NBT BANCORP INC 10-Q

Item 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The purpose of this discussion and analysis is to provide a concise description of the consolidated financial condition and results of operations of NBT Bancorp Inc. (“NBT”) and its wholly owned subsidiaries, including NBT Bank, National Association (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”) and NBT Holdings, Inc. (“NBT Holdings”) (collectively referred to herein as the “Company”). This discussion will focus on results of operations, financial condition, capital resources and asset/liability management. Reference should be made to the Company’s consolidated financial statements and footnotes thereto included in this Form 10‑Q as well as to the Company’s Annual Report on Form 10‑K for the year ended December 31, 2020 for an understanding of the following discussion and analysis. Operating results for the three and nine month periods ending September 30, 2021 are not necessarily indicative of the results of the full year ending December 31, 2021 or any future period. Forward-looking Statements Certain statements in this filing and future filings by the NBT Bancorp Inc. (the “Company”) with the Securities and Exchange Commission (“SEC”), in the Company’s press releases or other public or stockholder communications or in oral statements made with the approval of an authorized executive officer, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as “anticipate,” “believe,” “expect,” “forecasts,” “projects,” “will,” “can,” “would,” “should,” “could,” “may,” or other similar terms. There are a number of factors, many of which are beyond the Company’s control that could cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company’s assessment of that impact; (2) changes in the level of nonperforming assets and charge-offs; (3) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (4) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board (“FRB”); (5) inflation, interest rate, securities market and monetary fluctuations; (6) political instability; (7) acts of war or terrorism; (8) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (9) changes in consumer spending, borrowings and savings habits; (10) changes in the financial performance and/or condition of the Company’s borrowers; (11) technological changes; (12) acquisitions and integration of acquired businesses; (13) the ability to increase market share and control expenses; (14) changes in the competitive environment among financial holding companies; (15) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and its subsidiaries must comply, including those under the Dodd-Frank Act, Economic Growth, Regulatory Relief, Consumer Protection Act of 2018, Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), and other legislative and regulatory responses to the coronavirus (“COVID-19”) pandemic; (16) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board (“FASB”) and other accounting standard setters; (17) changes in the Company’s organization, compensation and benefit plans; (18) the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews; (19) greater than expected costs or difficulties related to the integration of new products and lines of business; (20) the adverse impact on the U.S. economy, including the markets in which we operate, of the COVID-19 global pandemic; and (21) the Company’s success at managing the risks involved in the foregoing items. Currently, one of the most significant factors that could cause actual outcomes to differ materially from the Company’s forward-looking statements is the potential adverse effect of the current COVID-19 pandemic on the financial condition, results of operations, cash flows and performance of the Company, its customers and the global economy and financial markets. The extent to which the COVID-19 pandemic impacts the Company will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the pandemic, and its impact on the Company’s customers and demand for financial services, the actions governments, businesses and individuals take in response to the pandemic, the impact of the COVID-19 pandemic and actions taken in response to the pandemic on global and regional economies, national and local economic activity, the speed and effectiveness of vaccine and treatment developments and their deployment, including public adoption rates of COVID-19 vaccines, and the pace of recovery when the COVID-19 pandemic subsides, among others. Moreover, investors are cautioned to interpret many of the risks identified under the section entitled “Risk Factors” in our Form 10-K for the year ended December 31, 2020 as being heightened as a result of the ongoing and numerous adverse impacts of the COVID-19 pandemic. The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including, but not limited to, those described above and other factors discussed in the Company’s annual and quarterly reports previously filed with the SEC, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected. 28 Table of Contents Unless required by law, the Company does not undertake, and specifically disclaims any obligations to, publicly release any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Non-GAAP Measures This Quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Where non-GAAP disclosures are used in this Form 10-Q, the comparable GAAP measure, as well as a reconciliation to the comparable GAAP measure, is provided in the accompanying tables. Management believes that these non-GAAP measures provide useful information that is important to an understanding of the results of the Company’s core business as well as provide information standard in the financial institution industry. Non-GAAP measures should not be considered a substitute for financial measures determined in accordance with GAAP and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Critical Accounting Policies The Company has identified policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain. The judgment and assumptions made are based upon historical experience or other factors that management believes to be reasonable under the circumstances. Because of the nature of the judgment and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations. These policies relate to the allowance for credit losses, pension accounting and provision for income taxes. The allowance for credit losses consists of the allowance for credit losses and the allowance for losses on unfunded commitments. Measurement of Credit Losses on Financial Instruments (“CECL”) approach requires an estimate of the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses under the CECL approach is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is generally the starting point for estimating expected credit losses. The Company then considers whether the historical loss experience should be adjusted for asset-specific risk characteristics or current conditions at the reporting date that did not exist over the period from which historical experience was used. Finally, the Company considers forecasts about future economic conditions that are reasonable and supportable. The allowance for losses on unfunded commitments represents the expected credit losses on off-balance sheet commitments such as unfunded commitments to extend credit and standby letters of credit. However, a liability is not recognized for commitments unconditionally cancellable by the Company. The allowance for losses on unfunded commitments is determined by estimating future draws and applying the expected loss rates on those draws. Management of the Company considers the accounting policy relating to the allowance for credit losses to be a critical accounting policy given the uncertainty in evaluating the level of the allowance required to cover management’s estimate of all expected credit losses over the expected contractual life of our loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods. While management’s current evaluation of the allowance for credit losses indicates that the allowance is appropriate, the allowance may need to be increased under adversely different conditions or assumptions. Going forward, the impact of utilizing the CECL approach to calculate the reserve for credit losses will be significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the reserve for credit losses, and therefore, greater volatility to our reported earnings. Management is required to make various assumptions in valuing the Company’s pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate, the rate of increase in future compensation levels and interest rate of credit for cash balance plans. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations and expert opinions in determining the various rates used to estimate pension expense. The Company also considers market interest rates and discounted cash flows in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels. The Company is subject to examinations from various taxing authorities. Such examinations may result in challenges to the tax return treatment applied by the Company to specific transactions. Management believes that the assumptions and judgments used to record tax-related assets or liabilities have been appropriate. Should tax laws change or the taxing authorities determine that management’s assumptions were inappropriate, an adjustment may be required which could have a material effect on the Company’s results of operations. 29 Table of Contents The Company’s policies on the CECL method for allowance for credit losses, pension accounting and provision for income taxes are disclosed in Note 1 to the consolidated financial statements presented in our 2020 Annual Report on Form 10-K. All accounting policies are important and as such, the Company encourages the reader to review each of the policies included in Note 1 to the consolidated financial statements presented in our 2020 Annual Report on Form 10-K to obtain a better understanding of how the Company’s financial performance is reported. Refer to Note 3 to the unaudited interim consolidated finance statements in this Quarterly Report on Form 10-Q for recently adopted accounting standards. Overview Significant factors management reviews to evaluate the Company’s operating results and financial condition include, but are not limited to: net income and earnings per share, return on average assets and equity, net interest margin, noninterest income, operating expenses, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons. The Company’s results in 2021 and 2020 have been impacted by the COVID-19 pandemic and the CECL accounting methodology, including the estimated impact of the COVID-19 pandemic on expected credit losses. The following information should be considered in connection with the Company’s results for the three and nine months ended September 30, 2021: ● net income for the three months ended September 30, 2021 was $37.4 million, up $2.3 million from the third quarter of 2020 and down $2.9 million from the second quarter of 2021 ; ● diluted earnings per share of $0.86 for the three months ended September 30, 2021 , up $0.06 from the third quarter of 2020 and down $0.06 from the second quarter of 2021 ; ● period end loans were $7.6 billion, up 1%, annualized, from December 31, 2020 (4.2% excluding Paycheck Protection Program (“PPP”) loans); ● net charge-offs to average loans of 0.11%, annualized (0.12% excluding PPP loans) and allowance for loan losses to total loans at 1.23% (1.28% excluding PPP loans and related allowance); ● book value per share of $28.65 at September 30, 2021 ; tangible book value per share grew 2% for the quarter and 10% from September 30, 2020 to $21.95 (1) . (1) Non-GAAP measure - Stockholders’ equity less goodwill and intangible assets divided by common shares outstanding. COVID-19 Pandemic and Company Response The year 2020 began with overall stable U.S. economic conditions that were significantly impacted by the COVID-19 pandemic and subsequent shut-down of non-essential business throughout the Company’s footprint. A prolonged global pandemic like COVID-19 could adversely affect our operations. The results of operations and the ultimate effect of pandemic will depend on numerous factors that are highly uncertain including how long restrictions for business and individuals will last, further information around the severity of the virus itself, additional actions taken by federal, state and local governments to contain and treat COVID-19 and what, if any, additional government relief will be provided. The expected impact of the pandemic on the Company’s business, financial condition, results of operations, and its customers has not fully manifested. The fiscal stimulus and relief programs appear to have delayed or mitigated any materially adverse financial impact to the Company. Once these stimulus programs have been exhausted, the Company’s credit metrics may worsen and loan losses could ultimately materialize. Any potential loan losses will be contingent upon the resurgence of the virus, including any new strains, offset by the potency of the vaccine along with its extensive distribution, and the ability for customers and businesses to return to their prepandemic routines. However, economic uncertainty remains relatively high and volatility is expected to continue in 2021. In response, the Company immediately formed an Executive Task Force and engaged its established Incident Response Team under its Business Continuity Plan to execute a comprehensive pandemic response plan. The Company has taken significant steps to address the needs of its customers impacted by COVID-19. The Company provided payment relief for all its customers for 180 days or less, waiving associated late fees while not reporting these payment deferrals as late payments to the credit bureaus for all its consumer customers who were current prior to this event. The Company has also offered longer payment deferral options on a limited, case by case basis to address certain customers’ hardships related to the pandemic where we are able to gather information on the ongoing viability of the borrower’s long-term ability to return to full payment. The Company continues to responsibly lend to qualified consumer and commercial customers and designed special lending programs as well as participating in government sponsored relief programs to respond to customers’ needs during the pandemic. The Company believes our historically strong underwriting practices, diverse and granular portfolios, and geographic footprint will help to mitigate any adverse impact to the Company. The Company has been a participant in the Small Business Administration’s Paycheck Protection Program, a loan guarantee program created under the CARES Act targeted to provide small businesses with support to cover payroll and certain other expenses. Loans made under the PPP are fully guaranteed by the Small Business Administration (“SBA”), whose guarantee is backed by the full faith and credit of the United States. PPP covered loans also afford borrowers forgiveness up to the principal amount of the PPP covered loan, plus accrued interest, if the loan proceeds are used to retain workers and maintain payroll or to make certain mortgage interest, lease and utility payments, and certain other criteria are satisfied. The SBA will reimburse PPP lenders for any amount of a PPP covered loan that is forgiven, and PPP lenders will not be held liable for any representations made by PPP borrowers in connection with their requests for loan forgiveness. Lenders receive pre-determined fees for processing and servicing PPP loans. In addition, PPP loans are risk-weighted at zero percent under the generally-applicable Standardized Approach used to calculate risk-weighted assets for regulatory capital purposes. The Company processed approximately 3,100 loans totaling $287 million in relief during the nine months ended September 30, 2021 as compared to 3,000 loans totaling over $548 million in 2020. The Company is supporting the PPP application and forgiveness processes with online resources, educational webinars and a partnership with a certified public accounting firm. As of September 30, 2021, the Company has received payment from the SBA on 2,622 of our loans totaling $449.8 million. 