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, 2021 for an understanding of the following discussion and analysis. Operating results for the three month period ending March 31, 2022 are not necessarily indicative of the results of the full year ending December 31, 2022 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, including international military conflicts, 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. 30 Table of Contents 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, treatment developments, public adoption rates of COVID-19 vaccines, including booster shots, and their effectiveness against emerging variants of COVID-19, the impact of the COVID-19 pandemic 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, 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, 2021 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. 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 and Estimates 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 credit losses for loans, as reported in our consolidated statements of financial condition, is adjusted by an expense for credit losses, which is recognized in earnings, and reduced by the charge-off of loan amounts, net of recoveries. 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. 31 Table of Contents Management of the Company considers the accounting policy relating to the allowance for credit losses to be a critical accounting estimate 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. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws. Quarterly, a review of income tax expense and the carrying value of deferred tax assets and liabilities is performed and balances are adjusted as appropriate. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions. Although management believes that the assumptions and judgments used to record tax-related assets or liabilities have been reasonable and appropriate, actual results could differ and we may be exposed to losses or gains that could be material. Should tax laws change or the taxing authorities during their examinations determine that their assumptions differ from management’s and we do not prevail in a dispute over interpretations of tax laws, an adjustment may be required which could have a material effect on the Company’s results of operations. 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 2021 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 2021 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 2022 and 2021 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 months ended March 31, 2022: ● net income for the three months ended March 31, 2022 was $39.1 million, up $1.8 million from the fourth quarter of 2021 and down $0.7 million from the first quarter of 2021; ● diluted earnings per share of $0.90 for the three months ended March 31, 2022, up $0.04 from the fourth quarter of 2021 and down $0.01 from the first quarter of 2021; ● noninterest income for the three months ended March 31, 2022 was $42.7 million, up $1.5 million from the fourth quarter of 2021 and up $5.6 million from the first quarter of 2021; represents 35% of total revenues; ● period end loans were $7.6 billion, up 8%, annualized, from December 31, 2021 (11% excluding Paycheck Protection Program (“PPP”) loans); ● strong credit quality metrics including net charge-offs to average loans of 0.14% annualized, and allowance for loan losses to total loans at 1.18%; ● book value per share of $27.96 at March 31, 2022; tangible book value per share (1) was $21.25 at March 31, 2022, $22.26 at December 31, 2021 and $20.71 at March 31, 2021. (1) Non-GAAP measure - Refer to non-GAAP reconciliation below. 32 Table of Contents COVID-19 Pandemic The COVID-19 pandemic and countermeasures taken to contain its spread have caused economic and financial disruptions globally. The impact of the COVID-19 pandemic on the Company’s results of operations and the ultimate effect of the 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 and any variants, 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 pandemic appears to be slowly receding, and thus becoming less disruptive on the Company's business, financial condition, results of operations, and its clients as of March 31, 2022. However, economic uncertainty remains high and volatility is expected to continue in 2022. The Company believes its historically strong underwriting practices, diverse and granular portfolios and geographic footprint will help to mitigate any adverse impact to the Company. The Company has participated in the Small Business Administration’s (“SBA”) PPP, a loan guarantee program created under the CARES Act and the Consolidated Appropriation 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 SBA, whose guarantee is backed by the full faith and credit of the United States government. 