Program Liquidity Facility (“PPPLF”) used to help provide financing for the origination of PPP loans decreased from $267.6 million at December 31, 2021 to $136.6 million at March 31, 2022. Borrowings under the PPPLF bear interest at a rate of 0.35%, and there are no fees paid by the Company. 34 Credit At March 31, 2022, the Company had a total of $3.1 million in unguaranteed loans and leases on payment deferral with $122 thousand in accrued interest receivable. In addition, the Company had $31.2 million in unguaranteed loans on SBA payment assistance at March 31, 2022. As of March 31, 2022, almost all loans after expiration of assistance have returned to making regular payments. In 2021, the Company disclosed certain industries that had heightened levels of exposure as a result of COVID-19. Specifically, management identified six verticals that were considered to be “at-risk” of significant COVID-19 impacts. These verticals were hotels, educational services, wine and craft beverage, quick service restaurants, entertainment centers and fitness centers. Businesses within these six verticals generally have continued to show notable improvements and are now considered to have emerged from at-risk status. As of March 31, 2022, these verticals contained six loans still on payment deferral with an aggregate balance of $2.3 million, $950 thousand of which was unguaranteed, and 10 loans that continue to receive SBA payment subsidies with an aggregate balance of $26.4 million, $5.9 million of which was unguaranteed. While there are positive signs of emerging from at-risk status, management continues to closely monitor these vulnerable verticals for signs of weakness. As a result of the uncertain economic environment caused by COVID-19, the Company continues to engage in more frequent communication with borrowers in an effort to better understand their situation and the challenges faced as circumstances evolve, which the Company anticipates will enable it to respond proactively as needs and issues arise. Results of Operations Performance Summary Three months ended March 31, 2022 compared with three months ended March 31, 2021 For the three months ended March 31, 2022, the Company reported net income of $34.5 million, or $0.76 per diluted share, compared to net income of $39.4 million, or $0.88 per diluted share, for the first quarter of 2021. The decrease in net income was primary due to the following items: • Provision for loan and lease credit losses increasing $2.7 million, or 310.3%, compared to a recovery of $873 thousand for the first quarter of 2021. The first quarter of 2021 recovery was largely due to significant improvement in forecasts related to employment and default expectations as the economic outlook had improved significantly over that experienced in 2020; • A net loss on the loan servicing asset revaluation increasing by $3.1 million, or 205.1%, from a net gain of $1.5 million for the first quarter of 2021; • The net gain on loans accounted for under the fair value option decreasing by $3.7 million, or 87.8%; • Increased income tax expense of $4.2 million, or 100.6%, primarily due to vesting of restricted stock unit awards with market price conditions during the first three months of 2021; and • Increased noninterest expense of $7.4 million, or 12.8%, principally comprised of salaries and employee benefits up $7.1 million, or 22.8%; travel expense up $1.2 million, or 187.9%; advertising and marketing expense up $1.1 million, or 165.2%; and technology expense up $1.2 million, or 24.1%; all partially offset by decreased impairment charges of $3.1 million related to renewable energy tax credits during the three months ended March 31, 2021 combined with decreased professional services expense of $1.0 million, or 27.1%. Other key factors partially offsetting the decrease in net income for the first quarter of 2022 were: • Increased net interest income of $7.8 million, or 11.2%, predominately driven by significant growth in the total loan and lease portfolio combined with lower costs of interest-bearing deposits; and • Increased net gains on sales of loans of $9.0 million, or 75.8%. 35 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, 2022 compared with three months ended March 31, 2021 For the three months ended March 31, 2022, net interest income increased $7.8 million, or 11.2%, to $77.8 million compared to $70.0 million for the three months ended March 31, 2021. This increase was principally due to the significant growth in the held for investment loan and lease portfolios since the first quarter of 2021. This increase over the prior year was significantly higher when excluding the effects of declining levels of PPP loan net interest income for the compared period, which has been declining over time as PPP loans are paid down. 