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 and nine month periods ending September 30, 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 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 of 1995. 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 the perceived overall value of these products and services by users; (9) changes in consumer spending, borrowing and saving habits; (10) changes in the financial performance and/or condition of the Company’s borrowers; (11) technological changes; (12) acquisition 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 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 or other public health crises; and (21) the Company’s success at managing the risks involved in the foregoing items. 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 obligation 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. 29 Table of Contents 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. Amounts previously reported in the consolidated financial statements are reclassified whenever necessary to conform to current period presentation. Critical Accounting 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. 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. One of the most significant judgements involved in estimating the Company’s allowance for credit losses relates to the macroeconomic forecasts used to estimate expected credit losses over the forecast period. As of September 30, 2022, the model incorporated a baseline economic outlook along with an alternative downside scenario. All else held equal, the changes in the weightings of our forecasted scenarios would impact the amount of estimated allowance for credit losses through changes in the quantitative reserve and scenario-specific qualitative adjustments. To demonstrate the sensitivity of the allowance for credit losses estimate to macroeconomic forecast weightings assumptions as of September 30, 2022, the Company increased the downside scenario weighting by 10% to 60% and decreased the baseline scenario to 40% weighting which resulted in a 3% increase in the overall estimated allowance for credit losses. The Company’s policies on the CECL method for allowance for credit losses 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 financial statements in this Quarterly Report on Form 10-Q for recently adopted accounting standards. 30 Table of Contents 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 following information should be considered in connection with the Company’s results for the three and nine months ended September 30, 2022: ● net income for the three months ended September 30, 2022 was $39.0 million, up $1.5 million from the third quarter of 2021 and up $1.2 million from the second quarter of 2022; ● diluted earnings per share of $0.90 for the three months ended September 30, 2022, up $0.04 from the third quarter of 2021 and up $0.02 from the second quarter of 2022; ● noninterest income for the three months ended September 30, 2022 was $37.2 million, down $3.2 million from the third quarter of 2021 and down $4.5 million from the second quarter of 2022; represents 28% of total revenues excluding securities gains (losses); ● period end loans were $7.90 billion, up 7.2%, annualized, from December 31, 2021 (9.1% excluding Paycheck Protection Program (“PPP”) loans); ● strong credit quality metrics including net charge-offs to average loans of 0.07% annualized for the three months ended September 30, 2022 and 0.08% annualized for the nine months ended September 30, 2022, and allowance for loan losses to total loans at 1.22%; ● book value per share of $27.00 at September 30, 2022; tangible book value per share (1) was $20.25 at September 30, 2022, $20.99 at June 30, 2022 and $21.95 at September 30, 2021. (1) Non-GAAP measure - Refer to non-GAAP reconciliation below. 