Item 2. Management’s Discussion and Analysis
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain significant factors which have affected the financial condition and results of operations of the Company as reflected in the unaudited consolidated balance sheet as of September 30, 2023, as compared to December 31, 2022, and operating results for the three and nine months ended September 30, 2023 and 2022. These comments should be read in conjunction with the Company's unaudited consolidated financial statements and accompanying notes appearing elsewhere herein and our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 24, 2023.
In addition to the historical information contained herein, this Form 10-Q includes “forward-looking statements” within the meaning of such term under the Private Securities Litigation Reform Act of 1995. These statements are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, including prevailing interest rates and the rate of inflation; the continuing effects of the recent failures of Silicon Valley Bank and Signature Bank, including increased deposit volatility and potential regulatory developments; changes in the financial markets; changes in business plans as circumstances warrant; risks related to mergers and acquisitions and the integration of acquired businesses; changes to U.S. tax laws, regulations and guidance; and other risks detailed from time to time in filings made by the Company with the SEC. Readers should note that the forward-looking statements included herein are not a guarantee of future events, and that actual events may differ materially from those made in or suggested by the forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “will,” “propose,” “may,” “plan,” “seek,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” or “continue,” or similar terminology. Any forward-looking statements presented herein are made only as of the date of this document, and we do not undertake any obligation to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, or otherwise .
Critical Accounting Policies
The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances. These estimates form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates and judgments that management believes have the most effect on the Company’s reported financial position and results of operations are set forth in “Note 2 – Basis of Presentation and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements, included in our Annual Report on Form 10-K for the year ended December 31, 2022. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2022.
Significant Developments and Transactions
Each item listed below affects the comparability of our results of operations for the three and nine months ended September 30, 2023 and 2022, and our financial condition as of September 30, 2023 and December 31, 2022, and may affect the comparability of financial information we report in future fiscal periods.
Balance sheet repositioning. In the third quarter of 2023, the Company recognized a one-time enhancement fee of $6.6 million from surrender and replacement of certain company-owned life insurance policies, which was intended to offset an increase in tax expense related to the surrender. The tax expense associated with the surrender of the policies totaled $4.5 million. In addition, the Company sold $65.9 million of investment securities, recognizing a loss of $4.9 million, and repaid $17.0 million of FHLB advances.
Redemption of Subordinated Notes. In the second quarter of 2023, the Company redeemed $6.6 million of outstanding subordinated notes. The weighted average redemption price was 89.2% of the aggregate principal amount of the subordinated notes, plus accrued and unpaid interest. The Company recorded gains totaling $0.7 million on these redemptions.
On October 15, 2022, the Company redeemed the outstanding Fixed-to-Floating Rate Subordinated Notes due October 15, 2027, having an aggregate principal amount of $40.0 million, in accordance with the terms of the notes. The aggregate redemption price was 100% of the aggregate principal amount of the subordinated notes, plus accrued and unpaid interest.
Preferred Stock Issuance. On August 24, 2022, the Company issued and sold 4,600,000 depositary shares, each representing a 1/40th ownership interest in a share of the Company’s 7.75% fixed rate reset non-cumulative, non-convertible, perpetual preferred stock, Series A. The net proceeds were $110.5 million.
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Commercial FHA Mortgage Loan Servicing Rights. During the third quarter of 2022, we committed to a plan to sell the commercial servicing rights asset and transferred $24.0 million of commercial FHA loan servicing rights to held for sale. At June 30, 2023, the Company abandoned its plans to sell this servicing asset and removed this asset from held for sale at lower of cost or fair value with no gain or loss recognized.
Recent Acquisitions. On June 17, 2022, the Company completed its acquisition of the deposits and certain loans and other assets associated with FNBC's branches in Mokena and Yorkville, Illinois. The Company acquired $79.8 million in assets, including $60.3 million in cash and $16.6 million in loans, and assumed $79.8 million in deposits.
Results of Operations
Overview. The following table sets forth condensed income statement information of the Company for the three and nine months ended September 30, 2023 and 2022:
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in thousands, except per share data) 2023 2022 2023 2022
Income Statement Data:
Interest income $ 103,585 $ 79,556 $ 299,615 $ 211,540
Interest expense 44,989 15,532 121,675 29,355
Net interest income 58,596 64,024 177,940 182,185
Provision for credit losses 5,168 6,974 14,182 16,582
Noninterest income 18,185 15,826 52,717 46,052
Noninterest expense 42,038 43,496 129,414 125,719
Income before income taxes 29,575 29,380 87,061 85,936
Income taxes 11,533 5,859 25,672 19,783
Net income 18,042 23,521 61,389 66,153
Preferred dividends 2,229 — 6,685 —
Net income available to common shareholders $ 15,813 $ 23,521 $ 54,704 $ 66,153
Per Share Data:
Basic earnings per common share $ 0.71 $ 1.04 $ 2.43 $ 2.93
Diluted earnings per common share $ 0.71 $ 1.04 2.43 2.92
Performance Metrics:
Return on average assets 0.91 % 1.22 % 1.04 % 1.19 %
Return on average shareholders' equity 9.28 % 13.31 % 10.63 % 13.26 %
During the three months ended September 30, 2023, we generated net income of $18.0 million, or diluted earnings per common share of $0.71, compared to net income of $23.5 million, or diluted earnings per common share of $1.04, in the three months ended September 30, 2022. Earnings for the third quarter of 2023 compared to the third quarter of 2022 decreased primarily due to a $5.4 million decrease in net interest income and a $5.7 million increase in income tax expense. These results were partially offset by a $1.8 million decrease in provision for credit losses, a $2.4 million increase in noninterest income and a $1.5 million decrease in noninterest expense.
During the nine months ended September 30, 2023, we generated net income of $61.4 million, or diluted earnings per common share of $2.43, compared to net income of $66.2 million, or diluted earnings per common share of $2.92, in the nine months ended September 30, 2022. Earnings for the nine months ended September 30, 2023 compared to nine months ended September 30, 2022 decreased primarily due to a $4.2 million decrease in net interest income, a $3.7 million increase in noninterest expense and a $5.9 million increase in income tax expense. These results were partially offset by a $2.4 million decrease in provision for credit losses and a $6.7 million increase in noninterest income.
Net Interest Income and Margin. Our primary source of revenue is net interest income, which is the difference between interest income from interest-earning assets (primarily loans and securities) and interest expense of funding sources (primarily interest-bearing deposits and borrowings). Net interest income is influenced by many factors, primarily the volume and mix of interest-earning assets, funding sources, and interest rate fluctuations. Noninterest-bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. Net interest margin is calculated as net interest income divided by average interest-earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free
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interest income has been adjusted to a pretax-equivalent income, assuming a federal income tax rate of 21% for three and nine months ended September 30, 2023 and 2022.