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 $22.6 million. Average interest-earning assets increased by $411.8 million, or 5.5%, to $7.85 billion for the first quarter of 2022, compared to $7.44 billion for the first quarter of 2021, while the yield on average interest-earning assets decreased two basis points to 4.79%. The cost of funds on interest-bearing liabilities for the first quarter of 2022 decreased 21 basis points to 0.81% while the average balance of interest-bearing liabilities increased by $218.1 million, or 3.0%, over the first quarter of 2021. The increase in average interest-bearing liabilities was largely driven by funding for significant loan originations and growth. This increase was muted by a $1.27 billion reduction in borrowings largely related to PPPLF repayments since March 31, 2021. As indicated in the rate/volume table below, increased volume on interest-earning assets and greater levels of rate reductions on interest-bearing liabilities outpaced the lower yields on interest-earning assets and higher volume of interest-bearing liabilities, resulting in increases to interest income of $4.6 million and decreases to interest expense of $3.3 million for the first quarter of 2022 compared to the first quarter of 2021. For the first quarter of 2022 compared to the first quarter of 2021, net interest margin increased from 3.81% to 4.02%, respectively, due primarily to significant loan portfolio growth, the maturity of longer term deposits which are repricing at lower rates and the continued deployment of excess liquidity. As of March 31, 2022, the Company had $130.8 million in PPP loan balances on its books which includes $2.7 million in net deferred fees remaining to be recognized into future interest income. The Company expects to recognize most of the remaining net deferred fees for PPP loans in 2022. In March 2022, the Federal Reserve increased the federal funds target rate by 25 basis points and released projections where the midpoint of the projected target range for the federal funds rate would rise to 1.9% by the end of 2022 to 2.8% by the end of 2023 and remaining static through the end of 2024. These projections imply approximately seven 25 basis point increases in the federal funds rate in 2022, followed by four in 2023. There can be no assurance that any increases in the federal funds rate will occur, and if they do, the amount and timing of actual increases are subject to change. See Item 3. Quantitative and Qualitative Disclosures About Market Risk for information about the Company’s sensitivity to interest rates. 36 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, respect ively, for the periods presented and annualizing that result. Loan fees are included in interest income on loans. Three Months Ended March 31, 2022 2021 Average Balance Interest Average Yield/Rate Average Balance Interest Average Yield/Rate Interest-earning assets: Interest-earning balances in other banks $ 223,638 $ 179 0.32 % $ 331,260 $ 297 0.36 % Federal funds sold 9,197 6 0.26 28,202 6 0.09 Investment securities 895,592 3,399 1.54 736,158 2,929 1.61 Loans held for sale 1,115,441 15,183 5.52 1,158,844 15,077 5.28 Loans and leases held for investment (1) 5,609,338 74,015 5.35 5,186,963 69,916 5.47 Total interest-earning assets 7,853,206 92,782 4.79 7,441,427 88,225 4.81 Less: Allowance for credit losses on loans and leases (62,732 ) (52,317 ) Noninterest-earning assets 588,171 593,573 Total assets $ 8,378,645 $ 7,982,683 Interest-bearing liabilities: Interest-bearing checking $ — $ — — % $ 250,005 $ 356 0.58 % Savings 3,605,905 4,840 0.54 2,356,598 3,512 0.60 Money market accounts 91,463 54 0.24 105,753 83 0.32 Certificates of deposit 3,551,310 9,454 1.08 3,151,575 12,993 1.67 Total deposits 7,248,678 14,348 0.80 5,863,931 16,944 1.17 Borrowings 262,485 655 1.01 1,429,177 1,331 0.38 Total interest-bearing liabilities 7,511,163 15,003 0.81 7,293,108 18,275 1.02 Noninterest-bearing deposits 86,570 63,917 Noninterest-bearing liabilities 51,940 39,155 Shareholders' equity 728,972 586,503 Total liabilities and shareholders' equity $ 8,378,645 $ 7,982,683 Net interest income and interest rate spread $ 77,779 3.98 % $ 69,950 3.79 % Net interest margin 4.02 % 3.81 % Ratio of average interest-earning assets to average interest-bearing liabilities 104.55 % 102.03 % (1) Average loan and lease balances include non-accruing loans and leases. 37 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, 2022 vs. 2021 Increase (Decrease) Due to Rate Volume Total Interest income: Interest-earning balances in other banks $ (26 ) $ (92 ) $ (118 ) Federal funds sold 8 (8 ) — Investment securities (150 ) 620 470 Loans held for sale 684 (578 ) 106 Loans and leases held for investment (1,534 ) 5,633 4,099 Total interest income (1,018 ) 5,575 4,557 Interest expense: Interest-bearing checking — (356 ) (356 ) Savings (441 ) 1,769 1,328 Money market accounts (19 ) (10 ) (29 ) Certificates of deposit (4,895 ) 1,356 (3,539 ) Borrowings 1,324 (2,000 ) (676 ) Total interest expense (4,031 ) 759 (3,272 ) Net interest income $ 3,013 $ 4,816 $ 7,829 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 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 2022, there was a provision for loan and lease credit losses of $1.8 million compared to a recovery of loan and lease credit losses of $873 thousand for the same period in 2021. The level of provision expense in the first quarter of 2022 was primarily the result of continued improvement in forecasts related to employment and default expectations combined with the effect of higher than usual recoveries in certain verticals and overall growth in the loan and lease portfolio . In comparison, t he first quarter of 2021 recovery was largely due to significant improvement in forecasts related to employment and default expectations as the economic outlook had improved significantly over that experienced in 2020. Loans and leases held for investment at