30 Table of Contents On December 27, 2020, the President signed into law the Consolidated Appropriation Act (“CAA”). The CAA, among other things, extends the life of the PPP, effectively creating a second round of PPP loans for eligible businesses. The Company is participating in the CAA’s second round of PPP lending. In mid-January the Company opened its lending portal and began processing PPP loan applications from current and new customers. As of September 30, 2021, the Company has originated $287 million in PPP loans during this round with an average loan size of $93,000. The Company established a committee to ensure employee and customer safety and a nimble response across geographic and functional areas. The five focus areas for the Company’s reopening are employee well-being, alternate work plans, physical workspace, working with customers and vendors, and policies, training and communication. The Committee monitored state and local responses and adapted physical locations across its footprint in its re-opening plans and will continue to monitor and adapt its response as the impact of COVID-19 continues to develop. The Company has taken several steps to address the safety of its employees and its customers including health and safety protocols to protect branch and onsite workers, full-time remote and hybrid work arrangement, additional benefits for health, childcare/eldercare needs and well-being and new mobile, online, business banking and mortgage platforms were launched in 2020. Results of Operations Net income for the three months ended September 30, 2021 was $37.4 million, down $2.9 million from $40.3 million for the second quarter of 2021 and up $2.3 million from $35.1 million for the third quarter of 2020. Diluted earnings per share for the three months ended September 30, 2021 was $0.86, as compared with $0.92 for the prior quarter, and $0.80 for the third quarter of 2020. Return on average assets (annualized) was 1.26% for the three months ended September 30, 2021 as compared to 1.39% for the prior quarter and 1.29% for the same period last year. Return on average equity (annualized) was 12.04% for the three months ended September 30, 2021 as compared to 13.42% for the prior quarter and 12.09% for the three months ended September 30, 2020. Return on average tangible common equity (annualized) was 15.97% for the three months ended September 30, 2021 as compared to 17.93% for the prior quarter and 16.51% for the three months ended September 30, 2020. Net income for the nine months ended September 30, 2021 was $117.6 million, up $47.4 from $70.2 million for the same period last year. Diluted earnings per share for the nine months ended September 30, 2021 was $2.69 as compared with $1.60 for the same period in 2020. Return on average assets (annualized) was 1.37% for the nine months ended September 30, 2021 as compared to 0.90% for the same period last year. Return on average equity (annualized) was 13.00% for the nine months ended September 30, 2021 as compared to 8.23% for the nine months ended September 30, 2020. Return on average tangible common equity (annualized) was 17.35% for the nine months ended September 30, 2021 as compared to 11.36% for the nine months ended September 30, 2020. Return on average tangible common equity is a non-GAAP measure and excludes amortization of intangible assets (net of tax) from net income and average tangible equity calculated as follows: Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2021 2020 2021 2020 Net income $ 37,433 $ 35,113 $ 117,575 $ 70,194 Amortization of intangible assets (net of tax) 497 642 1,618 1,930 Net income, excluding intangible amortization $ 37,930 $ 35,755 $ 119,193 $ 72,124 Average stockholders’ equity $ 1,233,045 $ 1,155,056 $ 1,209,586 $ 1,139,871 Less: average goodwill and other intangibles 290,492 293,572 291,177 291,472 Average tangible common equity $ 942,553 $ 861,484 $ 918,409 $ 848,399 Net Interest Income Net interest income is the difference between interest income on earning assets, primarily loans and securities and interest expense on interest-bearing liabilities, primarily deposits and borrowings. Net interest income is affected by the interest rate spread, the difference between the yield on interest-earning assets and cost of interest-bearing liabilities, as well as the volumes of such assets and liabilities. Net interest income is one of the key determining factors in a financial institution’s performance as it is the principal source of earnings. 31 Table of Contents Net interest income was $77.7 million for the third quarter of 2021, down $1.5 million, or 1.9%, from the previous quarter. PPP loan interest and fees recognized into interest income for the three months ended September 30, 2021 was $2.9 million compared to $4.7 million for the previous quarter. The fully taxable equivalent (“FTE”) net interest margin was 2.88% for the three months ended September 30, 2021, a decrease of 12 bps from the previous quarter. Interest income decreased $1.8 million, or 2.2%, as the yield on average interest-earning assets decreased 13 bps from the prior quarter to 3.05%, while average interest-earning assets of $10.7 billion increased $96.4 million from the prior quarter, primarily due to an increase in short-term interest-bearing accounts due to higher levels of short-term interest bearing accounts (“excess liquidity”) and an increase in average investment securities. Interest expense was down $0.3 million, or 6.7%, as the cost of interest-bearing liabilities decreased 2 bps to 0.27% for the quarter ended September 30, 2021, driven by interest-bearing deposit costs decreasing 2 bps. Net interest income was $77.7 million for the third quarter of 2021, down $0.3 million, or 0.3%, from the third quarter of 2020. PPP loan interest and fees recognized into interest income for the three months ended September 30, 2021 was $2.9 million compared to $4.6 million for the third quarter of 2020. The FTE net interest margin was 2.88% for the three months ended September 30, 2021, a decrease of 29 bps from the third quarter of 2020. Interest income decreased $2.8 million, or 3.3%, as the yield on average interest-earning assets decreased 40 bps from the same period in 2020 to 3.05%, while average interest-earning assets of $10.7 billion increased $0.9 billion from the third quarter of 2020, primarily due to excess liquidity and an increase in average investment securities. Interest expense was down $2.5 million, or 35.6%, as the cost of interest-bearing liabilities decreased 18 bps to 0.27% for the quarter ended September 30, 2021, driven by interest-bearing deposit costs decreasing 14 bps along with a 53 bps decrease in short-term borrowings cost. Net interest income for the first nine months of 2021 was $235.9 million, up $0.3 million, or 0.1%, from the same period in 2020. PPP loan interest and fees recognized into interest income for the nine months ended September 30, 2021 was $13.8 million compared to $8.5 million for the same period in 2020. FTE net interest margin of 3.01% for the nine months ended September 30, 2021, was down from 3.35% for the same period in 2020. Interest income decreased $11.3 million, or 4.3%, as the yield on average interest-earning assets decreased 52 bps from the same period in 2020 to 3.20%, while average interest-earning assets of $10.5 billion increased $1.1 billion primarily due to excess liquidity and an increase in average investment securities. Interest expense was down $11.6 million, or 44.2%, for the nine months ended September 30, 2021 as compared to the same period in 2020 as the cost of interest-bearing liabilities decreased 27 bps to 0.30%, driven by interest-bearing deposit costs decreasing 25 bps along with a 87 bps decrease in short-term borrowings cost. The Federal Reserve lowered its target fed funds rate by 150 basis points in the first quarter of 2020. 