On July 26, 2023, the Federal Reserve approved its 11th interest rate increase in just over a year. The increase moved the federal funds rate to a target range of 5.25%-5.50%, the highest since August 2007. At its September meeting, the Federal Reserve decided to leave interest rates unchanged. Minutes from that meeting indicated that the Federal Reserve officials believed that rates would need to stay elevated until they are convinced inflation is heading back to 2%. The benchmark federal funds rate remains at a target range between 5.25%-5.50%, compared to a target rate of 0.00%-0.25% at the beginning of 2022.
During the three months ended September 30, 2023, net interest income, on a tax-equivalent basis, decreased to $58.8 million compared to $64.3 million for the three months ended September 30, 2022. The tax-equivalent net interest margin decreased to 3.20% for the third quarter of 2023 compared to 3.63% in the third quarter of 2022.
During the nine months ended September 30, 2023 , net interest income, on a tax-equivalent basis, decreased to $178.6 million with a tax-equivalent net interest margin of 3.27% compared to net interest income, on a tax-equivalent basis, of $183.2 million and a tax-equivalent net interest margin of 3.60% for the nine months ended September 30, 2022 .
Average Balance Sheet, Interest and Yield/Rate Analysis. The following tables present the average balance sheets, interest income, interest expense and the corresponding average yields earned and rates paid for the three and nine months ended September 30, 2023 and 2022. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments.
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Three Months Ended September 30,
2023 2022
(tax-equivalent basis, dollars in thousands) Average
balance Interest
& fees Yield/
Rate Average
balance Interest
& fees Yield/
Rate
Interest-earning assets:
Federal funds sold and cash investments $ 78,391 $ 1,036 5.24 % $ 195,657 $ 1,125 2.28 %
Investment securities :
Taxable investment securities 813,582 7,475 3.65 653,277 3,765 2.31
Investment securities exempt from federal income tax (1)
49,416 347 2.79 95,745 795 3.32
Total securities 862,998 7,822 3.60 749,022 4,560 2.44
Loans :
Loans (2)
6,245,179 93,488 5.94 5,973,378 72,901 4.84
Loans exempt from federal income tax (1)
52,389 630 4.77 66,980 667 3.95
Total loans 6,297,568 94,118 5.93 6,040,358 73,568 4.83
Loans held for sale 6,078 104 6.80 6,044 60 3.87
Nonmarketable equity securities 39,347 710 7.16 37,765 550 5.78
Total interest-earning assets 7,284,382 103,790 5.65 7,028,846 79,863 4.51
Noninterest-earning assets 622,969 618,138
Total assets $ 7,907,351 $ 7,646,984
Interest-bearing liabilities:
Deposits:
Checking and money market deposits $ 3,770,735 $ 29,401 3.09 % $ 3,558,696 $ 9,032 1.01 %
Savings deposits 604,475 506 0.33 718,970 149 0.08
Time deposits 865,263 6,441 2.95 630,201 1,018 0.64
Brokered time deposits 113,883 1,421 4.95 14,478 50 1.35
Total interest-bearing deposits 5,354,356 37,769 2.80 4,922,345 10,249 0.83
Short-term borrowings 20,127 14 0.28 58,271 28 0.19
FHLB advances and other borrowings 402,500 4,557 4.49 340,163 2,424 2.83
Subordinated debt 93,441 1,280 5.43 139,324 2,010 5.77
Trust preferred debentures 50,379 1,369 10.78 49,751 821 6.54
Total interest-bearing liabilities 5,920,803 44,989 3.01 5,509,854 15,532 1.12
Noninterest-bearing liabilities:
Noninterest-bearing deposits 1,116,988 1,372,626
Other noninterest-bearing liabilities 97,935 63,638
Total noninterest-bearing liabilities 1,214,923 1,436,264
Shareholders’ equity 771,625 700,866
Total liabilities and shareholders’ equity $ 7,907,351 $ 7,646,984
Net interest income / net interest margin (3)
$ 58,801 3.20 % $ 64,331 3.63 %
(1) Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%. Tax-equivalent adjustments totaled $0.2 million and $0.3 million for the three months ended September 30, 2023 and 2022, respectively.
(2) Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.
(3) Net interest margin during the periods presented represents: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.
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Nine Months Ended September 30,
2023 2022
(tax-equivalent basis, dollars in thousands) Average
balance Interest
& fees Yield/
Rate Average
balance Interest
& fees Yield/
Rate
Interest-earning assets:
Federal funds sold and cash investments $ 76,939 $ 2,868 4.98 % $ 268,111 $ 1,764 0.88 %
Investment securities :
Taxable investment securities 784,954 19,744 3.35 709,163 11,717 2.20
Investment securities exempt from federal income tax (1)
59,992 1,359 3.02 111,165 2,736 3.28
Total securities 844,946 21,103 3.33 820,328 14,453 2.35
Loans :
Loans (2)
6,270,427 272,297 5.81 5,597,514 192,430 4.60
Loans exempt from federal income tax (1)
54,151 1,708 4.22 69,360 2,012 3.88
Total loans 6,324,578 274,005 5.79 5,666,874 194,442 4.59
Loans held for sale 3,900 179 6.14 15,629 357 3.05
Nonmarketable equity securities 44,034 2,104 6.39 36,832 1,521 5.52
Total interest-earning assets 7,294,397 300,259 5.50 6,807,774 212,537 4.17
Noninterest-earning assets 615,383 621,510
Total assets $ 7,909,780 $ 7,429,284
Interest-bearing liabilities:
Deposits:
Checking and money market deposits $ 3,743,483 $ 79,858 2.85 % $ 3,364,552 $ 13,188 0.52 %
Savings deposits 626,976 1,145 0.24 711,108 287 0.05
Time deposits 791,555 14,694 2.48 624,282 2,588 0.55
Brokered time deposits 61,838 2,094 4.53 17,668 157 1.19
Total interest-bearing deposits 5,223,852 97,791 2.50 4,717,610 16,220 0.46
Short-term borrowings 26,865 53 0.26 62,495 73 0.16
FHLB advances and other borrowings 471,084 15,959 4.53 319,791 5,071 2.12
Subordinated debt 96,820 3,985 5.49 139,233 6,032 5.78
Trust preferred debentures 50,216 3,887 10.35 49,603 1,959 5.28
Total interest-bearing liabilities 5,868,837 121,675 2.77 5,288,732 29,355 0.74
Noninterest-bearing liabilities:
Noninterest-bearing deposits 1,184,410 1,402,900
Other noninterest-bearing liabilities 84,650 70,427
Total noninterest-bearing liabilities 1,269,060 1,473,327
Shareholders’ equity 771,883 667,225
Total liabilities and shareholders’ equity $ 7,909,780 $ 7,429,284
Net interest income / net interest margin (3)
$ 178,584 3.27 % $ 183,182 3.60 %
(1) Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%. Tax-equivalent adjustments totaled $0.6 million and $1.0 million for the nine months ended September 30, 2023 and 2022, respectively.