historical cost were $5.14 billion as of March 31, 2022, increasing by $471.7 million, or 10.1%, compared to March 31, 2021. Excluding PPP loans and net unearned fees on those loans, the balance in loans and leases held for investment at historical cost was $5.01 billion at March 31, 2022, an increase of $1.79 billion, or 55.4%, over March 31, 2021. Net charge-offs for loans and leases carried at historical cost were $2.4 million, or 0.19% of average quarterly loans and leases held for investment, carried at historical cost, on an annualized basis, for the three months ended March 31, 2022, compared to a net recovery of $984 thousand, or (0.09)%, for the three months ended March 31, 2021 The increase in net charge-offs for the first quarter of 2022 was principally related to one relationship that was fully reserved for in the fourth quarter of 2021. 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. 38 In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $4.5 million and $5.8 million accounted for under the fair value option at March 31, 2022 and 2021, respectively, totaled $19.5 million, which was 0.38% of the held for investment loan and lease portfolio carried at historical cost at March 31, 2022, compared to $24.7 million, or 0.53% of loans and leases held for investment carried at historical cost at March 31, 2021. Nonperforming loans and leases carried at historical cost whic h are not guaranteed by the SBA or USDA were 0.39% and 0.77% of the historical cost portion of the held for investment loan and lease portfolio, excluding PPP loans, at March 31, 2022 and 2021, respectively. 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 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, 2022/2021 Increase (Decrease) 2022 2021 Amount Percent Noninterest income Loan servicing revenue $ 6,356 $ 6,434 $ (78 ) (1.21 )% Loan servicing asset revaluation (1,569 ) 1,493 (3,062 ) (205.09 ) Net gains on sales of loans 20,977 11,929 9,048 75.85 Net gain on loans accounted for under the fair value option 516 4,218 (3,702 ) (87.77 ) Equity method investments income (loss) (2,124 ) (1,157 ) (967 ) (83.58 ) Equity security investments gains (losses), net (44 ) 105 (149 ) (141.90 ) Lease income 2,503 2,599 (96 ) (3.69 ) Management fee income 1,488 1,934 (446 ) (23.06 ) Other noninterest income 4,565 3,502 1,063 30.35 Total noninterest income $ 32,668 $ 31,057 $ 1,611 5.19 % For the three months ended March 31, 2022, noninterest income increased by $1.6 million, or 5.2%, compared to the three months ended March 31, 2021. The increase over the prior year is primarily the result of a $9.0 million increase in gains on sales of loans partially offset by increased losses arising from the loan servicing asset valuation of $3.1 million combined with lower gains on loans accounted for under the fair value option of $3.7 million. 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, 2022 2021 2021 2020 2019 2018 Amount of loans and leases originated $ 865,063 $ 1,180,219 $ 4,480,725 $ 4,450,198 $ 2,001,886 $ 1,765,680 Guaranteed portions of loans sold 219,703 136,747 668,462 542,596 340,374 945,178 Outstanding balance of guaranteed loans sold (1) 2,786,403 2,843,963 2,756,915 2,819,625 2,746,480 3,045,460 (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. 39 Changes in various components of noninterest income are discussed in more detail be low. 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, 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 March 31, 2022, there was a negative loan servicing revaluation adjustment of $1.6 million, compared to a positive adjustment of $1.5 million the three months ended March 31, 2021. The decrease in the loan servicing asset revaluation from the first quarter of 2021 was largely related to prepayment speeds increasing over the prior year. Net Gains on Sales of Loans: For the three months ended March 31, 2022, net gains on sales of loans increased $9.0 million, or 75.9%, compared to the first quarter of 2021. The volume of guaranteed loans sold increased $83.0 million, or 60.7%, in the first quarter of 2022 to $219.7 million from $136.7 million in the first quarter of 2021. The volume of loan sales in the first quarter of 2022 was influenced by current market considerations. The average net gain on sale premium decreased from 110% to 109%, in the first quarters of 2021 and 2022, respectively, which was largely a product of the mix of loan sales combined with slightly lower premiums. Net Gain on Loans Accounted for Under the Fair Value Option : For the three months ended March 31 , 2022, the net gain on loans accounted for under the fair value option decreased $3.7 million, or 87.8%, compared to the three months ended March 31 , 2021. The carrying amount of loans accounted for under the fair value option at March 31 , 2022 and 2021 was $625.7 million ($25.1 million classified as held for sale and $600.6 million classified as held for investment) and $826.7 million ($35.9 million classified as held for sale and $790.8 million classified as held for investment), respectively, a decrease of $201.1 million, or 24.3%. The decreased net gain on loans accounted for under the fair value option during first quarter of 2022 as compared to the first quarter of 2021 was largely the result of significant economic forecasts improvements experienced to a greater degree in the first quarter of 2021 as compared to the first quarter of 2022. 