32 Table of Contents Average Balances and Net Interest Income The following tables include the condensed consolidated average balance sheet, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest-bearing liabilities on a taxable equivalent basis. Three Months Ended September 30, 2021 September 30, 2020 (Dollars in thousands) Average Balance Interest Yield/ Rates Average Balance Interest Yield/ Rates Assets: Short-term interest-bearing accounts $ 1,014,120 $ 403 0.16 % $ 477,946 $ 130 0.11 % Securities available for sale (1) (3) 1,513,071 5,898 1.55 % 1,137,604 5,603 1.96 % Securities held to maturity (1) (3) 657,314 3,234 1.95 % 621,812 4,008 2.56 % Federal Reserve Bank and FHLB stock 25,154 121 1.91 % 29,720 529 7.08 % Loans (2) (3) 7,517,839 72,857 3.84 % 7,559,218 75,049 3.95 % Total interest-earning assets $ 10,727,498 $ 82,513 3.05 % $ 9,826,300 $ 85,319 3.45 % Other assets 1,019,797 967,194 Total assets $ 11,747,295 $ 10,793,494 Liabilities and stockholders’ equity: Money market deposit accounts $ 2,580,570 $ 1,266 0.19 % $ 2,364,606 $ 1,680 0.28 % NOW deposit accounts 1,442,678 183 0.05 % 1,207,064 144 0.05 % Savings deposits 1,691,539 219 0.05 % 1,447,021 192 0.05 % Time deposits 565,216 880 0.62 % 684,708 2,251 1.31 % Total interest-bearing deposits $ 6,280,003 $ 2,548 0.16 % $ 5,703,399 $ 4,267 0.30 % Short-term borrowings 99,703 28 0.11 % 277,890 446 0.64 % Long-term debt 14,029 89 2.52 % 64,137 398 2.47 % Subordinated debt 98,311 1,359 5.48 % 97,934 1,375 5.59 % Junior subordinated debt 101,196 517 2.03 % 101,196 565 2.22 % Total interest-bearing liabilities $ 6,593,242 $ 4,541 0.27 % $ 6,244,556 $ 7,051 0.45 % Demand deposits $ 3,676,883 $ 3,111,617 Other liabilities 244,125 282,265 Stockholders’ equity 1,233,045 1,155,056 Total liabilities and stockholders’ equity $ 11,747,295 $ 10,793,494 Net interest income (FTE) $ 77,972 $ 78,268 Interest rate spread 2.78 % 3.00 % Net interest margin (FTE) 2.88 % 3.17 % Taxable equivalent adjustment $ 298 $ 325 Net interest income $ 77,674 $ 77,943 (1) Securities are shown at average amortized cost. (2) For purposes of these computations, nonaccrual loans and loans held for sale are included in the average loan balances outstanding. (3) Interest income for tax-exempt securities and loans have been adjusted to a FTE basis using the statutory Federal income tax rate of 21%. 33 Table of Contents Nine Months Ended September 30, 2021 September 30, 2020 (Dollars in thousands) Average Balance Interest Yield/ Rates Average Balance Interest Yield/ Rates Assets: Short-term interest-bearing accounts $ 860,067 $ 763 0.12 % $ 311,577 $ 464 0.20 % Securities available for sale (1) (3) 1,438,117 17,204 1.60 % 1,028,962 16,956 2.20 % Securities held to maturity (1) (3) 623,284 10,237 2.20 % 619,379 12,562 2.71 % Federal Reserve Bank and FHLB stock 25,290 443 2.34 % 35,349 1,674 6.33 % Loans (2) (3) 7,555,276 222,821 3.94 % 7,437,566 231,168 4.15 % Total interest-earning assets $ 10,502,034 $ 251,468 3.20 % $ 9,432,833 $ 262,824 3.72 % Other assets 984,372 938,296 Total assets $ 11,486,406 $ 10,371,129 Liabilities and stockholders’ equity: Money market deposit accounts $ 2,557,172 $ 4,022 0.21 % $ 2,275,765 $ 8,646 0.51 % NOW deposit accounts 1,419,102 531 0.05 % 1,153,780 548 0.06 % Savings deposits 1,633,941 625 0.05 % 1,369,219 553 0.05 % Time deposits 590,385 3,404 0.77 % 762,548 8,436 1.48 % Total interest-bearing deposits $ 6,200,600 $ 8,582 0.19 % $ 5,561,312 $ 18,183 0.44 % Short-term borrowings 103,314 130 0.17 % 412,312 3,215 1.04 % Long-term debt 15,976 301 2.52 % 64,165 1,184 2.46 % Subordinated debt 98,204 4,077 5.55 % 35,750 1,503 5.62 % Junior subordinated debt 101,196 1,572 2.08 % 101,196 2,186 2.89 % Total interest-bearing liabilities $ 6,519,290 $ 14,662 0.30 % $ 6,174,735 $ 26,271 0.57 % Demand deposits $ 3,514,005 $ 2,800,297 Other liabilities 243,525 256,226 Stockholders’ equity 1,209,586 1,139,871 Total liabilities and stockholders’ equity $ 11,486,406 $ 10,371,129 Net interest income (FTE) $ 236,806 $ 236,553 Interest rate spread 2.90 % 3.15 % Net interest margin (FTE) 3.01 % 3.35 % Taxable equivalent adjustment $ 899 $ 983 Net interest income $ 235,907 $ 235,570 (1) Securities are shown at average amortized cost. (2) For purposes of these computations, nonaccrual loans and loans held for sale are included in the average loan balances outstanding. (3) Interest income for tax-exempt securities and loans have been adjusted to a FTE basis using the statutory Federal income tax rate of 21%. 34 Table of Contents The following table presents changes in interest income and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume) and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of change. Three Months Ended September 30, Increase (Decrease) 2021 over 2020 (In thousands) Volume Rate Total Short-term interest-bearing accounts $ 194 $ 79 $ 273 Securities available for sale 1,625 (1,330 ) 295 Securities held to maturity 221 (995 ) (774 ) Federal Reserve Bank and FHLB stock (71 ) (337 ) (408 ) Loans (375 ) (1,817 ) (2,192 ) Total FTE interest income $ 1,594 $ (4,400 ) $ (2,806 ) Money market deposit accounts $ 144 $ (558 ) $ (414 ) NOW deposit accounts 30 9 39 Savings deposits 32 (5 ) 27 Time deposits (341 ) (1,030 ) (1,371 ) Short-term borrowings (183 ) (235 ) (418 ) Long-term debt (317 ) 8 (309 ) Subordinated debt 6 (22 ) (16 ) Junior subordinated debt - (48 ) (48 ) Total FTE interest expense $ (629 ) $ (1,881 ) $ (2,510 ) Change in FTE net interest income $ 2,223 $ (2,519 ) $ (296 ) Nine Months Ended September 30, Increase (Decrease) 2021 over 2020 (In thousands) Volume Rate Total Short-term interest-bearing accounts $ 548 $ (249 ) $ 299 Securities available for sale 5,636 (5,388 ) 248 Securities held to maturity 78 (2,403 ) (2,325 ) Federal Reserve Bank and FHLB stock (383 ) (848 ) (1,231 ) Loans 3,560 (11,907 ) (8,347 ) Total FTE interest income $ 9,439 $ (20,795 ) $ (11,356 ) Money market deposit accounts $ 958 $ (5,582 ) $ (4,624 ) NOW deposit accounts 112 (129 ) (17 ) Savings deposits 102 (30 ) 72 Time deposits (1,613 ) (3,419 ) (5,032 ) Short-term borrowings (1,456 ) (1,629 ) (3,085 ) Long-term debt (908 ) 25 (883 ) Subordinated debt 2,592 (18 ) 2,574 Junior subordinated debt - (614 ) (614 ) Total FTE interest expense $ (213 ) $ (11,396 ) $ (11,609 ) Change in net FTE interest income $ 9,652 $ (9,399 ) $ 253 35 Table of Contents Noninterest Income Noninterest income is a significant source of revenue for the Company and an important factor in the Company’s results of operations. The following table sets forth information by category of noninterest income for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2021 2020 2021 2020 Service charges on deposit accounts $ 3,489 $ 3,087 $ 9,544 $ 9,613 ATM and debit card fees 8,172 7,194 23,343 19,184 Retirement plan administration fees 10,495 9,685 30,372 26,840 Wealth management fees 8,783 7,695 25,099 21,791 Insurance services 3,720 3,742 10,689 11,303 Bank owned life insurance 1,548 1,255 4,588 4,010 Net securities gains (losses) (100 ) 84 568 (548 ) Other 4,222 4,985 12,480 15,968 Total noninterest income $ 40,329 $ 37,727 $ 116,683 $ 108,161 Noninterest income for the three months ended September 30, 2021 was $40.3 million, up $1.0 million, or 2.6%, from the prior quarter and up $2.6 million, or 6.9%, from the third quarter of 2020. Excluding net securities gains (losses), noninterest income for the three months ended September 30, 2021 was $40.4 million, up $1.3 million, or 3.4%, from the prior quarter and up $2.8 million, or 7.4%, from the third quarter of 2020. The increase from the prior quarter was primarily driven by higher service charges on deposit accounts, higher retirement plan administration fees due to market performance and organic growth in relationships and higher wealth management fees driven by market performance and organic growth. The increase from the third quarter of 2020 was primarily due to higher ATM and debit card fees due to increased volume and higher per transaction rates, higher wealth management fees driven by market performance and organic growth, an increase in retirement plan administration fees driven by driven by market performance and organic growth, and higher service