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 6,100 loans totaling $835 million in relief. The Company is supporting the forgiveness process under the PPP with online resources, educational webinars and a partnership with a certified public accounting firm. As of March 31, 2022, the Company has received payment from the SBA on 5,479 of our loans totaling $754 million and total forgiveness and paydown is equal to 94% of the original balance. Results of Operations The Company reported net income of $39.1 million for the three months ended March 31, 2022, up $1.8 million from the fourth quarter of 2021 and down $0.7 million from the first quarter of 2021. Net interest income was $80.3 million for the three months ended March 31, 2022, down $4.8 million, or 5.7%, from the fourth quarter of 2021 and up $1.3 million or 1.6% from the first quarter of 2021. Average interest-earning assets were up $71.9 million, or 0.7%, from the prior quarter and grew $0.9 billion, or 9.3%, from the first quarter of 2021. The provision for loan losses was $0.6 million for the three months ended March 31, 2022, as compared with $3.1 million in the fourth quarter of 2021 and a net benefit of $2.8 million in the first quarter of 2021. 33 Table of Contents The following table sets forth certain financial highlights: Three Months Ended March 31, 2022 December 31, 2021 March 31, 2021 Performance: Diluted earnings per share $ 0.90 $ 0.86 $ 0.91 Return on average assets (2) 1.32 % 1.23 % 1.46 % Return on average equity (2) 12.78 % 11.89 % 13.57 % Return on average tangible common equity (2) 16.87 % 15.70 % 18.24 % Net interest margin, fully taxable equivalent (“FTE”) (2) 2.95 % 3.08 % 3.17 % Capital: Equity to assets 9.90 % 10.41 % 10.32 % Tangible equity ratio 7.70 % 8.20 % 8.00 % Book value per share $ 27.96 $ 28.97 $ 27.43 Tangible book value per share $ 21.25 $ 22.26 $ 20.71 Leverage ratio 9.52 % 9.41 % 9.60 % Common equity tier 1 capital ratio 12.23 % 12.25 % 12.13 % Tier 1 capital ratio 13.39 % 13.43 % 13.38 % Total risk-based capital ratio 15.64 % 15.73 % 15.92 % The following tables provide non-GAAP reconciliations: Three Months Ended (In thousands) March 31, 2022 December 31, 2021 March 31, 2021 Net income $ 39,126 $ 37,310 $ 39,846 Amortization of intangible assets (net of tax) 477 488 609 Net income, excluding intangible amortization $ 39,603 $ 37,798 $ 40,455 Average stockholders’ equity $ 1,241,188 $ 1,244,751 $ 1,191,280 Less: average goodwill and other intangibles 289,218 289,834 291,921 Average tangible common equity $ 951,970 $ 954,917 $ 899,359 Return on average tangible common equity (2) 16.87 % 15.70 % 18.24 % Three Months Ended (In thousands) March 31, 2022 December 31, 2021 March 31, 2021 Stockholder’s equity $ 1,202,250 $ 1,250,453 $ 1,190,981 Intangibles 288,832 289,468 291,464 Assets $ 12,147,833 $ 12,012,111 $ 11,537,253 Tangible equity ratio 7.70 % 8.20 % 8.00 % Three Months Ended (In thousands, except share and per share data) March 31, 2022 December 31, 2021 March 31, 2021 Stockholder’s equity $ 1,202,250 $ 1,250,453 $ 1,190,981 Intangibles 288,832 289,468 291,464 Tangible equity $ 913,418 $ 960,985 $ 899,517 Diluted common shares outstanding 42,992 43,168 43,425 Tangible book value $ 21.25 $ 22.26 $ 20.71 (2) Annualized. 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. 34 Table of Contents Net interest income was $80.3 million for the first quarter of 2022, down $4.8 million, or 5.7%, from the previous quarter. PPP loan interest and fees recognized into interest income for the three months ended March 31, 2022 was $2.0 million compared to $7.5 million for the previous quarter. The FTE net interest margin was 2.95% for the three months ended March 31, 2022, a decrease of 13 bps from the previous quarter. Interest income decreased $5.1 million, or 5.7%, as the yield on average interest-earning assets decreased 14 bps from the prior quarter to 3.09%, while average interest-earning assets of $11.1 billion increased $71.9 million from the prior quarter, primarily due to an increase in average investment securities partly offset by a decrease in short-term interest-bearing accounts (“excess liquidity”). Interest expense was down $0.3 million, or 6.6%, as the cost of interest-bearing liabilities decreased 1 bps to 0.23% for the quarter ended March 31, 2022, driven by interest-bearing deposit costs decreasing 2 bps. Net interest income was $80.3 million for the first quarter of 2022, up $1.3 million, or 1.6%, from the first quarter of 2021. PPP loan interest and fees recognized into interest income for the three months ended March 31, 2022 was $2.0 million compared to $6.2 million for the three months ended March 31, 2021. The FTE net interest margin was 2.95% for the three months ended March 31, 2022, a decrease of 22 bps from the first quarter of 2021. Interest income decreased $0.1 million, or 0.1%, as the yield