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, 2022/2021 Increase (Decrease) 2022 2021 Amount Percent Noninterest expense Salaries and employee benefits $ 38,507 $ 31,366 $ 7,141 22.77 % Non-employee expenses: Travel expense 1,897 659 1,238 187.86 Professional services expense 2,791 3,831 (1,040 ) (27.15 ) Advertising and marketing expense 1,729 652 1,077 165.18 Occupancy expense 2,327 2,112 215 10.18 Technology expense 6,053 4,878 1,175 24.09 Equipment expense 3,816 3,701 115 3.11 Other loan origination and maintenance expense 3,113 3,327 (214 ) (6.43 ) Renewable energy tax credit investment impairment — 3,127 (3,127 ) (100.00 ) FDIC insurance 1,972 1,765 207 11.73 Other expense 3,509 2,854 655 22.95 Total non-employee expenses 27,207 26,906 301 1.12 Total noninterest expense $ 65,714 $ 58,272 $ 7,442 12.77 % Total noninterest expense for the three months ended March 31 , 2022, increased $7.4 million, or 12.8%, compared to the same period in 2021. The increase in noninterest expense for the comparable three month period was largely driven by various components, as discussed below. 40 Salaries and employee benefits : Total personnel expense for the three months ended March 31 , 2022 increased by $7.1 million, or 22.8%, c ompared to the same period in 2021. The increase in salaries and employee benefits was principally related to continued investment in human resources to support strategic and growth initiatives. Total full-time equivalent employees increased from 651 at March 31 , 2021, to 842 at March 31 , 2022. Salaries and employee benefits expense included $5.0 million of stock-based compensation in the first quarter of both 2022 and 2021. Expenses related to the employee stock purchase program, stock grants, stock op tion compensation and restricted stock expense are all considered stock-based compensation. Travel expense: Travel expenses increased $1.2 million, or 187.9%, compared to the same period in 2021 . Travel expenses increased primarily in relation to supporting both loan origination volume and the customer base as travel restrictions continued to ease. Professional services expense: Professional services expense decreased $1.0 million, or 27.1%, compared to the same period in 2021. The decrease compared to the prior periods was largely driven by lower legal fees. Advertising and marketing expense : Advertising and marketing expense increased $1.1 million, or 165.2%. The increase over the first quarter of 2021 was largely a driven by renewed marketing events. Technology expense : Technology expense is a new line item which replaces data processing expense in previous consolidated income statements. This new line item includes data processing expense and other non-compensation related costs reclassified from equipment expense and other expense line items for software, computer and telecommunications. This reclassification was made primarily to improve the clarity of expenses related to the Company’s ongoing technology initiatives and is reflected in all comparative periods of this filing. Technology expense for the first quarter of 2022 was $6.1 million, a $1.2 million increase over the first quarter of 2021. This increase was primarily related to enhanced investments in the Company’s technology resources. Renewable energy tax credit investment impairment: During the first quarter of 2021, the Company recognized $3.1 million in impairment charges related to a $3.9 million renewable energy tax credit investment that was fully funded. Investments of this type generate a return primarily through the realization of income tax credits and other benefits; accordingly, impairment of the investment amount is recognized in conjunction with the realization of related tax benefits. Income Tax Expense For the three months ended March 31, 2022, income tax expense was $8.4 million compared to $4.2 million for the first quarter of 2021, and the Company’s effective tax rates were 19.6% and 9.6%, respectively. The effective tax rate for the first quarter of 2022 was principally influenced by anticipated renewable energy tax credits associated with investments expected in 2021 but delayed to 2022 due to supply chain issues. The higher level of income tax expense for the first quarter of 2022 compared to the first quarter of 2021 was primarily driven by vesting of restricted stock unit awards with market price conditions during the first three months of 2021 , as the fair value of these awards exceeded the total compensation cost recognized by the Company for book purposes. 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 11. 