(2) Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.
(3) Net interest margin during the periods presented represents: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.
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Interest Rates and Operating Interest Differential. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. Changes which are not due solely to volume or rate have been allocated proportionally to the change due to volume and the change due to rate.
Three Months Ended September 30, 2023 compared with Three Months Ended September 30, 2022 Nine Months Ended September 30, 2023 compared with Nine Months Ended September 30, 2022
Change due to: Interest
Variance Change due to: Interest
Variance
(tax-equivalent basis, dollars in thousands) Volume Rate Volume Rate
EARNING ASSETS:
Federal funds sold and cash investments $ (1,112) $ 1,023 $ (89) $ (4,189) $ 5,293 $ 1,104
Investment securities:
Taxable investment securities 1,204 2,506 3,710 1,579 6,448 8,027
Investment securities exempt from federal income tax (355) (93) (448) (1,210) (167) (1,377)
Total securities 849 2,413 3,262 369 6,281 6,650
Loans:
Loans 3,693 16,894 20,587 26,178 53,689 79,867
Loans exempt from federal income tax (160) 123 (37) (460) 156 (304)
Total loans 3,533 17,017 20,550 25,718 53,845 79,563
Loans held for sale — 44 44 (403) 225 (178)
Nonmarketable equity securities 26 134 160 321 262 583
Total earning assets $ 3,296 $ 20,631 $ 23,927 $ 21,816 $ 65,906 $ 87,722
INTEREST-BEARING LIABILITIES:
Checking and money market deposits $ 1,090 $ 19,279 $ 20,369 $ 4,780 $ 61,890 $ 66,670
Savings deposits (60) 417 357 (94) 952 858
Time deposits 1,065 4,358 5,423 1,899 10,207 12,106
Brokered deposits 789 582 1,371 945 992 1,937
Total interest-bearing deposits 2,884 24,636 27,520 7,530 74,041 81,571
Short-term borrowings (22) 8 (14) (55) 35 (20)
FHLB advances and other borrowings 575 1,558 2,133 3,762 7,126 10,888
Subordinated debt (637) (93) (730) (1,789) (258) (2,047)
Trust preferred debentures 13 535 548 36 1,892 1,928
Total interest-bearing liabilities $ 2,813 $ 26,644 $ 29,457 $ 9,484 $ 82,836 $ 92,320
Net interest income $ 483 $ (6,013) $ (5,530) $ 12,332 $ (16,930) $ (4,598)
Interest Income. Interest income, on a tax-equivalent basis, increased $23.9 million to $103.8 million in the three months ended September 30, 2023 as compared to the same quarter in 2022, primarily due to improved yields on earning assets. The yield on earning assets increased 114 basis points to 5.65% from 4.51% primarily due to the impact of increasing market interest rates.
Average earning assets increased to $7.28 billion in the third quarter of 2023 from $7.03 billion in the same quarter in 2022. Increases in average loans and investment securities of $257.2 million and $114.0 million, respectively, were partially offset by a decrease in federal funds sold and cash investments of $117.3 million.
Average loans increased $257.2 million in the third quarter of 2023 compared to the same quarter of 2022 across all loan categories, except for commercial FHA warehouse lines and consumer loans. Average commercial loans increased $38.5 million. Included in this category are commercial FHA warehouse lines. Average commercial FHA warehouse lines decreased $37.2 million to $20.4 million in the third quarter of 2023. Excluding the changes in the commercial FHA warehouse line portfolio, average commercial loans increased $75.7 million in the third quarter of 2023 compared to the same period one year prior.
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Average construction loans increased this quarter by $164.7 million, compared to the prior year's third quarter, primarily due to funding draws on existing multifamily project lines. Average balances in our consumer loan portfolio decreased this quarter by $42.2 million compared to the prior year third quarter due a decrease in loans originated through the program with GreenSky.
For the nine months ended September 30, 2023, interest income, on a tax-equivalent basis, increased $87.7 million to $300.3 million as compared to the same period in 2022, primarily due to improved yields on earning assets. The yield on earning assets increased 133 points to 5.50% from 4.17%, primarily due to the impact of increasing market interest rates.
Average earning assets increased to $7.29 billion in the first nine months of 2023 from $6.81 billion in the same period in 2022. An increase in average loans of $657.7 million was partially offset by a $191.2 million decrease in federal funds sold and cash investments.
Average commercial loans increased $99.1 million for the nine months ended September 30, 2023 compared to the same period of 2022. Commercial FHA warehouse lines decreased $54.6 million to $15.7 million during this period. Excluding the changes in the commercial FHA warehouse line portfolio, average commercial loans increased $153.7 million for the nine months ended September 30, 2023 compared to the same period one year prior.
Average balances in all of our other loan classifications increased for the nine months ended September 30, 2023 compared to the same period of 2022. Average commercial real estate loans, construction loans, and lease portfolios also increased $253.2 million, $149.5 million and $64.6 million, respectively, for the nine months ended September 30, 2023 compared to the same period of 2022.
Interest Expense. Interest expense increased $29.5 million to $45.0 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. The cost of interest-bearing liabilities increased to 3.01% for the third quarter of 2023 compared to 1.12% for the third quarter of 2022 due to the increase in deposit costs as a result of the rate increases announced by the Federal Reserve.
Interest expense on deposits increased $27.5 million to $37.8 million for the three months ended September 30, 2023 from the comparable period in 2022 . The increase was primarily due to an increase in rates paid on deposits. Average balances of interest-bearing deposit accounts increased $432.0 million, or 8.78%, to $5.35 billion for the three months ended September 30, 2023 compared to the same period one year earlier. The increase in volume was attributable to increases of retail deposits and brokered deposits of $60.2 million and $127.6 million, respectively. In addition, our Insured Cash Sweep product average balances increased $538.0 million.
For the nine month period ended September 30, 2023, interest expense increased $92.3 million to $121.7 million compared to the nine months ended September 30, 2022. The cost of interest-bearing liabilities increased to 2.77% for the first nine months of 2023 compared to 0.74% for the same period of 2022. I nterest expense on deposits increased to $97.8 million from $16.2 million for the comparable period in 2022 , primarily due to increases in interest rates on deposits.
Interest expense on FHLB advances and other borrowings increased $2.1 million and $10.9 million for the three and nine months ended September 30, 2023, respectively, from the comparable periods in 2022, due to increases in both average balances and the cost of funds. Average balances increased $62.3 million and $151.3 million for the three and nine months ended September 30, 2023, respectively, from the comparable periods in 2022. Average costs of funds increased 166 basis points and 241 basis points, respectively, for the three and nine months ended September 30, 2023, from the comparable periods in 2022.