on average interest-earning assets decreased 29 bps from the same period in 2021 to 3.09%, while average interest-earning assets increased $0.9 billion, or 9.3%, from the first quarter of 2021, primarily due to excess liquidity and an increase in average investment securities. Interest expense decreased $1.4 million, or 26.7%, as the cost of interest-bearing liabilities decreased 11 bps to 0.23% for the quarter ended March 31, 2022, driven by interest-bearing deposit costs decreasing 10 bps. 35 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 March 31, 2022 December 31, 2021 March 31, 2021 (Dollars in thousands) Average Balance Interest Yield/ Rates Average Balance Interest Yield/ Rates Average Balance Interest Yield/ Rates Assets: Short-term interest-bearing accounts $ 990,319 $ 403 0.17 % $ 1,145,794 $ 465 0.16 % $ 587,358 $ 136 0.09 % Securities taxable (1) 2,284,578 9,407 1.67 % 2,081,796 8,251 1.57 % 1,768,945 7,931 1.82 % Securities tax-exempt (1)(3) 258,513 1,172 1.84 % 257,320 1,199 1.85 % 184,842 1,259 2.76 % Federal Reserve Bank and FHLB stock 25,026 122 1.98 % 25,149 174 2.74 % 25,606 155 2.45 % Loans (2)(3) 7,530,674 73,382 3.95 % 7,507,165 79,510 4.20 % 7,574,337 75,131 4.02 % Total interest-earning assets $ 11,089,110 $ 84,486 3.09 % $ 11,017,224 $ 89,599 3.23 % $ 10,141,088 $ 84,612 3.38 % Other assets 947,578 982,136 960,994 Total assets $ 12,036,688 $ 11,999,360 $ 11,102,082 Liabilities and stockholders’ equity: Money market deposit accounts $ 2,720,338 $ 1,022 0.15 % $ 2,678,477 $ 1,095 0.16 % $ 2,484,120 $ 1,391 0.23 % NOW deposit accounts 1,583,091 192 0.05 % 1,551,846 207 0.05 % 1,358,955 169 0.05 % Savings deposits 1,794,549 143 0.03 % 1,725,004 204 0.05 % 1,547,983 195 0.05 % Time deposits 494,632 485 0.40 % 537,875 626 0.46 % 615,343 1,417 0.93 % Total interest-bearing deposits $ 6,592,610 $ 1,842 0.11 % $ 6,493,202 $ 2,132 0.13 % $ 6,006,401 $ 3,172 0.21 % Federal funds purchased - - - 65 - - - - - Repurchase agreements 72,768 16 0.09 % 97,389 28 0.11 % 109,904 44 0.16 % Short-term borrowings - - - 1 - - 5,278 26 2.00 % Long-term debt 13,979 87 2.52 % 14,004 88 2.49 % 19,913 124 2.53 % Subordinated debt 98,531 1,359 5.59 % 98,422 1,360 5.48 % 98,095 1,359 5.62 % Junior subordinated debt 101,196 549 2.20 % 101,196 518 2.03 % 101,196 530 2.12 % Total interest-bearing liabilities $ 6,879,084 $ 3,853 0.23 % $ 6,804,279 $ 4,126 0.24 % $ 6,340,787 $ 5,255 0.34 % Demand deposits 3,710,124 3,719,070 3,319,024 Other liabilities 206,292 231,260 250,991 Stockholders’ equity 1,241,188 1,244,751 1,191,280 Total liabilities and stockholders’ equity $ 12,036,688 $ 11,999,360 $ 11,102,082 Net interest income (FTE) $ 80,633 $ 85,473 $ 79,357 Interest rate spread 2.86 % 2.99 % 3.04 % Net interest margin (FTE) 2.95 % 3.08 % 3.17 % Taxable equivalent adjustment $ 285 $ 292 $ 302 Net interest income $ 80,348 $ 85,181 $ 79,055 (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%. 36 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 March 31, Increase (Decrease) 2022 over 2021 (In thousands) Volume Rate Total Short-term interest-bearing accounts $ 127 $ 140 $ 267 Securities taxable 2,164 (688 ) 1,476 Securities tax-exempt 411 (498 ) (87 ) Federal Reserve Bank and FHLB stock (3 ) (30 ) (33 ) Loans (431 ) (1,318 ) (1,749 ) Total FTE interest income $ 2,268 $ (2,394 ) $ (126 ) Money market deposit accounts $ 123 $ (492 ) $ (369 ) NOW deposit accounts 27 (4 ) 23 Savings deposits 28 (80 ) (52 ) Time deposits (237 ) (695 ) (932 ) Repurchase agreements (12 ) (16 ) (28 ) Short-term borrowings (13 ) (13 ) (26 ) Long-term debt (37 ) - (37 ) Subordinated debt 6 (6 ) - Junior subordinated debt - 19 19 Total FTE interest expense $ (115 ) $ (1,287 ) $ (1,402 ) Change in FTE net interest income $ 2,383 $ (1,107 ) $ 1,276 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 March 31, (In thousands) 2022 2021 Service charges on deposit accounts $ 3,688 $ 3,027 Card services income 8,695 7,550 Retirement plan administration fees 13,279 10,098 Wealth management 8,640 7,910 Insurance services 3,788 3,461 Bank owned life insurance 1,654 1,381 Net securities (losses) gains (179 ) 467 Other 3,094 3,144 Total noninterest income $ 42,659 $ 37,038 Noninterest income for the three months ended March 31, 2022 was $42.7 million, up $1.5 million, or 3.8%, from the prior quarter and up $5.6 million, or 15.2%, from the first quarter of 2021. Excluding net securities (losses) gains, noninterest income for the three months ended March 31, 2022 was $42.8 million, up $1.7 million, or 4.2% from the prior quarter and up $6.3 million, or 17.1% from the first quarter of 2021. The increase from the prior quarter was primarily driven by an increase in retirement plan administration fees driven by higher activity-based fees, continued organic growth as well as the impact of positive equity market returns over the past year. The increase from the first quarter of 2021 was primarily due to an increase in retirement plan administration fees driven by higher activity-based fees, continued organic growth as well as the impact of positive equity market returns over the past year, higher wealth management fees aided by market performance and additional new customers, higher card services income due to increased volume and higher per transaction rates and higher service charges on deposit accounts as the volume of transactions has normalized to near pre-pandemic levels. 