charges on deposit accounts due to lower overdraft charges during the COVID-19 pandemic, partly offset by lower swap fees and lower mortgage banking income. Noninterest income for the nine months ended September 30, 2021 was $116.7 million, up $8.5 million, or 7.9%, from the same period in 2020. Excluding net securities gains (losses), noninterest income for the nine months ended September 30, 2021 would have been $116.1 million, up $7.4 million, or 6.8%, from the same period in 2020. The increase from the prior year was primarily due to higher ATM and debit card fess due to increased volume and higher per transaction rates, higher wealth management fees driven by market performance and organic growth and an increase in retirement plan administration fees driven by the April 1, 2020 acquisition of Alliance Benefit Group of Illinois, Inc. (“ABG”), partly offset by lower swap fees and lower mortgage banking income. Noninterest Expense Noninterest expenses are also an important factor in the Company’s results of operations. The following table sets forth the major components of noninterest expense for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2021 2020 2021 2020 Salaries and employee benefits $ 44,190 $ 40,451 $ 128,462 $ 120,918 Occupancy 5,117 5,294 16,281 16,354 Data processing and communications 3,881 4,058 13,039 12,370 Professional fees and outside services 3,784 3,394 11,403 10,694 Equipment 5,577 5,073 16,247 14,494 Office supplies and postage 1,364 1,530 4,478 4,621 FDIC expense 772 645 2,243 1,949 Advertising 583 530 1,502 1,461 Amortization of intangible assets 663 856 2,157 2,573 Loan collection and other real estate owned, net 706 620 1,959 2,365 Other 6,232 3,857 14,405 14,730 Total noninterest expense $ 72,869 $ 66,308 $ 212,176 $ 202,529 Noninterest expense for the three months ended September 30, 2021 was $72.9 million, up $1.5 million, or 2.0%, from the prior quarter and up $6.6 million, or 9.9%, from the third quarter of 2020. The increase from the prior quarter was due to higher salaries and employee benefits due to one additional day of payroll in the third quarter, increased medical expenses and higher incentive compensation accruals. Other expenses increased due to $2.3 million in non-recurring costs, primarily from estimated litigation settlement costs related to a pending lawsuit regarding certain of the Company’s deposit products and related disclosures. The Company does not anticipate further material accruals related to this legal matter. The increase in noninterest expense from the third quarter of 2020 was due to higher salaries and employee benefits due to annual merit pay increases, increased medical expenses and higher incentive compensation accrual. Higher equipment expense due to higher technology costs associated with several digital upgrades. Other expenses increased due to $2.3 million in non-recurring costs, including the previously mentioned estimated litigation settlement costs. 36 Table of Contents Noninterest expense for the nine months ended September 30, 2021 was $212.2 million, up $9.6 million, or 4.8%, from the same period in 2020. The increase from the prior year was driven by higher salaries and employee benefits due to annual merit pay increases, the ABG acquisition and higher medical expenses, increase in data processing communication expense driven by continued investments in digital platform solutions including a PPP specific platform, an increase in professional fees and outside services as a result of projects paused during the COVID-19 pandemic, higher equipment expense due to higher technology costs associated with several digital upgrades. Income Taxes Income tax expense for the three months ended September 30, 2021 was $11.0 million, down $1.0 million from the prior quarter and up $0.1 million from the third quarter of 2020. The effective tax rate was 22.8% for the third quarter of 2021, 22.9% in the prior quarter and 23.8% for the third quarter of 2020. The lower effective tax rate compared to the third quarter of 2020 was due to the change in the level of taxable income to bring the nine months ended September 30, 2020 estimated effective tax rate to 21.75%. Income tax expense for the nine months ended September 30, 2021 was $34.2 million, up $14.9 million from the same period of 2020. The effective tax rate of 22.5% for the first nine months of 2021 was up from 21.5% for the same period in the prior year. The increase in income tax expense from the prior year was due to a higher level of taxable income as a result of the COVID-19 pandemic and decreased provision for loan losses. 37 Table of Contents ANALYSIS OF FINANCIAL CONDITION Securities Total securities increased $296.2 million, or 14.8%, from December 31, 2020 to September 30, 2021. The securities portfolio represented 19.1% of total assets as of September 30, 2021 as compared to 18.3% of total assets as of December 31, 2020. The following table details the composition of securities available for sale, securities held to maturity and equity securities for the periods indicated: September 30, 2021 December 31, 2020 Mortgage-backed securities: With maturities 15 years or less 20 % 21 % With maturities greater than 15 years 8 % 8 % Collateralized mortgage obligations 33 % 35 % Municipal securities 18 % 13 % U.S. agency notes 18 % 20 % Corporate 2 % 1 % Equity securities 1 % 2 % Total 100 % 100 % The Company’s mortgage-backed securities, U.S. agency notes and collateralized mortgage obligations are all guaranteed by Fannie Mae, Freddie Mac, Federal Home Loan Bank, Federal Farm Credit Banks or Ginnie Mae (“GNMA”). GNMA securities are considered similar in credit quality to U.S. Treasury securities, as they are backed by the full faith and credit of the U.S. government. Currently, there are no subprime mortgages in our investment portfolio. Loans A summary of loans, net of deferred fees and origination costs, by type (1) for the periods indicated follows: (In thousands) September 30, 2021 December 31, 2020 Commercial $ 1,466,597 $ 1,451,560 Commercial real estate 2,320,341 2,196,477 Paycheck protection program 276,195 430,810 Residential real estate 1,549,684 1,466,662 Indirect auto 873,860 931,286 Specialty lending 692,919 579,644 Home equity 339,316 387,974 Other consumer 47,530 54,472 Total loans $ 7,566,442 $ 7,498,885 (1) Loans are summarized by business line which do not align to how the Company assesses credit risk in the estimate for credit losses under CECL. Total loans increased by $67.6 million from December 31, 2020 to September 30, 2021. Total PPP loans as of September 30, 2021 were $276.2 million (net of unamortized fees). The following PPP loan activity occurred during the nine months ended September 30, 2021: $286.6 million in PPP loan originations, $449.8 million of loans forgiven and $13.8 million of interest and fees recognized into interest income. Excluding PPP loans, period end loans increased $222.2 million from December 31, 2020. Commercial and industrial loans increased $15.0 million to $1.5 billion; commercial real estate loans increased $123.9 million to $2.3 billion; and total consumer loans increased $83.3 million to $3.5 billion. Total loans represent approximately 63.1% of assets as of September 30, 2021, as compared to 68.6% as of December 31, 2020. Allowance for Loan Losses, Provision for Loan Losses and Nonperforming Assets Management considers the accounting policy relating to the allowance for credit losses to be a critical accounting policy given the degree of judgment exercised in evaluating the level of the allowance required to estimate expected credit losses over the expected contractual life of our loan portfolio and the material effect that such judgments can have on the consolidated results of operations. Required additions or reductions to the allowance for credit losses are made periodically by charges or credits to the provision for loan losses. These are necessary to maintain the allowance at a level which management believes is reasonably reflective of the overall loss expected over the contractual life of the loan portfolio. While management uses available information to recognize losses on loans, additions or reductions to the allowance may fluctuate from one reporting period to another. These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above. Management considers the allowance for credit losses to be appropriate based on evaluation and analysis of the loan portfolio. 