Interest expense on subordinated debt decreased $0.7 million and $2.0 million for the three and nine months ended September 30, 2023, respectively, from the comparable periods in 2022. The Company redeemed $6.6 million of subordinated debt in the second quarter of 2023 and $40.0 million of subordinated debt on October 15, 2022.
Interest expense on trust preferred debentures increased $0.5 million and $1.9 million for the three and nine months ended September 30, 2023, respectively, from the comparable periods in 2022, due to interest rate increases, as these debt instruments reprice quarterly.
Provision for Credit Losses. The Company's provision for credit losses on loans totaled $5.2 million for the three months ended September 30, 2023, compared to $7.0 million for the three months ended September 30, 2022. For the nine months ended September 30, 2023 and 2022 , the Company recorded provision expense of $14.2 million and $16.6 million, respectively.
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The provision for credit losses on loans recognized during the three and nine months ended September 30, 2023 was made at a level deemed necessary by management to absorb estimated losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for credit losses is completed quarterly by management, the results of which are used to determine provision for credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and reasonable and supportable forecasts along with other qualitative and quantitative factors.
Noninterest Income. Noninterest income increased 14.91% for the three months ended September 30, 2023, compared to the same period one year prior, and increased 14.47% for the nine months ended September 30, 2023, compared to the same period one year prior. The following table sets forth the major components of our noninterest income for the three and nine months ended September 30, 2023 and 2022:
Three Months Ended September 30, Increase
(decrease) Nine Months Ended September 30, Increase
(decrease)
(dollars in thousands) 2023 2022 2023 2022
Noninterest income:
Wealth management revenue $ 6,288 $ 6,199 $ 89 $ 18,968 $ 19,481 $ (513)
Residential mortgage banking revenue 507 210 297 1,452 1,193 259
Service charges on deposit accounts 3,149 2,783 366 8,744 7,544 1,200
Interchange revenue 3,609 3,531 78 10,717 10,401 316
Loss on sales of investment securities, net (4,961) (129) (4,832) (6,478) (230) (6,248)
Impairment on commercial mortgage servicing rights — — — — (1,263) 1,263
Company-owned life insurance 7,558 929 6,629 9,325 2,788 6,537
Other income 2,035 2,303 (268) 9,989 6,138 3,851
Total noninterest income $ 18,185 $ 15,826 $ 2,359 $ 52,717 $ 46,052 $ 6,665
Loss on sale of investment securities . The Company took advantage of certain market conditions during the three and nine months ended September 30, 2023 to reposition out of lower yielding securities into other structures, which are expected to result in improved overall margin, liquidity and capital allocations. These transactions resulted in losses of $5.0 million and $6.5 million in the three and nine months ended September 30, 2023, with expected paybacks to occur within a one year period.
Company-owned life insurance income. Company-owned life insurance income increased $6.6 million for each the three and nine months ended September 30, 2023, as compared to the same periods in 2022. As previously discussed, the Company recognized a one-time enhancement fee of $6.6 million from the surrender and replacement of certain life insurance policies.
Other noninterest income. Other income increased $3.9 million for the nine months ended September 30, 2023, as compared to the same period in 2022. As mentioned previously, the Company recognized a gain of $0.7 million on the redemption of subordinated debt in the second quarter of 2023. Also in the second quarter of 2023, we recognized a gain of $0.8 million on the sale of OREO. Net unrealized gains on our equity securities increased $1.4 million for the nine months ended September 30, 2023, compared to the same period in 2022. As a result of designating our commercial FHA loan servicing rights as held for sale, we did not amortize the servicing asset nor record impairment during the first half of 2023. In the nine months ended September 30, 2023 and 2022, amortization expense totaled $0.6 million and $1.9 million, respectively.
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Noninterest Expense. The following table sets forth the major components of noninterest expense for the three and nine months ended September 30, 2023 and 2022:
Three Months Ended September 30, Increase
(decrease) Nine Months Ended September 30, Increase
(decrease)
(dollars in thousands) 2023 2022 2023 2022
Noninterest expense:
Salaries and employee benefits $ 22,307 $ 22,889 $ (582) $ 69,407 $ 67,404 $ 2,003
Occupancy and equipment 3,730 3,850 (120) 12,052 11,094 958
Data processing 6,468 6,093 375 19,323 18,048 1,275
FDIC insurance 1,107 977 130 3,632 2,633 999
Professional 1,554 1,693 (139) 4,977 5,181 (204)
Marketing 950 1,026 (76) 2,323 2,447 (124)
Communications 507 587 (80) 1,514 1,934 (420)
Loan expense 866 1,137 (271) 3,104 3,379 (275)
Amortization of intangible assets 1,129 1,361 (232) 3,628 4,077 (449)
Other expense 3,420 3,883 (463) 9,454 9,522 (68)
Total noninterest expense $ 42,038 $ 43,496 $ (1,458) $ 129,414 $ 125,719 $ 3,695
Salaries and employee benefits. For the nine months ended September 30, 2023, salaries and employee benefits expense increased $2.0 million as compared to the same period in 2022, primarily due to annual salary increases and increased medical insurance expense. The Company employed 911 employees at September 30, 2023 compared to 930 employees at September 30, 2022.
Occupancy and Equipment Expense. For the nine months ended September 30, 2023, occupancy and equipment expense increased $1.0 million as compared to the same period in 2022 primarily as a result of the non-controllable seasonal expenses in the first quarter of 2023, including snow removal. In addition, the Company transitioned to an outsourced facilities management program and incurred increased repair expenses as a result of deferred maintenance.
Data processing fees. The $0.4 million and $1.3 million increases in data processing fees for the three and nine months ended September 30, 2023, respectively, as compared to the same periods in 2022, were primarily the result of our continuing investments in technology to better serve our growing customer base and increased transaction volumes.
FDIC Insurance Expense. For the nine months ended September 30, 2023, FDIC insurance expense increased $1.0 million, as compared to the same period in 2022, primarily as a result of the FDIC increasing the base assessment rate by 2 basis points, effective January 1, 2023.
Income Tax Expense. The Company's effective tax rate was 39.0% and 19.9% for the three months ended September 30, 2023 and 2022, respectively. For the nine months ended September 30, 2023 and 2022, the Company's effective tax rate was 29.5% and 23.0%, respectively. The increase in the effective tax rate from the three and nine months ended September 30, 2022 is due primarily to tax expense of $4.5 million associated with a surrender of company-owned life insurance policies, as previously discussed, and a $1.4 million return to provision adjustment recognized in the third quarter of 2023.
Financial Condition
Assets. Total assets increased to $7.98 billion at September 30, 2023, as compared to $7.86 billion at December 31, 2022.