37 Table of Contents 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 March 31, (In thousands) 2022 2021 Salaries and employee benefits $ 45,508 $ 41,601 Technology and data services 8,547 8,892 Occupancy 6,793 6,889 Professional fees and outside services 4,276 3,589 Office supplies and postage 1,424 1,499 FDIC expenses 802 808 Advertising 654 451 Amortization of intangible assets 636 812 Loan collection and other real estate owned, net 384 590 Other 3,119 2,757 Total noninterest expense $ 72,143 $ 67,888 Noninterest expense for the three months ended March 31, 2022 was $72.1 million, down $3.0 million, or 3.9%, from the prior quarter and up $4.3 million, or 6.3%, from the first quarter of 2021. The decrease from the prior quarter was primarily driven by lower other expenses due principally to the seasonal timing of certain items, lower professional fees and outside services due to timing of cost associated with several digital and other technology-related initiatives, lower loan collection and other real estate owned due to the gain on the sale of a property in the first quarter of 2022 and a write-down of a property in the prior quarter. The decrease from the prior quarter was partly offset by the increase in salaries and employee benefits due to seasonally higher payroll taxes and stock-based compensation expenses, partly offset by two less payroll days. The increase from the first quarter of 2021 was due to higher salaries and employee benefits due to increased salaries and wages including merit pay increases and higher levels of incentive compensation and higher professional fees and outside services due to timing of cost associated with several digital and other technology-related initiatives. Income Taxes Income tax expense for the three months ended March 31, 2022 was $11.1 million, up $0.4 million from the prior quarter and comparable to the first quarter of 2021. The effective tax rate was 22.2% for the first quarter of 2022 compared to 22.4% for the fourth quarter of 2021 and 21.9% for the first quarter of 2021. 38 Table of Contents ANALYSIS OF FINANCIAL CONDITION Securities Total securities increased $136.1 million, or 5.5%, from December 31, 2021 to March 31, 2022. The securities portfolio represents 21.3% of total assets as of March 31, 2022 as compared to 20.4% of total assets as of December 31, 2021. The following table details the composition of securities available for sale, securities held to maturity and regulatory investments for the periods indicated: March 31, 2022 December 31, 2021 Mortgage-backed securities: With maturities 15 years or less 15 % 18 % With maturities greater than 15 years 12 % 8 % Collateral mortgage obligations 34 % 34 % Municipal securities 16 % 17 % U.S. agency notes 20 % 20 % Corporate 2 % 2 % Equity securities 1 % 1 % 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, the 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 the loan portfolio by major categories (1) , net of deferred fees and origination costs, for the periods indicated follows: (In thousands) March 31, 2022 December 31, 2021 Commercial $ 1,214,834 $ 1,155,240 Commercial real estate 2,709,611 2,655,367 Paycheck protection program 50,977 101,222 Residential real estate 1,584,551 1,571,232 Indirect auto 890,643 859,454 Specialty lending 835,546 778,291 Home equity 319,180 330,357 Other consumer 44,484 47,296 Total loans $ 7,649,826 $ 7,498,459 (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 $151.4 million, or 8.2% annualized, from December 31, 2021 to March 31, 2022. Total PPP loans as of March 31, 2022 were $51.0 million (net of unamortized fees). The following PPP loan activity occurred during three months ended March 31, 2022; there were no PPP loan originations, $48.4 million of loans forgiven and $2.0 million of interest and fees recognized into interest income. Excluding PPP loans, period end loans increased $201.6 million from December 31, 2021. Commercial and industrial loans increased $59.6 million to $1.2 billion; commercial real estate loans increased $54.2 million to $2.7 billion; and total consumer loans increased $87.8 million to $3.7 billion. Total loans represent approximately 63.0% of assets as of March 31, 2022, as compared to 62.4% as of December 31, 2021. Allowance for Credit 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. The CECL approach requires an estimate of the credit losses expected over the life of a loan (or pool of loans). It replaces the incurred loss approach’s threshold that required recognition of a credit loss when it was probable a loss event was incurred. The allowance for credit losses is a valuation account that is deducted from, or added to, the loans’ amortized cost basis to present the net, lifetime amount expected to be collected on the loans. Loan losses are charged off against the allowance when management believes a loan balance is confirmed to be uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. 