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, 2022 2021 Banking $ 37,840 $ 41,056 Fintech (1,749 ) (907 ) Other (1,582 ) (722 ) Consolidated net income $ 34,509 $ 39,427 41 Banking For the three months ended March 31, 2022, net income decreased $3.2 million compared to the same period of 2021. Net interest income increased $8.3 million, or 11.8%, compared to the same period of 2021. See the analysis of net interest income included in the above section captioned “Net Interest Income and Margin” as it is predominantly related to the Banking segment. See the analysis of provision for loan and lease credit losses included in the above section captioned “ Provision for Loan and Lease Credit Losses ” as it is entirely related to the Banking segment. Noninterest income increased $1.4 million compared to the same period of 2021. The increase was principally driven by an increase in net gains on sales of loans of $9.0 million and partially offset by a decrease in loan servicing asset revaluation of $3.1 million combined with a $3.7 million lower gain arising from loans accounted for under the fair value option. See the analysis of these categories of noninterest income included in the above section captioned “Noninterest Income” for additional discussion. Noninterest expense increased $5.8 million, or 10.4%, compared to same period of 2021. See the analysis of these categories of noninterest expense included in the above section captioned “Noninterest Expense” for additional discussion. For the three months ended March 31, 2022, income tax expense increased $4.4 million, or 95.2%, compared to the same period of 2021. See the above section captioned “Income Tax Expense.” Fintech For the three months ended March 31, 2022, net income decreased by $842 thousand compared to same period of 2021. The decrease was principally due to heightened levels of salaries and benefits. Noninterest expense increased $1.1 million compared to the same period of 2021. As mentioned above, this increase was largely due increased levels of salaries and benefits. Discussion and Analysis of Financial Condition March 31, 2022 vs. December 31, 2021 Total assets at March 31, 2022 were $8.62 billion, an increase of $406.6 million, or 5.0%, compared to total assets of $8.21 billion at December 31, 2021. 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 was $507.8 million at March 31, 2022, an increase of $304.0 million, or 149.2%, compared to $203.8 million at December 31, 2021. This increase reflects liquidity planning through increased levels of deposits and heightened levels of loan sales. • Growth in total loans and leases held for investment and held for sale of $129.1 million resulting from strong origination activity in the first three months of 2022. Total originations during the first three months of 2022 were $865.1 million. Total investment securities available-for-sale decreased $61.5 million during the first three months of 2022, from $906.1 million at December 31, 2021, to $844.6 million at March 31, 2022, a decrease of 6.8%. The decrease was largely the result of $50.6 million in unrealized losses arising from negative market impacts for the Company’s available-for-sale investment portfolio. At March 31, 2022, the investment portfolio was comprised of U.S. government agencies, U.S. government-sponsored entity mortgage-backed securities, municipal bonds and other debt securities. 42 Loans and leases held for sale decreased $87.9 million, or 7.9%, during the first three months of 2022, from $1.12 billion at December 31, 2021, to $1.03 billion at March 31, 2022. The decrease was primarily the result of strong loan sales in the first three months of 2022 combined with higher levels of loans being retained as held for investment. Loans and leases held for investment increased $217.0 million, or 3.9%, during the first three months of 2022, from $5.52 billion at December 31, 2021, to $5.74 billion at March 31, 2022. The increase was primarily the result of the above-mentioned loan originations in 2022 combined with increased levels of loans retained as held for investment. Excluding PPP loans, total loans and leases held for investment increased $348.0 million, or 6.6%, during the first three months of 2022. All PPP loans are classified as held for investment. Total deposits were $7.64 billion at March 31, 2022, an increase of $525.1 million, or 7.4%, from $7.11 billion at December 31, 2021. The increase in deposits is largely driven by significant loan origination efforts. Borrowings decreased to $196.9 million at March 31, 2022 from $318.3 million at December 31, 2021. This decrease was related principally to net curtailments of borrowings through the PPPLF in the first quarter of 2022 from PPP loan forgiveness. These PPPLF borrowings are used to help fund PPP loans. Shareholders’ equity at March 31, 2022 was $713.3 million as compared to $715.1 million at December 31, 2021. The book value per share was $16.29 at March 31, 2022 compared to $16.39 at December 31, 2021. Average equity to average assets was 8.7% for the three months ended March 31, 2022 compared to 8.8% for the year ended December 31, 2021. The decrease in shareholders’ equity for the first three months of 2022 was principally the result of $38.5 million in other comprehensive loss associated with negative market impacts on the Company’s available-for-sale investment portfolio partially offset by net income of $34.5 million and stock-based compensation expense of $5.0 million. 