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Loans. The loan portfolio is the largest category of our assets. At September 30, 2023, total loans were $6.28 billion as compared to $6.31 billion at December 31, 2022. The following table shows loans by category as of September 30, 2023 and December 31, 2022:
September 30, 2023 December 31, 2022
(dollars in thousands) Balance Percent Balance Percent
Loans:
Commercial:
Equipment finance loans $ 578,931 9.2 % $ 616,751 9.8 %
Equipment finance leases 485,460 7.8 491,744 7.8
Commercial FHA lines 48,547 0.8 25,029 0.4
Other commercial loans 943,761 15.0 872,794 13.8
Total commercial loans and leases 2,056,699 32.8 2,006,318 31.8
Commercial real estate 2,412,164 38.4 2,433,159 38.6
Construction and land development 416,801 6.6 320,882 5.1
Residential real estate 375,211 6.0 366,094 5.8
Consumer 1,020,008 16.2 1,180,014 18.7
Total loans, gross 6,280,883 100.0 % 6,306,467 100.0 %
Allowance for credit losses on loans (66,669) (61,051)
Total loans, net $ 6,214,214 $ 6,245,416
Total loans decreased $25.6 million to $6.28 billion at September 30, 2023, as compared to December 31, 2022, as the Company continued to originate loans in a more selective and deliberate approach to balance liquidity and funding costs. The increase in our construction and land development portfolio of $95.9 million was primarily driven by draws on existing lines. In addition, our commercial loans and leases increased $50.4 million.
Consumer loans decreased $160.0 million at September 30, 2023 primarily due to a decrease in loans originated through the program with GreenSky, as expected. On January 24, 2023, the Company notified GreenSky that, effective October 21, 2023, the Company would terminate its participation in GreenSky’s loan origination program. Following the termination, GreenSky is expected to continue servicing all loans originated through the program.
The principal segments of our loan portfolio are discussed below:
Commercial loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small- and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs, business expansions and farm operations. Commercial loans generally include lines of credit and loans with maturities of five years or less. The loans are generally made with business operations as the primary source of repayment, but may also include collateralization by inventory, accounts receivable and equipment, and generally include personal guarantees. The commercial loan category also includes loans originated by the equipment financing business that are secured by the underlying equipment.
Commercial real estate loans. Our commercial real estate loans consist of both real estate occupied by the borrower for ongoing operations and non-owner occupied real estate properties. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as owner occupied offices, warehouses and production facilities, office buildings, hotels, mixed-use residential and commercial facilities, retail centers, multifamily properties and assisted living facilities. Our commercial real estate loan portfolio also includes farmland loans. Farmland loans are generally made to a borrower actively involved in farming rather than to passive investors.
Construction and land development loans. Our construction and land development loans are comprised of residential construction, commercial construction and land acquisition and development loans. Interest reserves are generally established on real estate construction loans.
Residential real estate loans. Our residential real estate loans consist of residential properties that generally do not qualify for secondary market sale.
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Consumer loans. Our consumer loans include direct personal loans, indirect automobile loans, lines of credit and installment loans originated through home improvement specialty retailers and contractors. Personal loans are generally secured by automobiles, boats and other types of personal property and are made on an installment basis.
Lease financing. Our equipment leasing business provides financing leases to varying types of businesses nationwide for purchases of business equipment and software. The financing is secured by a first priority interest in the financed asset and generally requires monthly payments.
The following table shows the contractual maturities of our loan portfolio and the distribution between fixed and adjustable interest rate loans at September 30, 2023:
September 30, 2023
Within One Year One Year to Five Years Five Years to 15 Years After 15 Years
(dollars in thousands) Fixed Rate Adjustable
Rate Fixed Rate Adjustable
Rate Fixed Rate Adjustable
Rate Fixed Rate Adjustable
Rate Total
Commercial $ 92,106 $ 476,928 $ 654,184 $ 43,224 $ 160,891 $ 95,857 $ — $ 48,049 $ 1,571,239
Commercial real estate 157,723 295,113 987,952 382,396 380,537 183,848 5,496 19,099 2,412,164
Construction and land development 13,662 67,570 107,525 167,375 15,344 42,529 1,013 1,783 416,801
Total commercial loans 263,491 839,611 1,749,661 592,995 556,772 322,234 6,509 68,931 4,400,204
Residential real estate 969 3,368 8,530 19,238 26,218 39,106 162,533 115,249 375,211
Consumer 3,314 533 979,100 534 36,526 — 1 — 1,020,008
Lease financing 13,930 — 365,602 — 105,928 — — — 485,460
Total loans $ 281,704 $ 843,512 $ 3,102,893 $ 612,767 $ 725,444 $ 361,340 $ 169,043 $ 184,180 $ 6,280,883
Loan Quality
We use what we believe is a comprehensive methodology to monitor credit quality and prudently manage credit concentration within our loan portfolio. Our underwriting policies and practices govern the risk profile, credit and geographic concentration for our loan portfolio. We also have what we believe to be a comprehensive methodology to monitor these credit quality standards, including a risk classification system that identifies potential problem loans based on risk characteristics by loan type as well as the early identification of deterioration at the individual loan level.
Analysis of the Allowance for Credit Losses on Loans. The allowance for credit losses on loans was $66.7 million, or 1.06% of total loans, at September 30, 2023 compared to $61.1 million, or 0.97% of total loans, at December 31, 2022. The following table allocates the allowance for credit losses on loans by loan category:
September 30, 2023 December 31, 2022
(dollars in thousands) Allowance Percent (1)
Allowance Percent (1)
Commercial $ 19,410 1.24 % $ 14,639 0.97 %
Commercial real estate 24,611 1.02 29,290 1.20
Construction and land development 3,530 0.85 2,435 0.76
Total commercial loans 47,551 1.08 46,364 1.09
Residential real estate 5,698 1.52 4,301 1.17
Consumer 3,984 0.39 3,599 0.30
Lease financing 9,436 1.94 6,787 1.38
Total allowance for credit losses on loans $ 66,669 1.06 % $ 61,051 0.97 %
(1) Represents the percentage of the allowance to total loans in the respective category.
We measure expected credit losses over the life of each loan utilizing a combination of models which measure probability of default and loss given default, among other things. The measurement of expected credit losses is impacted by loan and borrower attributes and certain macroeconomic variables. Models are adjusted to reflect the impact of certain current macroeconomic variables as well as their expected changes over a reasonable and supportable forecast period.
The allowance allocated to commercial loans totaled $19.4 million, or 1.24% of total commercial loans, at September 30, 2023, compared to $14.6 million, or 0.97%, at December 31, 2022. Modeled expected credit losses increased
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$2.5 million and qualitative factor adjustments related to commercial loans increased $0.9 million. Specific allocations for commercial loans that were evaluated for expected credit losses on an individual basis increased $1.3 million. There were no specific allocation reserves for commercial loans in prior period.