39 Table of Contents 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. Management estimates the allowance balance using relevant available information, from internal and external sources, related to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Company historical loss experience was supplemented with peer information when there was insufficient loss data for the Company. Significant management judgment is required at each point in the measurement process. The allowance for credit losses is measured on a collective (pool) basis, with both a quantitative and qualitative analysis that is applied on a quarterly basis, when similar risk characteristics exist. The respective quantitative allowance for each segment is measured using an econometric, discounted PD/LGD modeling methodology in which distinct, segment-specific multi-variate regression models are applied to multiple, probabilistically weighted external economic forecasts. Under the discounted cash flows methodology, expected credit losses are estimated over the effective life of the loans by measuring the difference between the net present value of modeled cash flows and amortized cost basis. After quantitative considerations, management applies additional qualitative adjustments so that the allowance for credit loss is reflective of the estimate of lifetime losses that exist in the loan portfolio at the balance sheet date. Portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for credit losses. Upon adoption of CECL, management revised the manner in which loans were pooled for similar risk characteristics. Management developed segments for estimating loss based on type of borrower and collateral which is generally based upon federal call report segmentation and have been combined or subsegmented as needed to ensure loans of similar risk profiles are appropriately pooled. Additional information about our Allowance for Loan Losses is included in Note 5 to the consolidated financial statements. The Company’s management considers the allowance for credit losses to be appropriate based on evaluation and analysis of the loan portfolio. The allowance for credit losses totaled $90.0 million at March 31, 2022, compared to $92.0 million at December 31, 2021 and $105.0 million at March 31, 2021. The allowance for credit losses as a percentage of loans was 1.18% (1.18% excluding PPP loans) at March 31, 2022, compared to 1.23% (1.24% excluding PPP loans) at December 31, 2021 and 1.38% (1.48% excluding PPP loans) at March 31, 2021. The allowance for credit losses was 324.25% of nonperforming loans at March 31, 2022, compared to 280.98% at December 31, 2021 and 230.50% at March 31, 2021. The allowance for credit losses was 348.68% of nonaccrual loans at March 31, 2022, compared to 303.78% of nonaccrual loans at December 31, 2021 and compared to 241.94% at March 31, 2021. The decrease in allowance for credit losses from December 31, 2021 and March 31, 2021 to March 31, 2022 was primarily due to the improved economic conditions in the CECL forecast, partly offset by providing for the increase in loan balances. The provision for loan losses was $0.6 million for three months ended March 31, 2022, compared to $3.1 million in the prior quarter and a net benefit of $2.8 million for the same period in the prior year. Provision expense decreased from the prior quarter due to reductions in the reserve due to improved economic conditions in the CECL forecast, partly offset by providing for the increase in loan balances and a decline in net charge-offs in the current quarter. Provision expense increased from the same period in the prior year due primarily to the stable economic condition forecast in the current quarter as compared to improvements in the significantly deteriorated economic conditions that took place at the end of first quarter in 2020 due to COVID-19. Net charge-offs totaled $2.6 million during the three months ended March 31, 2022, compared to net charge-offs of $4.1 million during the fourth quarter of 2021 and $2.2 million in the first quarter of 2021. Net charge-offs to average loans was 14 bps for the three months ended March 31, 2022, compared to 22 bps for the fourth quarter of 2021 and 12 bps for the three months ended March 31, 2021. As of March 31, 2022, the unfunded commitment reserve totaled $4.8 million, compared to $5.1 million as of December 31, 2021 and $5.9 million as of March 31, 2021. Nonperforming assets consist of nonaccrual loans, loans over 90 days 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. 