38 Table of Contents The allowance for credit losses totaled $93.0 million at September 30, 2021, compared to $98.5 million at June 30, 2021 and $114.5 million at September 30, 2020. The allowance for credit losses as a percentage of loans was 1.23% (1.28% excluding PPP loans) at September 30, 2021, compared to 1.31% (1.38% excluding PPP loans) at June 30, 2021 and 1.51% (1.62% excluding PPP loans) at September 30, 2020. The decrease in the allowance for credit losses from June 30, 2021 and September 30, 2020 to September 30, 2021 was primarily due to the improved economic conditions in the CECL forecast. The provision for loan losses was a net benefit of $3.3 million for three months ended September 30, 2021, compared to a net benefit of $5.2 million in the prior quarter and a provision expense of $3.3 million for the same period in the prior year. Provision expense increased from the prior quarter due primarily to increased net charge-offs and higher reserves established due to change in loan mix, partly offset by continued improvement in economic conditions in the CECL forecast. Provision expense decreased from the same period in the prior year due primarily to the improved economic condition forecast in the current quarter as compared to deterioration of the economic forecast that took place at the end of the third quarter in 2020 due to COVID-19. Net charge-offs totaled $2.2 million during the three months ended September 30, 2021, compared to net charge-offs of $1.3 million during the second quarter of 2021 and $2.3 million in the third quarter of 2020. The provision for loan losses was a net benefit of $11.4 million for the nine months ended September 30, 2021, compared to a provision expense of $51.7 million for the nine months ended September 30, 2020. Provision expense decreased from the same period in the prior year due primarily to the improved economic condition forecast in the current quarter as compared to significant deterioration of the economic forecast that took place at the end of the nine months ended September 30, 2020 due to COVID-19. Net charge-offs totaled $5.6 million during the nine months ended September 30, 2021, compared to net charge-offs of $13.2 million during the nine months ended September 30, 2020. As of September 30, 2021, the unfunded commitment reserve totaled $5.3 million, compared to $5.8 million as of June 30, 2021 and $5.5 million as of September 30, 2020. Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due and still accruing, restructured loans, other real estate owned (“OREO”) and nonperforming securities. Loans are generally placed on nonaccrual when principal or interest payments become 90 days past due, unless the loan is well secured and in the process of collection. Loans may also be placed on nonaccrual when circumstances indicate that the borrower may be unable to meet the contractual principal or interest payments. The threshold for evaluating classified and nonperforming loans specifically evaluated for impairment is $1.0 million. OREO represents property acquired through foreclosure and is valued at the lower of the carrying amount or fair value, less any estimated disposal costs. September 30, 2021 December 31, 2020 (Dollars in thousands) Amount % Amount % Nonaccrual loans: Commercial $ 19,726 55 % $ 23,557 53 % Residential 10,139 28 % 13,082 29 % Consumer 1,585 5 % 3,020 7 % Troubled debt restructured loans 4,287 12 % 4,988 11 % Total nonaccrual loans $ 35,737 100 % $ 44,647 100 % Loans 90 days or more past due and still accruing: Commercial $ 441 15 % $ 493 16 % Residential 1,109 38 % 518 16 % Consumer 1,390 47 % 2,138 68 % Total loans 90 days or more past due and still accruing $ 2,940 100 % $ 3,149 100 % Total nonperforming loans $ 38,677 $ 47,796 OREO 859 1,458 Total nonperforming assets $ 39,536 $ 49,254 Total nonperforming loans to total loans 0.51 % 0.64 % Total nonperforming assets to total assets 0.33 % 0.45 % Allowance for loan losses to total nonperforming loans 240.45 % 230.14 % Total nonperforming assets were $ 39.5 million at September 30, 2021 , compared to $ 49.3 million at December 31, 2020 and $40.1 million at September 30, 2020 . Nonperforming loans at September 30, 2021 were $ 38.7 million, or 0.51% , of total loans (0.53% excluding PPP loan originations), compared with $ 47.8 million, or 0.64% of total loans (0.68% excluding PPP loan originations) at December 31, 2020 and $38.5 million, or 0.51% of total loans (0.55% excluding PPP loan originations) at September 30, 2020 . 39 Table of Contents Nonperforming loans were consistent compared to a year ago. Past due loans as a percentage of total loans was 0.46% at September 30, 2021 (0.48% excluding PPP loan originations), up from 0.37% at December 31, 2020 (0.39% excluding PPP loan originations) and up from 0.26% at September 30, 2020 (0.28% excluding PPP loan originations). The Company began offering short-term loan modifications to assist borrowers during the COVID-19 pandemic. The CARES Act, along with a joint agency statement issued by banking regulatory agencies, provides that short-term modifications made in response to COVID-19 do not need to be accounted for as a troubled debt restructuring (“TDR”). The Company evaluated the short-term modification programs provided to its borrowers and has concluded the modifications were generally made to borrowers who were in good standing prior to the COVID-19 pandemic and the modifications were temporary and minor in nature and therefore do not qualify for designation as TDRs. As of September 30, 2021, $2.0 million of total loans outstanding were in payment deferral programs, of which 71% are commercial borrowers and 29% are consumer borrowers. As of December 31, 2020, $106.0 million of total loans outstanding were in payment deferral programs, of which 80% were commercial borrowers and 20% were consumer borrowers. In addition to nonperforming loans discussed above, the Company has also identified approximately $105.7 million in potential problem loans at September 30, 2021 as compared to $136.6 million at December 31, 2020 and $117.7 million at September 30, 2020. The increase in potential problem loans from September 30, 2020 is primarily due to the Company’s proactive approach to risk ratings throughout the deferral process and relates to higher risk industries impacted by the COVID-19 pandemic. Higher risk industries include entertainment, restaurants, retail, healthcare and accommodations. As of September 30, 2021, 8.7% of the Company’s outstanding loans were in higher risk industries due to the COVID-19 pandemic. Potential problem loans are loans that are currently performing, with a possibility of loss if weaknesses are not corrected. Such loans may need to be disclosed as nonperforming at some time in the future. Potential problem loans are classified by the Company’s loan rating system as “substandard.” Management cannot predict the extent to which economic conditions may worsen or other factors, which may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured or require increased allowance coverage and provision for loan losses. To mitigate this risk the Company maintains a diversified loan portfolio, has no significant concentration in any particular industry and originates loans primarily within its footprint. Deposits Total deposits were $ 10.2 billion at September 30, 2021 , up $ 1.1 billion, or 12.3% , from December 31, 2020 . Total average deposits increased $ 1.4 billion, or 16.2% , from the same period last year. The growth was driven primarily by an increase of $ 713.7 million, or 25.5% , in demand deposits, combined with an increase in interest-bearing deposits of $ 639.3 million, or 11.5% , due to growth in money market deposit accounts (“MMDA”), NOW deposit