The allowance allocated to commercial real estate loans totaled $24.6 million, or 1.02% to total commercial real estate loans, at September 30, 2023, decreasing $4.7 million, from $29.3 million, or 1.20% of total commercial real estate loans, at December 31, 2022. Modeled expected credit losses decreased $2.6 million and qualitative factor adjustments related to commercial real estate loans decreased $0.6 million. Specific allocations for commercial real estate loans that were evaluated for expected credit losses on an individual basis decreased from $1.5 million at December 31, 2022 to $0.0 million at September 30, 2023.
The allowance allocated to the lease portfolio totaled $9.4 million, or 1.94% of total commercial leases, at September 30, 2023, increasing $2.6 million from $6.8 million, or 1.38% of total commercial leases at December 31, 2022. Modeled expected credit losses increased $2.1 million and qualitative factor adjustments increased $0.6 million. There were no specific allocation reserves for commercial leases in either period.
In estimating expected credit losses as of September 30, 2023, we utilized certain forecasted macroeconomic variables from Oxford Economics in our models. The forecasted projections included, among other things, (i) U.S. gross domestic product growth of 1.5% for 2023 and 0.3% for 2024; (ii) Federal Reserve holding the policy rate through year end with a gradual decrease in 2024; and (iii) unemployment rate averaging 5.6% through the second quarter of 2024.
We qualitatively adjust the model results based on this scenario for various risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These "Q-Factor" adjustments are based upon management judgment and current assessment as to the impact of risks related to changes in lending policies and procedures; economic and business conditions; loan portfolio attributes and credit concentrations; and external factors, among other things, that are not already fully captured within the modeling inputs, assumptions and other processes. Management assesses the potential impact of such items within a range of severely negative impact to positive impact and adjusts the modeled expected credit loss by an aggregate adjustment percentage based upon the assessment. As a result of this assessment as of September 30, 2023, modeled expected credit losses were adjusted upwards with a qualitative factor adjustment of approximately 54 basis points of total loans, increasing from 50 basis points at December 31, 2022. The Q-Factor adjustment at September 30, 2023 was based primarily on declining credit quality conditions within the equipment financing segment, economic conditions, including persistent inflation fears, an increasing risk of recession and the impact of rising fuel prices on businesses and consumers.
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The following table provides an analysis of the allowance for credit losses on loans, provision for credit losses on loans and net charge-offs for the three and nine months ended September 30, 2023 and 2022:
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in thousands) 2023 2022 2023 2022
Balance, beginning of period $ 64,950 $ 54,898 $ 61,051 $ 51,062
Charge-offs:
Commercial 3,249 1,655 5,289 3,869
Commercial real estate 2,316 1,232 4,606 4,084
Construction and land development 44 — 378 6
Residential real estate 95 166 180 315
Consumer 250 316 773 812
Lease financing 1,394 485 2,555 1,190
Total charge-offs 7,348 3,854 13,781 10,276
Recoveries:
Commercial 80 45 577 354
Commercial real estate 3,678 1 4,006 6
Construction and land development — 18 32 30
Residential real estate 33 69 98 222
Consumer 53 121 226 381
Lease financing 55 367 278 1,013
Total recoveries 3,899 621 5,217 2,006
Net charge-offs 3,449 3,233 8,564 8,270
Provision for credit losses on loans 5,168 6,974 14,182 15,847
Balance, end of period $ 66,669 $ 58,639 $ 66,669 $ 58,639
Gross loans, end of period $ 6,280,883 $ 6,198,451 $ 6,280,883 $ 6,198,451
Average total loans $ 6,297,568 $ 6,040,358 $ 6,324,577 $ 5,666,874
Net charge-offs to average loans 0.22 % 0.21 % 0.18 % 0.20 %
Allowance for credit losses to total loans 1.06 % 0.95 % 1.06 % 0.95 %
Individual loans considered to be uncollectible are charged off against the allowance. Factors used in determining the amount and timing of charge-offs on loans include consideration of the loan type, length of delinquency, sufficiency of collateral value, lien priority and the overall financial condition of the borrower. Collateral value is determined using updated appraisals and/or other market comparable information. Charge-offs are generally taken on loans once the impairment is determined to be other-than-temporary. Recoveries on loans previously charged off are added to the allowance.
Charge-offs for the three months ended September 30, 2023 included $2.2 million on a commercial loan and $2.3 million on equipment financing loans and leases. In addition, a commercial real estate loan of $2.3 million was also charged-off in the third quarter. The Company specially reserved for this loss in the second quarter of 2023. The Company recognized a $3.4 million recovery on a commercial real estate loan, which was charged-off in 2017.
Net charge-offs for the three months ended September 30, 2023 totaled $3.4 million, compared to $3.2 million for the same period one year ago. For the nine months ended September 30, 2023, net charge-offs totaled $8.6 million, compared to $8.2 million for the same period one year ago.
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Nonperforming Loans . The following table sets forth our nonperforming assets by asset categories as of the dates indicated. Nonperforming loans include nonaccrual loans and loans past due 90 days or more and still accruing interest. The balances of nonperforming loans reflect the net investment in these assets, including deductions for purchase discounts.
(dollars in thousands) September 30, 2023 December 31, 2022
Nonperforming loans:
Commercial $ 8,836 $ 7,853
Commercial real estate 33,603 29,602
Construction and land development 2,025 229
Residential real estate 3,856 8,449
Consumer 103 921
Lease financing 7,558 2,369
Total nonperforming loans 55,981 49,423
Other real estate owned and other repossessed assets 2,696 8,401
Nonperforming assets $ 58,677 $ 57,824
Nonperforming loans to total loans 0.89 % 0.78 %
Nonperforming assets to total assets 0.74 % 0.74 %
Allowance for credit losses to nonperforming loans 119.09 % 123.53 %
We did not recognize interest income on nonaccrual loans during the three months ended September 30, 2023 or 2022 while the loans were in nonaccrual status. Additional interest income that would have been recorded on nonaccrual loans had they been current in accordance with their original terms was $0.8 million and $2.5 million for the three and nine months ended September 30, 2023, respectively, and $0.8 million and $1.9 million for the three and nine months ended September 30, 2022, respectively.
The following table presents the change in our non-performing loans for the nine months ended September 30, 2023:
(dollars in thousands) Nine Months Ended September 30, 2023
Balance, beginning of period $ 49,424
New nonperforming loans 35,071
Return to performing status (1,097)
Payments received (20,795)
Transfer to OREO and other repossessed assets (332)
Charge-offs (6,290)
Balance, end of period $ 55,981
Investment Securities. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk. The types and maturities of securities purchased are primarily based on our current and projected liquidity and interest rate sensitivity positions.
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The following table sets forth the book value and percentage of each category of investment securities at September 30, 2023 and December 31, 2022. The book value for investment securities classified as available for sale is equal to fair market value.