40 Table of Contents March 31, 2022 December 31, 2021 (Dollars in thousands) Amount % Amount % N onaccrual loans: Commercial $ 15,505 60 % $ 15,942 53 % Residential 5,530 22 % 8,862 29 % Consumer 1,906 7 % 1,511 5 % Troubled debt restructured loans 2,871 11 % 3,970 13 % Total nonaccrual loans $ 25,812 100 % $ 30,285 100 % Loans over 90 days past due and still accruing: Commercial $ - - $ - - Residential 562 29 % 808 33 % Consumer 1,382 71 % 1,650 67 % Total loans over 90 days past due and still accruing $ 1,944 100 % $ 2,458 100 % Total nonperforming loans $ 27,756 $ 32,743 OREO - 167 Total nonperforming assets $ 27,756 $ 32,910 Total nonaccrual loans to total loans 0.34 % 0.40 % Total nonperforming loans to total loans 0.36 % 0.44 % Total nonperforming assets to total assets 0.23 % 0.27 % Total allowance for loan losses to total nonperforming loans 324.25 % 280.98 % Total allowance for loan losses to nonaccrual loans 348.68 % 303.78 % Total nonperforming assets were $27.8 million at March 31, 2022, compared to $32.9 million at December 31, 2021 and $46.9 million at March 31, 2021. Nonperforming loans at March 31, 2022 were $27.8 million, or 0.36% of total loans (0.37% excluding PPP loan originations), compared with $32.7 million, or 0.44% of total loans (0.44% excluding PPP loan originations) at December 31, 2021 and $45.6 million, or 0.60% of total loans (0.64% excluding PPP loan originations) at March 31, 2021. The decrease in nonperforming loans primarily resulted from a reduction in commercial and residential mortgage nonaccrual loans. Total nonaccrual loans were $25.8 million or 0.33% of total loans at March 31, 2022, compared to $30.3 million or 0.40% of total loans at December 31, 2021 and compared to $43.4 million or 0.57% of total loans at March 31, 2021. Past due loans as a percentage of total loans was 0.24% at March 31, 2022 (0.25% excluding PPP loan originations), down from 0.29% at December 31, 2021 (0.29% excluding PPP loan originations) and up slightly from 0.22% at March 31, 2021 (0.23% excluding PPP loan originations). In addition to nonperforming loans discussed above, the Company has also identified approximately $66.7 million in potential problem loans at March 31, 2022 as compared to $74.9 million at December 31, 2021 and $136.7 million at March 31, 2021. 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.” The decrease in potential problem loans from March 31, 2021 is primarily due to the improved economic conditions which resulted in loans coming off deferral and returning to payment. Higher risk industries include entertainment, restaurants, retail, healthcare and accommodations. As of March 31, 2022, 8.8% of the Company’s outstanding loans were in higher risk industries due to the COVID-19 pandemic. 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 over 90 days 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 $10.5 billion at March 31, 2022, up $227.2 million, or 2.2%, from December 31, 2021. Total average deposits increased $1.0 billion, or 10.5%, from the same period last year. The growth was driven primarily by an increase of $391.1 million, or 11.8%, in demand deposits, combined with an increase in interest-bearing deposits of $586.2 million, or 9.8%, due to growth in money market deposit account (“MMDA”), NOW deposit account 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. 41 Table of Contents Borrowed Funds The Company’s borrowed funds consist of short-term borrowings and long-term debt. Short-term borrowings totaled $65.0 million at March 31, 2022 compared to $97.8 million at December 31, 2021. Long-term debt was $14.0 million at March 31, 2022 and December 31, 2021. 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 (“SOFR”) 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 March 31, 2022 and December 31, 2021 the subordinated debt net of unamortized issuance costs was $98.6 million and $98.5 million, respectively. Capital Resources Stockholders’ equity of $1.2 billion represented 9.90% of total assets at March 31, 2022 compared with $1.3 billion, or 10.41% of total assets, as of December 31, 2021. Stockholders’ equity decreased $48.2 million from December 31, 2021 as net income of $39.1 million for the three months ending March 31, 2022 was offset by a decrease in accumulated other comprehensive income of $68.0 million due to the change in the market value of securities available for sale, dividends declared of $12.1 million during the period and repurchase of common stock of $8.2 million. The