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 & Risk Committee of the Board of Directors. Nonperforming Assets The Bank places loans and leases on nonaccrual status when they become 90 days past due as to principal or interest payments, or prior to that if management has determined based upon current information available to them that the timely collection of principal or interest is not probable. When a loan or lease is placed on nonaccrual status, any interest previously accrued as income but not actually collected is reversed and recorded as a reduction of loan or lease interest and fee income. Typically, collections of interest and principal received on a nonaccrual loan or lease are applied to the outstanding principal as determined at the time of collection of the loan or lease. Troubled debt restructurings (“TDRs”) occur when, because of economic or legal reasons pertaining to the debtor’s financial difficulties, debtors are granted concessions that would not otherwise be considered. Such concessions would include, but are not limited to, the transfer of assets or the issuance of equity interests by the debtor to satisfy all or part of the debt, modification of the terms of debt or the substitution or addition of debtor(s). Nonperforming assets and TDRs, excluding loans measured at fair value, at March 31, 2022 were $93.8 million, which represented a $13.6 million, or 16.9%, increase from December 31, 2021. These nonperforming assets at March 31, 2022 were comprised of $52.3 million in nonaccrual loans and leases and $198 thousand in foreclosed assets. Of the $93.8 million of nonperforming assets and TDRs, $52.4 million carried a government guarantee, leaving an unguaranteed exposure of $41.4 million in total nonperforming assets and TDRs at March 31, 2022. This represents an increase of $4.4 million, or 12.0%, from an unguaranteed exposure of $37.0 million at December 31, 2021. 43 The following table provides information with respect to nonperforming assets and troubled debt restructurings , excluding loans measured at fair value, at the dates indicated. March 31, 2022 (1) December 31, 2021 (1) Nonaccrual loans and leases: Total nonperforming loans and leases (all on nonaccrual) $ 52,303 $ 42,533 Total accruing loans and leases past due 90 days or more — — Foreclosed assets 198 620 Total troubled debt restructurings 63,865 55,273 Less nonaccrual troubled debt restructurings (22,563 ) (18,210 ) Total performing troubled debt restructurings 41,302 37,063 Total nonperforming assets and troubled debt restructurings $ 93,803 $ 80,216 Allowance for credit losses on loans and leases $ 63,058 $ 63,584 Total nonperforming loans and leases to total loans and leases held for investment 1.02 % 0.87 % Total nonperforming loans and leases to total assets 0.65 % 0.56 % Total nonperforming assets and troubled debt restructurings to total assets 1.17 % 1.06 % Allowance for credit losses on loans and leases to loans and leases held for investment 1.23 % 1.30 % Allowance for credit losses on loans and leases to total nonperforming loans and leases 120.56 % 149.49 % (1) Excludes loans measured at fair value. March 31, 2022 (1) December 31, 2021 (1) Nonaccrual loans and leases guaranteed by U.S. government: Total nonperforming loans and leases guaranteed by the U.S government (all on nonaccrual) $ 32,828 $ 26,546 Total accruing loans and leases past due 90 days or more guaranteed by the U.S government — — Foreclosed assets guaranteed by the U.S. government 162 490 Total troubled debt restructurings guaranteed by the U.S. government 33,766 26,954 Less nonaccrual troubled debt restructurings guaranteed by the U.S. government (14,397 ) (10,770 ) Total performing troubled debt restructurings guaranteed by U.S. government 19,369 16,184 Total nonperforming assets and troubled debt restructurings guaranteed by the U.S. government $ 52,359 $ 43,220 Allowance for credit losses on loans and leases $ 63,058 $ 63,584 Total nonperforming loans and leases not guaranteed by the U.S. government to total held for investment loans and leases 0.38 % 0.33 % Total nonperforming loans and leases not guaranteed by the U.S. government to total assets 0.24 % 0.21 % Total nonperforming assets and troubled debt restructurings not guaranteed by the U.S. government to total assets 0.52 % 0.49 % Allowance for credit losses on loans and leases to total nonperforming loans and leases not guaranteed by the U.S government 323.79 % 397.73 % (1) Excludes loans measured at fair value. Total nonperforming assets and TDRs, including loans measured at fair value, at March 31, 2022 were $164.7 million, which represented a $11.2 million, or 7.3%, increase from December 31, 2021. These nonperforming assets at March 31, 2022 were comprised of $92.3 million in nonaccrual loans and leases and $198 thousand in foreclosed assets. Of the $164.7 million of nonperforming assets and TDRs, $108.6 million carried a government guarantee, leaving an unguaranteed exposure of $56.1 million in total nonperforming assets and TDRs at March 31, 2022. This represents an increase of $3.6 million, or 6.8%, from an unguaranteed exposure of $52.5 million at December 31, 2021. 44 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 7.1% at March 31, 2022, compared to 6.0% at December 31, 2021. Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management’s belief that the greater magnitude of risk resides in this portion, the ratios at both March 31, 2022 and December 31, 2021 were 2.6% and 2.3%, respectively. As of March 31, 2022, and December 31, 2021, potential problem (also referred to as criticized) and classified loans and leases, excluding loans measured at fair value, totaled $412.4 million and $372.7 million, respectively. The following is a discussion of these loans and leases. Risk Grades 5 through 8 represent the spectrum of criticized and classified loans and leases. For a complete description of the risk grading system, see Note 3. Loans and Leases Held for Investment and Credit Quality in the Company’s 2021 Form 10-K. At March 31 , 2022, the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $198.3 million resulting in unguaranteed exposure risk of $214.1 million, or 6.8% of total held for investment unguaranteed exposure carried at historical cost. This compares to the December 31, 2021 portion of criticized and classified loans and leases guaranteed by the SBA or USDA which totaled $197.2 million resulting in unguaranteed exposure risk of $175.5 million, or 6.3% of total held for investment unguaranteed exposure carried at historical cost. As of March 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: Educational Services at 13.0%, Wine and Craft Beverage at 10.9%, Hotels at 9.5%, Entertainment Centers at 9.2%, Healthcare at 7.5%, Senior Care at 7.3%, Agriculture at 7.1%, Fitness Centers at 5.3%, Veterinary at 4.8% and Self Storage at 4.4%. As of December 31, 2021, loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases: Educational Services at 16.1%, Wine and Craft Beverage at 13.7%, Hotels at 11.8%, Entertainment Centers at 10.4%, Healthcare at 9.0%, Fitness Centers at 5.3%, Self Storage at 4.8%, Agriculture at 4.5% and Veterinary at 4.4%. Other than Hotels which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division. The majority of the $40.0 million first quarter of 2022 increase in potential problem and classified loans and leases was comprised of borrowers largely concentrated in the Company’s more mature verticals. Furthermore, the Company believes that its underwriting and credit quality standards have remained high and continues to consider changing economic conditions in a rising interest rate environment. Loans and leases that experience insignificant payment delays and payment shortfalls are generally not individually evaluated for the purpose of estimating the allowance for credit losses. The Bank generally considers an “insignificant period of time” from payment delays to be a period of 90 days or less. The Bank would consider a modification for a customer experiencing what is expected to be a short-term event that has temporarily impacted cash flow. This could be due, among other reasons, to illness, weather, impact from a one-time expense, slower than expected start-up, construction issues or other short-term issues. Credit personnel will review the request to determine if the customer is stressed and how the event has impacted the ability of the customer to repay the loan or lease long term. At March 31 , 2022, the Company had a total of $3.1 million in modified unguaranteed loans and leases. Management endeavors to be proactive in its approach to identify and resolve problem loans and leases and is focused on working with the borrowers and guarantors of these loans and leases to provide loan and lease modifications when warranted. Management implements a proactive approach to identifying and classifying loans and leases as special mention (also referred to as criticized), Risk Grade 5. At March 31 , 2022, and December 31, 2021, Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled $310.8 million and $267.4 million, respectively. The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the first quarter of 2022 was principally confined to ten verticals: Senior Care ($18.5 million or 42.7%), Agriculture ($8.5 million or 19.7%), Venture Banking ($7.9 million or 18.3%), Solar Energy ($5.6 million or 12.9%), Rural Lending ($3.9 million or 9.0%), Bioenergy ($3.7 million or 8.6%), Veterinary ($3.4 million or 7.9%), Sponsor Finance ($2.9 million or 6.7%), Fitness Centers ($2.7 million or 6.2%) and Government Contracting ($2.6 million or 5.9%). Partially offsetting the above increases were declines in Risk Grade 5 loans principally concentrated in three verticals: Educational Services ($6.3 million or 14.5%), Hotels ($3.9 million or 8.9%) and Wine and Craft Beverage ($2.9 million or 6.6%). Other than Hotels, Sponsor Finance, Venture Banking, Solar Energy, Rural Lending, Bioenergy and Government Contracting, which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division. 45 At March 31 , 2022, approximately 98.2% of loans and leases classified as Risk Grade 5 are performing with only one relationship 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. Management monitors these borrowers closely and has observed financial conditions continuing to improve. Management has also noted that most loans with expired government assistance have been able to resume making regular payments . Allowance for Credit Losses on Loans and Leases The ACL of $63.6 million at December 31, 2021, decreased by $526 thousand, or 0.8%, to $63.1 million at March 31, 2022. The ACL as a percentage of loans and leases held for investment at historical cost amounted to 1.2% and 1.3% at March 31, 2022 and December 31, 2021, respectively. Excluding PPP loans and related reserves, the ACL as a percentage of loans and leases held for investment at historical cost also amounted to 1.2% and 1.3% at March 31, 2022 and December 31, respectively. The decrease in the ACL during the first quarter of 2022 was primarily due to continued improvement in forecasts related to employment and default expectations combined with the effect of higher than usual recoveries in certain verticals and overall growth in the loan and lease portfolio, as addressed more fully in the above section captioned “Provision for