September 30, 2023 December 31, 2022
(dollars in thousands) Balance Percent Balance Percent
Investment securities available for sale:
U.S. Treasury securities $ 1,563 0.2 % $ 81,230 10.6 %
U.S. government sponsored entities and U.S. agency securities 89,038 10.6 37,509 4.9
Mortgage-backed securities - agency 517,391 62.0 448,150 58.3
Mortgage-backed securities - non-agency 72,665 8.7 20,754 2.7
State and municipal securities 49,737 6.0 94,636 12.3
Collateralized loan obligations 22,385 2.7 — —
Corporate securities 82,230 9.8 85,955 11.2
Total investment securities, available for sale, at fair value $ 835,009 100.0 % $ 768,234 100.0 %
The following table sets forth the book value, maturities and weighted average yields for our investment portfolio at September 30, 2023. The book value for investment securities classified as available for sale is equal to fair market value.
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(dollars in thousands) Balance Percent Weighted average yield
Investment securities available for sale:
U.S. Treasury securities:
Maturing within one year $ 1,274 0.2 % 3.26 %
Maturing in one to five years 289 — 4.21
Maturing in five to ten years — — —
Maturing after ten years — — —
Total U.S. Treasury securities $ 1,563 0.2 % 3.43 %
U.S. government sponsored entities and U.S. agency securities:
Maturing within one year $ 9,981 1.2 % 4.89 %
Maturing in one to five years 65,037 7.8 4.42
Maturing in five to ten years 10,963 1.3 2.08
Maturing after ten years 3,057 0.3 5.77
Total U.S. government sponsored entities and U.S. agency securities $ 89,038 10.6 % 4.19 %
Mortgage-backed securities - agency:
Maturing within one year $ 5,594 0.7 % 2.47 %
Maturing in one to five years 244,137 29.2 3.74
Maturing in five to ten years 154,292 18.5 2.74
Maturing after ten years 113,368 13.6 2.25
Total mortgage-backed securities - agency $ 517,391 62.0 % 3.07 %
Mortgage-backed securities - non-agency:
Maturing within one year $ — — % — %
Maturing in one to five years 56,346 6.8 4.56
Maturing in five to ten years 9,239 1.1 2.25
Maturing after ten years 7,080 0.8 2.58
Total mortgage-backed securities - non-agency $ 72,665 8.7 % 3.99 %
State and municipal securities (1) :
Maturing within one year $ 1,320 0.2 % 3.21 %
Maturing in one to five years 7,485 0.9 3.07
Maturing in five to ten years 26,166 3.1 2.20
Maturing after ten years 14,766 1.8 2.81
Total state and municipal securities $ 49,737 6.0 % 2.53 %
Collateralized loan obligations:
Maturing within one year $ 10,967 1.3 % 8.36 %
Maturing in one to five years 11,418 1.4 6.79
Maturing in five to ten years — — —
Maturing after ten years — — —
Total collateralized loan obligations $ 22,385 2.7 % 7.56 %
Corporate securities:
Maturing within one year $ — — % — %
Maturing in one to five years 19,745 2.4 3.59
Maturing in five to ten years 62,485 7.4 3.61
Maturing after ten years — — —
Total corporate securities $ 82,230 9.8 % 3.60 %
Total investment securities, available for sale $ 835,009 100.0 % 3.37 %
(1) Weighted average yield for tax-exempt securities are presented on a tax-equivalent basis assuming a federal income tax rate of 21%.
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The table below presents the credit ratings for our investment securities classified as available for sale, at fair value, at September 30, 2023.
Amortized Fair Average credit rating
(dollars in thousands) cost Value AAA AA+/- A+/- BBB+/- <BBB- Not Rated
Investment securities available for sale:
U.S. Treasury securities $ 1,582 $ 1,563 $ — $ 1,563 $ — $ — $ — $ —
U.S. government sponsored entities and U.S. agency securities 93,291 89,038 71,119 17,919 — — — —
Mortgage-backed securities - agency 613,484 517,391 6 517,385 — — — —
Mortgage-backed securities - non-agency 77,617 72,665 13,604 59,061 — — — —
State and municipal securities 59,521 49,737 636 48,847 — 254 — —
Collateralized loan obligations 22,662 22,385 14,155 8,230 — — — —
Corporate securities 95,124 82,230 — 44,593 16,584 14,572 6,481 —
Total investment securities, available for sale $ 963,281 $ 835,009 $ 99,520 $ 697,598 $ 16,584 $ 14,826 $ 6,481 $ —
Liabilities. At September 30, 2023, liabilities totaled $7.21 billion compared to $7.10 billion at December 31, 2022.
Deposits. We emphasize developing total client relationships with our customers in order to increase our retail and commercial core deposit bases, which are our primary funding sources. Our deposits consist of noninterest-bearing and interest-bearing demand, savings and time deposit accounts.
Total deposits increased $40.4 million to $6.41 billion at September 30, 2023, as compared to December 31, 2022. Brokered time deposits increased to $119.1 million at September 30, 2023 from $12.8 million at December 31, 2022. In addition, interest rate promotions offered in 2023 on time deposit products resulted in an increases in balances of non-brokered time deposits of $236.3 million over the same period. These increases were partially offset by a decrease in noninterest-bearing demand account balances of $207.6 million, as a result of increasing deposit rates in response to the rate increases announced by the Federal Reserve. Our noninterest-bearing deposits decreased to 18.0% of total deposits at September 30, 2023 compared to 21.4% at December 31, 2022.
(dollars in thousands) September 30, 2023 December 31, 2022
Balance Percent Balance Percent
Noninterest-bearing demand $ 1,154,515 18.0 % $ 1,362,158 21.4 %
Interest-bearing:
Checking 2,572,224 40.2 2,494,073 39.2
Money market 1,090,962 17.0 1,184,101 18.6
Savings 582,359 9.1 661,932 10.4
Time 1,004,942 15.7 662,388 10.4
Total deposits $ 6,405,002 100.0 % $ 6,364,652 100.0 %
The Company estimates that uninsured deposits (1) totaled $1.28 billion, or 20% of total deposits, at September 30, 2023 compared to $1.55 billion, or 24%, at December 31, 2022. The following table sets forth the maturity of uninsured time deposits as of September 30, 2023:
(dollars in thousands) Amount
Three months or less $ 48,203
Three to six months 32,134
Six to 12 months 20,001
After 12 months 5,504
Total $ 105,842
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(1) Uninsured deposits include the Call Report estimate of uninsured deposits less affiliate deposits, estimated insured portion of servicing deposits, additional structured FDIC coverage and collateralized deposits.
Capital Resources and Liquidity Management
Capital Resources. Shareholders’ equity is influenced primarily by earnings, dividends, issuances and redemptions of common and preferred stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized holding gains or losses, net of taxes, on available-for-sale investment securities and cash flow hedges.