deferred tax asset related to the unrealized losses in investment securities decreased $22.8 million from December 31, 2021. The Company purchased 217,100 shares of its common stock during the first quarter of 2022 at an average price of $37.55 per share under its previously announced share repurchase program. As of March 31, 2022, there were 1,782,900 shares available for repurchase under this plan authorized on December 20, 2021 and set to expire on December 31, 2023. As the capital ratios in the following table indicate, the Company remained “well capitalized” at March 31, 2022 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 March 31, 2022 December 31, 2021 Tier 1 leverage ratio 9.52 % 9.41 % Common equity tier 1 capital ratio 12.23 % 12.25 % Tier 1 capital ratio 13.39 % 13.43 % Total risk-based capital ratio 15.64 % 15.73 % Cash dividends as a percentage of net income 30.88 % 30.82 % Per common share: Book value $ 27.96 $ 28.97 Tangible book value (1) $ 21.25 $ 22.26 Tangible equity ratio (2) 7.70 % 8.20 % (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 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. 42 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. The 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 March 31, 2022 balance sheet position: Interest Rate Sensitivity Analysis Change in interest rates (in basis points) Percent change in net interest income +200 5.64% +100 3.07% -50 (1.53%) 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, related inflationary pressures and FOMC monetary policy. In response to the economic impact of the pandemic, the federal funds rate was reduced by 150 bps in March 2020, term interest rates fell sharply across the yield curve and the Company reduced deposit rates. Inflationary pressures have resulted in a higher overall yield curve and expectations for material increases to short term interest rates. With deposit rates near their historic lows, the Company will focus on managing deposit expense in a rising rate environment while allowing assets to reprice upward. It is important to note that the current competitive lending environment may limit the Company’s ability to increase asset yields commensurate with relative interest rates. 43 Table of Contents Liquidity Risk Liquidity risk arises from the possibility that we may not be able to satisfy current or future financial commitments or may become unduly reliant on alternate funding sources. The objective of liquidity management is to ensure the Company can fund balance sheet growth, 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. Loan repayments and maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of investment securities and prepayments of loans and mortgage-related securities are strongly influenced by interest rates, the housing market, general and local economic conditions, and competition in the marketplace. Management continually monitors marketplace trends to identify patterns that might improve the predictability of the timing of deposit flows or asset prepayments. 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 March 31, 2022, the Company’s Basic Surplus measurement was 25.3% of total assets or approximately $3.1 billion as compared to the December 31, 2021 Basic Surplus of 28.5% or $3.4 billion, and was above the Company’s minimum of 5% (calculated at $607.4 million and $600.6 million, of period end total assets at March 31, 2022 and December 31, 2021, respectively) set forth in its liquidity policies. At March 31, 2022 and December 31, 2021, Federal Home Loan Bank (“FHLB”) advances outstanding totaled $14.0 million. At March 31, 2022 and December 31, 2021, the Bank had $8.0 million and $81.0 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 $1.8 billion at March 31, 2022 and $1.7 billion at December 31, 2021. In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $827.0 million and $999.1 million at March 31, 2022 and December 31, 2021, 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 $2.1 billion at March 31, 2022 and $2.0 billion at December 31, 2021. 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 March 31, 2022 and December 31, 2021, the Bank had the capacity to borrow $574.2 million and $580.8 million, respectively, from this program. The Company’s internal policies authorize borrowings up to 25% of assets. Under this policy, remaining available borrowing capacity totaled $3.0 billion at March 31, 2022 and $2.9 billion at December 31, 2021. 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 2022. The large inflow of deposits experienced since 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 March 31, 2022, 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 March 31, 2022, approximately $109.5 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. 44 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.