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 September 30, 2022. However, economic uncertainty remains high and volatility is expected to continue. The Company continues to monitor the impact of the COVID-19 pandemic on its business and customers, and 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 participated in the Small Business Administration’s (“SBA”) PPP, a guaranteed, forgivable loan 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, the 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 September 30, 2022, the Company has received payment from the SBA on 5,980 loans totaling $804 million and total forgiveness and paydown is equal to 99% of the original balance. Results of Operations The Company reported net income of $39.0 million for the three months ended September 30, 2022, up $1.2 million from $37.8 million for the second quarter of 2022 and up $1.5 million from $37.4 million for the third quarter of 2021. Net interest income was $94.5 million for the three months ended September 30, 2022, up $6.9 million, or 7.9%, from the second quarter of 2022 and up $16.8 million, or 21.6% from the third quarter of 2021. Average interest-earning assets were down $255.7 million, or 2.3% from the prior quarter and comparable to the third quarter of 2021. The provision for loan losses was $4.5 million for three months ended September 30, 2022, as compared with $4.4 million in the second quarter of 2022 and a net benefit of $3.3 million in the third quarter of 2021. 31 Table of Contents The Company reported net income of $115.9 million for the nine months ended September 30, 2022, down $1.7 million from $117.6 million for the same period last year. Net interest income was $262.4 million for the nine months ended September 30, 2022, up $26.5 million, or 11.2% from $235.9 million for the nine months ended September 30, 2021. Average interest-earning assets were up $429.8 million, or 4.1% from the same period last year. The provision for loan losses was $9.5 million for the nine months ended September 30, 2022, as compared to a net benefit of $11.4 million for the nine months ended September 30, 2021. The following table sets forth certain financial highlights: Three Months Ended Nine Months Ended September 30, 2022 June 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Performance : Diluted earnings per share $ 0.90 $ 0.88 $ 0.86 $ 2.68 $ 2.69 Return on average assets (2) 1.33 % 1.28 % 1.26 % 1.31 % 1.37 % Return on average equity (2) 12.87 % 12.73 % 12.04 % 12.79 % 13.00 % Return on average tangible common equity (2) 17.12 % 17.00 % 15.97 % 17.00 % 17.35 % Net interest margin, fully taxable equivalent (“FTE”) (2) 3.51 % 3.21 % 2.88 % 3.22 % 3.01 % Capital: Equity to assets 9.94 % 10.14 % 10.35 % 9.94 % 10.35 % Tangible equity ratio 7.64 % 7.87 % 8.13 % 7.64 % 8.13 % Book value per share $ 27.00 $ 27.75 $ 28.65 $ 27.00 $ 28.65 Tangible book value per share $ 20.25 $ 20.99 $ 21.95 $ 20.25 $ 21.95 Leverage ratio 10.21 % 9.77 % 9.47 % 10.21 % 9.47 % Common equity tier 1 capital ratio 12.17 % 12.14 % 12.20 % 12.17 % 12.20 % Tier 1 capital ratio 13.27 % 13.27 % 13.39 % 13.27 % 13.39 % Total risk-based capital ratio 15.50 % 15.50 % 15.74 % 15.50 % 15.74 % The following table provide non-GAAP reconciliations: Three Months Ended Nine Months Ended (In thousands, except per share data) September 30, 2022 June 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Return on average tangible common equity: Net income $ 38,973 $ 37,775 $ 37,433 $ 115,874 $ 117,575 Amortization of intangible assets (net of tax) 408 409 497 1,294 1,618 Net income, excluding intangible amortization $ 39,381 $ 38,184 $ 37,930 $ 117,168 $ 119,193 Average stockholders’ equity $ 1,201,656 $ 1,190,585 $ 1,233,045 $ 1,210,998 $ 1,209,586 Less: average goodwill and other intangibles 289,296 289,584 290,492 289,366 291,177 Average tangible common equity $ 912,360 $ 901,001 $ 942,553 $ 921,632 $ 918,409 Return on average tangible common equity (2) 17.12 % 17.00 % 15.97 % 17.00 % 17.35 % Tangible equity ratio: Stockholders’ equity $ 1,156,546 $ 1,188,556 $ 1,241,457 $ 1,156,546 $ 1,241,457 Intangibles 289,083 289,259 290,119 289,083 290,119 Assets $ 11,640,742 $ 11,720,459 $ 11,994,411 $ 11,640,742 $ 11,994,411 Tangible equity ratio 7.64 % 7.87 % 8.13 % 7.64 % 8.13 % Tangible book value: Stockholders’ equity $ 1,156,546 $ 1,188,556 $ 1,241,457 $ 1,156,546 $ 1,241,457 Intangibles 289,083 289,259 290,119 289,083 290,119 Tangible equity $ 867,463 $ 899,297 $ 951,338 $ 867,463 $ 951,338 Diluted common shares outstanding 42,839 42,836 43,338 42,839 