Loan and Lease Credit Losses” in “Results of Operations.” Actual past due held for investment loans and leases, inclusive of loans measured at fair value, have decreased by $14.3 million since December 31, 2021. Total loans and leases 90 or more days past due decreased $3.4 million, or 7.0%, compared to December 31, 2021. The decrease was comprised of a $264 thousand decrease in unguaranteed exposure combined with a $3.2 million decrease in the guaranteed portion of past due loans compared to December 31, 2021. At March 31, 2022 and December 31 , 2021, 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 0.6%. Total unguaranteed loans and leases past due were comprised of $15.6 million carried at historical cost, a decrease of $991 thousand, and $5.7 million measured at fair value, an increase of $632 thousand, as of March 31 , 2022 compared to December 31, 2021. Management continues to actively monitor and work to improve asset quality. Management believes the ACL of $63.1 million at March 31, 2022 is appropriate in light of the risk inherent in the loan and lease portfolio. Management’s judgments are based on numerous assumptions about current and expected events that it believes to be reasonable, but which may or may not be valid, including but not limited to factors related to the above mentioned SBA delinquency effect and pandemic-susceptible borrowers. 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 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. At March 31, 2022, the total amount of these four items was $3.88 billion, or 45.0% of total assets, an increase of $461.7 million from $3.42 billion, or 41.6% of total assets, at December 31, 2021. Loans and other assets are funded 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 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, 2022, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $842.1 million available to pledge as collateral. 46 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, 2021. See the section titled “Liquidity Management” in Part II, Item 7 of the Company’s 2021 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. For more information, see Note 10. Commitments and Contingencies in the accompanying notes to unaudited condensed consolidated financial statements. Asset/Liability Management and Interest Rate Sensitivity One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps. As of March 31 , 2022, the balance sheet’s total cumulative gap position was asset-sensitive at 4.6%. 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, nor growth. Therefore, management also uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to measure interest rate risk. As of March 31 , 2022, the Company’s interest rate risk profile under the earnings simulation model method remained asset-sensitive. 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. The quarterly revaluation adjustment to the servicing asset, however, adjusts in an opposite direction to interest rate changes. Asset/liability sensitivity is primarily derived from the prime-based loans that adjust as the prime interest rate changes, rates on cash accounts that adjusts as the federal funds rate changes and the longer duration of indeterminate term deposits. 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; 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. 47 Capital amounts and ratios as of March 31, 2022 and December 31, 20 2 1 , 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, 2022 Common Equity Tier 1 (to Risk-Weighted Assets) $ 724,078 12.10 % $ 269,237 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) $ 788,020 13.17 % $ 478,644 8.00 % N/A N/A Tier 1 Capital (to Risk-Weighted Assets) $ 724,078 12.10 % $ 358,983 6.00 % N/A N/A Tier 1 Capital (to Average Assets) $ 724,078 8.87 % $ 326,400 4.00 % N/A N/A Bank - March 31, 2022 Common Equity Tier 1 (to Risk-Weighted Assets) $ 677,361 11.88 % $ 256,554 4.50 % $ 370,578 6.50 % Total Capital (to Risk-Weighted Assets) $ 741,303 13.00 % $ 456,096 8.00 % $ 570,120 10.00 % Tier 1 Capital (to Risk-Weighted Assets) $ 677,361 11.88 % $ 342,072 6.00 % $ 456,096 8.00 % Tier 1 Capital (to Average Assets) $ 677,361 8.38 % $ 323,278 4.00 % $ 404,098 5.00 % Consolidated - December 31, 2021 Common Equity Tier 1 (to Risk-Weighted Assets) $ 689,367 12.38 % $ 250,619 4.50 % N/A N/A Total Capital (to Risk-Weighted Assets) $ 753,691 13.53 % $ 445,544 8.00 % N/A N/A Tier 1 Capital (to Risk-Weighted Assets) $ 689,367 12.38 % $ 334,158 6.00 % N/A N/A Tier 1 Capital (to Average Assets) $ 689,367 8.87 % $ 310,902 4.00 % N/A N/A Bank - December 31, 2021 Common Equity Tier 1 (to Risk-Weighted Assets) $ 640,652 12.05 % $ 239,201 4.50 % $ 345,512 6.50 % Total Capital (to Risk-Weighted Assets) $ 704,976 13.26 % $ 425,246 8.00 % $ 531,557 10.00 % Tier 1 Capital (to Risk-Weighted Assets) $ 640,652 12.05 % $ 318,934 6.00 % $ 425,246 8.00 % Tier 1 Capital (to Average Assets) $ 640,652 8.32 % $ 307,931 4.00 % $ 384,914 5.00 % (1) Prompt corrective action provisions are not applicable at the bank holding company level. 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, 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, 2021, 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 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; and • Valuation of servicing assets. 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. 48