accounts and savings deposit accounts, partly offset by a decrease in time accounts. The high rate of deposit growth was primarily due to funding of PPP loans and various government support programs. Borrowed Funds The Company’s borrowed funds consist of short-term borrowings and long-term debt. Short-term borrowings totaled $99.7 million at September 30, 2021 compared to $168.4 million at December 31, 2020. The notional value of interest rate swaps hedging cash flows related to short-term borrowings totaled $25.0 million at December 31, 2020 and matured during the nine months ended September 30, 2021. Long-term debt was $14.0 million at September 30, 2021 and $39.1 million at December 31, 2020. For more information about the Company’s borrowing capacity and liquidity position, see “Liquidity Risk” below. Subordinated Debt On June 23, 2020, the Company issued $100.0 million of 5.00% fixed-to-floating rate subordinated notes due 2030. The subordinated notes, which qualify as Tier 2 capital, bear interest at an annual rate of 5.00%, payable semi-annually in arrears commencing on January 1, 2021, and a floating rate of interest equivalent to the three-month Secured Overnight Financing Rate plus a spread of 4.85%, payable quarterly in arrears commencing on October 1, 2025. The subordinated debt issuance cost, which is being amortized on a straight-line basis, was $2.2 million. As of September 30, 2021 and December 31, 2020 the subordinated debt net of unamortized issuance costs was $98.4 million and $98.1 million, respectively. Capital Resources Stockholders’ equity of $1.2 billion represented 10.35% of total assets at September 30, 2021 compared with $1.2 billion, or 10.86% of total assets, as of December 31, 2020. Stockholders’ equity was consistent with December 31, 2020 as net income of $117.6 million for the nine months ending September 30, 2021 was offset by a decrease in accumulated other comprehensive income of $14.9 million, dividends declared of $35.6 million during the period and repurchase of common stock of $14.1 million. 40 Table of Contents The Company repurchased 119,342 shares of common stock during the third quarter of 2021 at a weighted average price of $35.30 per share excluding commissions under a previous announced plan. As of September 30, 2021, there were 1,600,000 shares available for repurchase under this plan authorized on October 28, 2019, amended on March 23, 2020 and January 27, 2021, and set to expire on December 31, 2021. The Board of Directors considers the Company’s capital levels, earnings position and earnings potential when making dividend decisions. The Board of Directors approved a fourth-quarter 2021 cash dividend of $0.28 per share at a meeting held on October 25, 2021. The dividend will be paid on December 15, 2021 to shareholders of record as of December 1, 2021. As the capital ratios in the following table indicate, the Company remained “well capitalized” at September 30, 2021 under applicable bank regulatory requirements. Capital measurements are well in excess of regulatory minimum guidelines and meet the requirements to be considered well capitalized for all periods presented. To be considered well capitalized, tier 1 leverage, common equity tier 1 capital, tier 1 capital and total risk-based capital ratios must be 5%, 6.5%, 8% and 10%, respectively. Capital Measurements September 30, 2021 December 31, 2020 Tier 1 leverage ratio 9.47 % 9.56 % Common equity tier 1 capital ratio 12.20 % 11.84 % Tier 1 capital ratio 13.39 % 13.09 % Total risk-based capital ratio 15.74 % 15.62 % Cash dividends as a percentage of net income 30.29 % 45.22 % Per common share: Book value $ 28.65 $ 27.22 Tangible book value (1) $ 21.95 $ 20.52 Tangible equity ratio (2) 8.13 % 8.41 % (1) Stockholders’ equity less goodwill and intangible assets divided by common shares outstanding. (2) Non-GAAP measure - Stockholders’ equity less goodwill and intangible assets divided by total assets less goodwill and intangible assets. In March 2020, the Office of the Comptroller of the Currency (“OCC”), the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (“FDIC”) announced an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. Under the modified CECL transition provision, the regulatory capital impact of the January 1, 2020 CECL adoption date adjustment to the allowance for credit losses (after-tax) has been deferred and will phase into regulatory capital at 25% per year commencing January 1, 2022. For the ongoing impact of CECL, the Company is allowed to defer the regulatory capital impact of the allowance for credit losses in an amount equal to 25% of the change in the allowance for credit losses (pre-tax) recognized through earnings for each period between January 1, 2020 and December 31, 2021. The cumulative adjustment to the allowance for credit losses between January 1, 2020 and December 31, 2021, will also phase into regulatory capital at 25% per year commencing January 1, 2022. The Company adopted the capital transition relief over the permissible five-year period. 41 Table of Contents Liquidity and Interest Rate Sensitivity Management Market Risk Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities or are immaterial to the results of operations. Interest rate risk is defined as an exposure to a movement in interest rates that could have an adverse effect on the Company’s net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than earning assets. When interest-bearing liabilities mature or reprice more quickly than earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income. To manage the Company’s exposure to changes in interest rates, management monitors the Company’s interest rate risk. Management’s Asset Liability Committee (“ALCO”) meets monthly to review the Company’s interest rate risk position and profitability and to recommend strategies for consideration by the Board of Directors. Management also reviews loan and deposit pricing and the Company’s securities portfolio, formulates investment and funding strategies and oversees the timing and implementation of transactions to assure attainment of the Board’s objectives in the most effective manner. Notwithstanding the Company’s interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income. In adjusting the Company’s asset/liability position, the Board and management aim to manage the Company’s interest rate risk while minimizing net interest margin compression. At times, depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin. The Company’s results of operations and net portfolio values remain vulnerable to changes in interest rates and fluctuations in the difference between long and short-term interest rates. The primary tool utilized by the ALCO to manage interest rate risk is earnings at risk modeling (interest rate sensitivity analysis). Information, such as principal balance, interest rate, maturity date, cash flows, next repricing date (if needed) and current rates are uploaded into the model to create an ending balance sheet. In addition, the ALCO makes certain assumptions regarding prepayment speeds for loans and mortgage related investment securities along with any optionality within the deposits and borrowings. The model is first run under an assumption of a flat rate scenario (i.e. no change in current interest rates) with a static balance sheet. Three additional models are run in which a gradual increase of 200 bps, a gradual increase of 100 bps and a gradual decrease of 50 bps takes place over a 12-month period with a static balance sheet. Under these scenarios, assets subject to prepayments are adjusted to account for faster or slower prepayment assumptions. Any investment securities or borrowings that have callable options embedded in them are handled accordingly based on the interest rate scenario. The resulting changes in net interest income are then measured against the flat rate scenario. The Company also runs other interest rate scenarios to highlight potential interest rate risk. In the declining rate scenario, net interest income is projected to decrease when compared to the forecasted