Shareholders’ equity increased $5.7 million to $764.3 million at September 30, 2023 as compared to December 31, 2022. The Company generated net income of $61.4 million during 2023. Offsetting this increase to shareholders’ equity were dividends to common shareholders of $20.0 million, dividends to preferred shareholders of $6.7 million, repurchases of common stock of $15.0 million and an increase in accumulated other comprehensive losses of $17.4 million.
The Company has a share repurchase program, whereby the Board of Directors authorized the Company to repurchase up to $25.0 million of its common stock. This program terminates December 31, 2023. As of September 30, 2023, $14.9 million, or 703,868 shares of the Company’s common stock, had been repurchased under the program, with approximately $10.1 million of remaining repurchase authority.
Liquidity Management. Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders.
Integral to our liquidity management is the administration of short-term borrowings. To the extent we are unable to obtain sufficient liquidity through core deposits, we seek to meet our liquidity needs through wholesale funding or other borrowings on either a short- or long-term basis.
Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction, which represents the amount of the Bank’s obligation. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. Investment securities with a carrying amount of $27.8 million and $46.1 million at September 30, 2023 and December 31, 2022, respectively, were pledged for securities sold under agreements to repurchase.
The table below presents our sources of liquidity as of September 30, 2023 and December 31, 2022:
(dollars in thousands) September 30, 2023 December 31, 2022
Cash and cash equivalents $ 132,132 $ 160,631
Unpledged securities 258,104 209,184
FHLB committed liquidity 883,855 997,388
FRB discount window availability 759,763 12,201
Total Estimated Liquidity $ 2,033,854 $ 1,379,404
Conditional Funding Based on Market Conditions
Additional credit facility $ 364,000 $ 250,000
Brokered CDs (additional capacity) $ 500,000 $ 500,000
The Company is a corporation separate and apart from the Bank and, therefore, must provide for its own liquidity. The Company’s main source of funding is dividends declared and paid to it by the Bank. There are statutory, regulatory and debt covenant limitations that affect the ability of the Bank to pay dividends to the Company. Management believed at September 30, 2023, that these limitations will not impact our ability to meet our ongoing short-term cash obligations.
Regulatory Capital Requirements
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We are subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action”, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies.
In December 2018, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the CECL accounting standard. In March 2020, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company is adopting the capital transition relief over the permissible five-year period.
At September 30, 2023, the Company and the Bank exceeded the regulatory minimums and met the regulatory definition of well-capitalized.
The following table presents the Company's and the Bank’s capital ratios and the minimum requirements at September 30, 2023:
Ratio Actual Minimum
Regulatory
Requirements (1)
Well
Capitalized
Total risk-based capital ratio
Midland States Bancorp, Inc. 12.84 % 10.50 % N/A
Midland States Bank 12.13 10.50 10.00 %
Tier 1 risk-based capital ratio
Midland States Bancorp, Inc. 10.62 8.50 N/A
Midland States Bank 11.21 8.50 8.00
Common equity tier 1 risk-based capital ratio
Midland States Bancorp, Inc. 8.16 7.00 N/A
Midland States Bank 11.21 7.00 6.50
Tier 1 leverage ratio
Midland States Bancorp, Inc. 9.67 4.00 N/A
Midland States Bank 10.21 4.00 5.00
(1) Total risk-based capital ratio, Tier 1 risk-based capital ratio and Common equity tier 1 risk-based capital ratio include the capital conservation buffer of 2.5%.
Quantitative and Qualitative Disclosures About Market Risk
Market Risk. Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We are primarily exposed to interest rate risk as a result of offering a wide array of financial products to our customers and secondarily to price risk from investments in securities backed by mortgage loans.
Interest Rate Risk. Interest rate risk is the risk to earnings arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (reprice risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR (basis risk).
We actively manage interest rate risk, as changes in market interest rates may have a significant impact on reported earnings. Changes in market interest rates may result in changes in the fair market value of our financial instruments, cash flows, and net interest income. We seek to achieve consistent growth in net interest income while managing volatility arising from shifts in market interest rates. Our Board of Directors’ Risk Policy and Compliance Committee oversees interest rate risk,
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as well as the establishment of risk measures, limits, and policy guidelines for managing the amount of interest rate risk and its effect on net interest income. The Committee meets quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits.
Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.
An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.
Interest rate risk measurement is calculated and reported to the Risk Policy and Compliance Committee at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.
We use Net Interest Income at Risk (“NII at Risk”) to model interest rate risk utilizing various assumptions for assets, liabilities, and derivatives. NII at Risk uses net interest income simulation analysis which involves forecasting net interest earnings under a variety of scenarios including changes in the level of interest rates, the shape of the yield curve, and spreads between market interest rates. The sensitivity of net interest income to changes in interest rates is measured using numerous interest rate scenarios including shocks, gradual ramps, curve flattening, curve steepening as well as forecasts of likely interest rates scenarios. Modeling the sensitivity of net interest earnings to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. To the extent that actual performance is different than what was assumed, actual net interest earnings sensitivity may be different than projected. We use a data warehouse to study interest rate risk at a transactional level and use various ad-hoc reports to continuously refine assumptions. Assumptions and methodologies regarding administered rate liabilities (e.g., savings accounts, money market accounts and interest-bearing checking accounts), balance trends, and repricing relationships reflect our best estimate of expected behavior and these assumptions are reviewed periodically.
The following table shows NII at Risk at the dates indicated:
Net interest income sensitivity (Shocks)
Immediate change in rates
(dollars in thousands) -200 -100 +100 +200
September 30, 2023:
Dollar change $ 13,564 $ 4,761 $ (7,540) $ (15,513)
Percent change 5.9 % 2.1 % (3.3) % (6.7) %
December 31, 2022:
Dollar change $ — $ (12,560) $ 10,814 $ 21,357
Percent change — % (4.2) % 3.6 % 7.2 %
We report NII at Risk to isolate the change in income related solely to interest-earning assets and interest-bearing liabilities. The NII at Risk results included in the table above reflect the analysis used quarterly by management. It models -200, −100, +100 and +200 basis point parallel shifts in market interest rates, implied by the forward yield curve over the next twelve months. We added a -200 basis point scenario as the Federal Reserve has indicated the rate increases may have run their course. We were within board policy limits for the -200, -100, +100 and +200 basis point scenarios at September 30, 2023.
Tolerance levels for risk management require the continuing development of remedial plans to maintain residual risk within approved levels as we adjust the balance sheet. NII at Risk reported at September 30, 2023 projects that our earnings exhibit increasing profitability in a declining rate environment, compared to December 31, 2022.
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Price Risk. Price risk represents the risk of loss arising from adverse movements in the prices of financial instruments that are carried at fair value and are subject to fair value accounting. We have price risk from mortgage-backed securities, derivative instruments, and equity investments.
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The quantitative and qualitative disclosures about market risk are included under “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures about Market Risk”.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.