43,338 Tangible book value per share $ 20.25 $ 20.99 $ 21.95 $ 20.25 $ 21.95 (2) Annualized 32 Table of Contents 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. Net interest income was $94.5 million for the third quarter of 2022, up $6.9 million, or 7.9%, from the previous quarter. PPP loan interest and fees recognized into interest income for the three months ended September 30, 2022 was $0.3 million compared to $1.3 million for the previous quarter. The FTE net interest margin was 3.51% for the three months ended September 30, 2022, an increase of 30 basis points (“bps”) from the previous quarter. Interest income increased $7.7 million, or 8.5%, as the yield on average interest-earning assets increased 33 bps from the prior quarter to 3.68%, while average interest-earning assets of $10.73 billion decreased $255.7 million from the prior quarter, primarily due to a decrease in short-term interest-bearing accounts (“excess liquidity”), resulting primarily from the incremental deployment of excess liquidity into loans and investment securities. Interest expense was up $0.8 million, or 21.5%, as the cost of interest-bearing liabilities increased 6 bps to 0.29% for the quarter ended September 30, 2022, driven by an increase in the cost of deposits and the higher interest rate on borrowings. Net interest income was $94.5 million for the third quarter of 2022, up $16.8 million, or 21.6%, from the third quarter of 2021. PPP loan interest and fees recognized into interest income for the three months ended September 30, 2022 was $0.3 million compared to $2.9 million for the third quarter of 2021. The FTE net interest margin was 3.51% for the three months ended September 30, 2022, an increase of 63 bps from the third quarter of 2021. Interest income increased $17.0 million, or 20.7%, as the yield on average interest-earning assets increased 63 bps from the same period in 2021 to 3.68%, while average interest-earning assets of $10.73 billion was comparable with the third quarter of 2021 as the decrease in excess liquidity was fully offset by the increase in loans and investment securities. Interest expense was up $0.2 million, or 4.3%, as the cost of interest-bearing liabilities increased 2 bps to 0.29% for the quarter ended September 30, 2022, driven by the higher interest rate on borrowings. Net interest income for the first nine months of 2022 was $262.4 million, up $26.5 million, or 11.2%, from the same period in 2021. PPP loan interest and fees recognized into interest income for the nine months ended September 30, 2022 was $3.6 million compared to $13.8 million for the same period in 2021. FTE net interest margin was 3.22% for the nine months ended September 30, 2022, an increase of 21 bps from the same period in 2021. Interest income increased $24.3 million, or 9.7%, as the yield on average interest-earning assets increased 17 bps from the same period in 2021 to 3.37%, while average interest-earning assets of $10.93 billion increased $429.8 million primarily due to an increase in average loans and investment securities. Interest expense was down $2.2 million, or 14.8%, for the nine months ended September 30, 2022 as compared to the same period in 2021 as the cost of interest-bearing liabilities decreased 5 bps to 0.25%, driven by interest-bearing deposit costs decreasing 7 bps. 33 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, 2022 September 30, 2021 (Dollars in thousands) Average Balance Interest Yield/ Rates Average Balance Interest Yield/ Rates Assets: Short-term interest-bearing accounts $ 191,463 $ 1,209 2.51 % $ 1,014,120 $ 403 0.16 % Securities taxable (1) 2,491,315 11,478 1.83 % 1,923,700 7,907 1.63 % Securities tax-exempt (1) (3) 211,306 1,318 2.47 % 246,685 1,225 1.97 % Federal Reserve Bank and FHLB stock 25,182 220 3.47 % 25,154 121 1.91 % Loans (2) (3) 7,808,025 85,326 4.34 % 7,517,839 72,857 3.84 % Total interest-earning assets $ 10,727,291 $ 99,551 3.68 % $ 10,727,498 $ 82,513 3.05 % Other assets 887,378 1,019,797 Total assets $ 11,614,669 $ 11,747,295 Liabilities and stockholders’ equity: Money market deposit accounts $ 2,332,341 $ 877 0.15 % $ 2,580,570 $ 1,266 0.19 % NOW deposit accounts 1,548,115 800 0.21 % 1,442,678 183 0.05 % Savings deposits 1,854,122 149 0.03 % 1,691,539 219 0.05 % Time deposits 455,168 407 0.35 % 565,216 880 0.62 % Total interest-bearing deposits $ 6,189,746 $ 2,233 0.14 % $ 6,280,003 $ 2,548 0.16 % Federal funds purchased 1,522 13 3.39 % - - - Repurchase agreements 69,048 17 0.10 % 99,703 28 0.11 % Short-term borrowings 6,440 54 3.33 % - - - Long-term debt 3,331 20 2.38 % 14,029 89 2.52 % Subordinated debt, net 98,748 1,360 5.46 % 98,311 1,359 5.48 % Junior subordinated debt 101,196 1,039 4.07 % 101,196 517 2.03 % Total interest-bearing liabilities $ 6,470,031 $ 4,736 0.29 % $ 6,593,242 $ 4,541 0.27 % Demand deposits $ 3,708,131 $ 3,676,883 Other liabilities 234,851 244,125 Stockholders’ equity 1,201,656 1,233,045 Total liabilities and stockholders’ equity $ 11,614,669 $ 11,747,295 Net interest income (FTE) $ 94,815 $ 77,972 Interest rate spread 3.39 % 2.78 % Net interest margin (FTE) 3.51 % 2.88 % Taxable equivalent adjustment $ 337 $ 298 Net interest income $ 94,478 $ 77,674 (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 Nine Months Ended September 30, 2022 September 30, 2021 (Dollars in thousands) Average Balance Interest Yield/ Rates Average Balance Interest Yield/ Rates Assets: Short-term interest-bearing accounts $ 575,517 $ 2,742 0.64 % $ 860,067 $ 763 0.12 % Securities taxable (1) 2,406,042 31,460 1.75 % 1,852,963 23,711 1.71 % Securities tax-exempt (1) (3) 242,033 3,664 2.02 % 208,438 3,730 2.39 % Federal Reserve Bank and FHLB stock 25,064 654 3.49 % 25,290 443 2.34 % Loans (2) (3) 7,683,159 237,290 4.13 % 7,555,276 222,821 3.94 % Total interest-earning assets $ 10,931,815 $ 275,810 3.37 % $ 10,502,034 $ 251,468 3.20 % Other assets 905,931 984,372 Total assets $ 11,837,746 $ 11,486,406 Liabilities and stockholders’ equity: Money market deposit accounts $ 2,541,927 $ 2,801 0.15 % $ 2,557,172 $ 4,022 0.21 % NOW deposit accounts 1,570,318 1,260 0.11 % 1,419,102 531 0.05 % Savings deposits 1,831,485 442 0.03 % 1,633,941 625 0.05 % Time deposits 475,966 1,328 0.37 % 590,385 3,404 0.77 % Total interest-bearing deposits $ 6,419,696 $ 5,831 0.12 % $ 6,200,600 $ 8,582 0.19 % Federal funds purchased 513 13 3.39 % - - - Repurchase agreements 67,279 46 0.09 % 101,574 104 0.14 % Short-term borrowings 2,170 54 3.33 % 1,740 26 2.07 % Long-term debt 7,509 140 2.49 % 15,976 301 2.52 % Subordinated debt, net 98,641 4,078 5.53 % 98,204 4,077 5.56 % Junior subordinated debt 101,196 2,325 3.07 % 101,196 1,572 2.08 % Total interest-bearing liabilities $ 6,697,004 $ 12,487 0.25 % $ 6,519,290 $ 14,662 0.30 % Demand deposits $ 3,709,761 $ 3,514,005 Other liabilities 219,983 243,525 Stockholders’ equity 1,210,998 1,209,586 Total liabilities and stockholders’ equity $ 11,837,746 $ 11,486,406 Net interest income (FTE) $ 263,323 $ 236,806 Interest rate spread 3.12 % 2.90 % Net interest margin (FTE) 3.22 % 3.01 % Taxable equivalent adjustment $ 912 $ 899 Net interest income $ 262,411 $ 235,907 (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%. 35 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) 2022 over 2021 (In thousands) Volume Rate Total Short-term interest-bearing accounts $ (578 ) $ 1,384 $ 806 Securities taxable 2,533 1,038 3,571 Securities tax-exempt (192 ) 285 93 Federal Reserve Bank and FHLB stock - 99 99 Loans 2,896 9,573 12,469 Total FTE interest income $ 4,659 $ 12,379 $ 17,038 Money market deposit accounts $ (113 ) $ (276 ) $ (389 ) NOW deposit accounts 14 603 617 Savings deposits 19 (89 ) (70 ) Time deposits (148 ) (325 ) (473 ) Federal funds purchased 13 - 13 Repurchase agreements (8 ) (3 ) (11 ) Short-term borrowings 54 - 54 Long-term debt (64 ) (5 ) (69 ) Subordinated debt, net 6 (5 ) 1 Junior subordinated debt - 522 522 Total FTE interest expense $ (227 ) $ 422 $ 195 Change in FTE net interest income $ 4,886 $ 11,957 $ 16,843 Nine Months Ended September 30, Increase (Decrease) 2022 over 2021 (In thousands) Volume Rate Total Short-term interest-bearing accounts $ (330 ) $ 2,309 $ 1,979 Securities taxable 7,221 528 7,749 Securities tax exempt 554 (620 ) (66 ) Federal Reserve Bank and FHLB stock (4 ) 215 211 Loans 3,819 10,650 14,469 Total FTE interest income $ 11,260 $ 13,082 $ 24,342 Money market deposit accounts $ (24 ) $ (1,197 ) $ (1,221 ) NOW deposit accounts 62 667 729 Savings deposits 69 (252 ) (183 ) Time deposits (567 ) (1,509 ) (2,076 ) Federal funds purchased 13 - 13 Repurchase agreements (29 ) (29 ) (58 ) Short-term borrowings 8 20 28 Long-term debt (158 ) (3 ) (161 ) Subordinated debt 18 (17 ) 1 Junior subordinated debt - 753 753 Total FTE interest expense $ (608 ) $ (1,567 ) $ (2,175 ) Change in net FTE interest income $ 11,868 $ 14,649 $ 26,517 36 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) 2022 2021 2022 2021 Service charges on deposit accounts $ 3,581 $ 3,489 $ 11,032 $ 9,544 Card services income 5,654 9,101 24,100 25,835 Retirement plan administration fees 11,496 10,495 37,451 30,372 Wealth management 8,402 8,783 25,294 25,099 Insurance services 3,892 3,720 11,258 10,689 Bank owned life insurance 1,560 1,548 4,625 4,588 Net securities (losses) gains (148 ) (100 ) (914 ) 568 Other 2,735 3,293 8,641 9,988 Total noninterest income $ 37,172 $ 40,329 $ 121,487 $ 116,683 Noninterest income for the three months ended September 30, 2022 was $37.2 million, down $4.5 million, or 10.8%, from the prior quarter and down $3.2 million, or 7.8%, from the third quarter of 2021. Excluding net securities (losses) gains, noninterest income for the three months ended September 30, 2022 was $37.3 million, down $4.9 million, or 11.7%, from the prior quarter and down $3.1 million, or 7.7%, from the third quarter of 2021. The decrease from the prior quarter and the third quarter of 2021 was primarily driven by lower card services income driven by the $3.8 million impact from the Company being subject to the statutory price cap provisions of the Durbin Amendment to the Dodd-Frank Act. In addition, the decrease from the prior quarter was impacted by lower retirement plan administration fees driven by market decline and lower activity-based fees partly offset by higher wealth management fees due to seasonal tax preparation services. The decrease from the third quarter of 2021 was also impacted by lower wealth management fees driven primarily by market performance and lower commercial loan swap fees which were partly offset by higher retirement plan administration driven by higher activity-based fees and organic growth. Noninterest income for the nine months ended September 30, 2022 was $121.5 million, up $4.8 million, or 4.1%, from the same period in 2021. Excluding net securities (losses) gains, noninterest income for the nine months ended September 30, 2022 was $122.4 million, up $6.3 million, or 5.4%, from the same period in 2021. The increase from the prior year 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 and higher service charges on deposit accounts as the volume of transactions has normalized to near pre-pandemic levels. These increases were partly offset by lower card services income driven by the $3.8 million impact from the Company being subject to the statutory price cap provisions of the Durbin Amendment to the Dodd-Frank Act and lower commercial loan swap fees. 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) 2022 2021 2022 2021 Salaries and employee benefits $ 48,371 $ 44,190 $ 140,595 $ 128,462 Technology and data services 9,096 8,421 26,588 26,154 Occupancy 6,481 6,154 19,761 19,413 Professional fees and outside services 3,817 3,784 11,999 11,403 Office supplies and postage 1,469 1,364 4,441 4,478 FDIC expense 787 772 2,399 2,243 Advertising 559 583 1,943 1,502 Amortization of intangible assets 544 663 1,725 2,157 Loan collection and other real estate owned, net 549 706 1,690 1,959 Other 5,021 6,232 13,815 14,405 Total noninterest expense $ 76,694 $ 72,869 $ 224,956 $ 212,176 37 Table of Contents Noninterest expense for the three months ended September 30, 2022 was $76.7 million, up $0.6 million, or 0.8%, from the prior quarter and up $3.8 million, or 5.2%, from the third quarter of 2021. The increase from the prior quarter was primarily driven by higher salaries and employee benefits due to one additional day of payroll in the third quarter and higher levels of incentive compensation accruals which was partly offset by lower other expenses due to seasonal timing of certain expenditures. The increase from the third quarter of 2021 was due to increased