net interest income in the flat rate scenario through the simulation period. The decrease in net interest income is a result of earning assets rolling over at lower yields while interest-bearing liabilities remain at or near their floors. In the rising rate scenarios, net interest income is projected to experience a modest increase from the flat rate scenario; however, the potential impact on earnings may be affected by the ability to lag deposit repricing on NOW, savings, MMDA and time accounts. Net interest income for the next twelve months in the +200/+100/-50 bp scenarios, as described above, is within the internal policy risk limits of not more than a 7.5% change in net interest income. The following table summarizes the percentage change in net interest income in the rising and declining rate scenarios over a 12-month period from the forecasted net interest income in the flat rate scenario using the September 30, 2021 balance sheet position: Interest Rate Sensitivity Analysis Change in interest rates (in bps points) Percent change in net interest income +200 6.93% +100 3.22% -50 (0.84%) The Company anticipates that the trajectory of net interest income will depend significantly on the timing and path of the recovery from the recent economic downturn. In response to the economic impact of the pandemic, the federal funds rate was reduced by 150 bps in March 2020, and term interest rates fell sharply across the yield curve. The Company has reduced deposit rates, but future reductions are likely to be smaller and more selective. With deposit rates near their lower bound, the Company will focus on managing asset yields in order to maintain the net interest margin. Competitive pressure may limit the Company’s ability to maintain asset yields in the current environment, however. 42 Table of Contents Liquidity Risk Liquidity involves the ability to meet the cash flow requirements of depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. ALCO is responsible for liquidity management and has developed guidelines, which cover all assets and liabilities, as well as off-balance sheet items that are potential sources or uses of liquidity. Liquidity policies must also provide the flexibility to implement appropriate strategies, regular monitoring of liquidity and testing of the contingent liquidity plan. Requirements change as loans grow, deposits and securities mature and payments on borrowings are made. Liquidity management includes a focus on interest rate sensitivity management with a goal of avoiding widely fluctuating net interest margins through periods of changing economic conditions. The primary liquidity measurement the Company utilizes is called “Basic Surplus,” which captures the adequacy of its access to reliable sources of cash relative to the stability of its funding mix of average liabilities. This approach recognizes the importance of balancing levels of cash flow liquidity from short and long-term securities with the availability of dependable borrowing sources, which can be accessed when necessary. At September 30, 2021, the Company’s Basic Surplus measurement was 29.4% of total assets or approximately $3.5 billion as compared to the December 31, 2020 Basic Surplus of 25.7% or $2.8 billion and was above the Company’s minimum of 5% (calculated at $599.7 million and $546.6 million, of period end total assets as September 30, 2021 and December 31, 2020, respectively) set forth in its liquidity policies. At September 30, 2021 and December 31, 2020, Federal Home Loan Bank (“FHLB”) advances outstanding totaled $14.0 million and $64.1 million, respectively. At September 30, 2021 and December 31, 2020, the Bank had $130.0 million and $74.0 million, respectively, of collateral encumbered by municipal letters of credit. The Bank is a member of the FHLB system and had additional borrowing capacity from the FHLB of approximately $1.7 billion at September 30, 2021 and $1.6 billion at December 31, 2020. In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $901.2 million and $839.4 million at September 30, 2021 and December 31, 2020, respectively, or used to collateralize other borrowings, such as repurchase agreements. The Company also has the ability to issue brokered time deposits and to borrow against established borrowing facilities with other banks (federal funds), which could provide additional liquidity of $2.0 billion at September 30, 2021 and $1.8 billion at December 31, 2020. In addition, the Bank has a “Borrower-in-Custody” program with the FRB with the addition of the ability to pledge automobile loans as collateral. At September 30, 2021 and December 31, 2020, the Bank had the capacity to borrow $588.3 million and $ 658.1 million, respectively, from this program. The Company’s internal policies authorize borrowing up to 25% of assets. Under this policy, remaining available borrowing capacity totaled $2.8 billion at September 30, 2021 and $2.6 billion at December 31, 2020. This Basic Surplus approach enables the Company to appropriately manage liquidity from both operational and contingency perspectives. By tempering the need for cash flow liquidity with reliable borrowing facilities, the Company is able to operate with a more fully invested and, therefore, higher interest income generating securities portfolio. The makeup and term structure of the securities portfolio is, in part, impacted by the overall interest rate sensitivity of the balance sheet. Investment decisions and deposit pricing strategies are impacted by the liquidity position. The Company considered its Basic Surplus position to be strong. However, certain events may adversely impact the Company’s liquidity position in 2021. The large inflow of deposits experienced in the second quarter of 2020 could reverse itself and flow out. In the current economic environment, draws against lines of credit could drive asset growth higher. Disruptions in wholesale funding markets could spark increased competition for deposits. These scenarios could lead to a decrease in the Company’s Basic Surplus measure below the minimum policy level of 5%. Significant monetary and fiscal policy actions taken by the federal government have helped to mitigate these risks. Enhanced liquidity monitoring was put in place to quickly respond to the changing environment during the COVID-19 pandemic including increasing the frequency of monitoring and adding additional sources of liquidity. At September 30, 2021, a portion of the Company’s loans and securities were pledged as collateral on borrowings. Therefore, once on-balance-sheet liquidity is depleted, future growth of earning assets will depend upon the Company’s ability to obtain additional funding, through growth of core deposits and collateral management and may require further use of brokered time deposits or other higher cost borrowing arrangements. The Company’s primary source of funds is the Bank. Certain restrictions exist regarding the ability of the subsidiary bank to transfer funds to the Company in the form of cash dividends. The approval of the OCC is required to pay dividends when a bank fails to meet certain minimum regulatory capital standards or when such dividends are in excess of a subsidiary bank’s earnings retained in the current year plus retained net profits for the preceding two years as specified in applicable OCC regulations. At September 30, 2021, approximately $193.0 million of the total stockholders’ equity of the Bank was available for payment of dividends to the Company without approval by the OCC. The Bank’s ability to pay dividends is also subject to the Bank being in compliance with regulatory capital requirements. The Bank is currently in compliance with these requirements. Under the State of Delaware General Corporation Law, the Company may declare and pay dividends either out of accumulated net retained earnings or capital surplus. 43 Table of Contents Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information called for by Item 3 is contained in the Liquidity and Interest Rate Sensitivity Management section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.