salaries and wages including merit pay increases and higher levels of incentive compensation accruals. Technology and data services expense increased from the third quarter of 2021 due to continued investment in digital platform solutions. Other expenses in the third quarter of 2021 included $2.3 million in estimated litigation settlement costs related to a settled lawsuit regarding certain of the Company’s deposit products and related disclosures. Noninterest expense for the nine months ended September 30, 2022 was $225.0 million, up $12.8 million, or 6.0%, from the same period in 2021. The increase from the prior year was driven by higher salaries and employee benefits due to increased salaries and wages including merit pay increases and higher levels of incentive compensation accruals, along with increased professional fees and outside services due to timing of expenditures. Other expenses decreased from the prior year due in to the 2021 $4.0 million estimated litigation settlement costs previously mentioned, partly offset by higher travel and training expenditures along with an increase in the provision for the reserve for unfunded commitments. Income Taxes Income tax expense for the three months ended September 30, 2022 was $11.5 million, up $0.5 million from the prior quarter and up $0.5 million from the third quarter of 2021. The effective tax rate was 22.8% for the third quarter of 2022, compared to 22.5% in the prior quarter and 22.8% for the third quarter of 2021. Income tax expense for the nine months ended September 30, 2022 was $33.6 million, down $0.6 million from the same period of 2021. The effective tax rate was 22.5% for the nine months ended September 30, 2022 and 2021. ANALYSIS OF FINANCIAL CONDITION Securities Total securities increased $62.3 million, or 2.5%, from December 31, 2021 to September 30, 2022. The securities portfolio represented 21.6% of total assets as of September 30, 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 equity securities for the periods indicated: September 30, 2022 December 31, 2021 Mortgage-backed securities: With maturities 15 years or less 14 % 18 % With maturities greater than 15 years 11 % 8 % Collateralized mortgage obligations 37 % 34 % Municipal securities 15 % 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, 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 the 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) September 30, 2022 December 31, 2021 Commercial & industrial $ 1,258,871 $ 1,155,240 Commercial real estate 2,724,728 2,655,367 Paycheck protection program 3,328 101,222 Residential real estate mortgages 1,626,528 1,571,232 Indirect auto 952,757 859,454 Residential solar 728,898 440,016 Home equity 313,557 330,357 Other consumer 296,117 385,571 Total loans $ 7,904,784 $ 7,498,459 (1) Loans are summarized by business line which does not align to how the Company assesses credit risk in the estimate for credit losses under CECL. 38 Table of Contents Total loans increased by $406.3 million, or 7.2% annualized, from December 31, 2021 to September 30, 2022. Total PPP loans as of September 30, 2022 were $3.3 million (net of unamortized fees). The following PPP loan activity occurred during the nine months ended September 30, 2022: there were no PPP loan originations, $99.3 million of loans forgiven and $3.6 million of interest and fees recognized into interest income. Excluding PPP loans, period end loans increased $504.2 million from December 31, 2021, or 9.1% annualized. Commercial and industrial loans increased $103.6 million to $1.26 billion; commercial real estate loans increased $69.4 million to $2.72 billion; and total consumer loans increased $331.2 million to $3.92 billion. Total loans represent approximately 67.9% of assets as of September 30, 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 estimate 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). 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. 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 for credit losses 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 probability of default (PD) and loss given default (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 $96.8 million at September 30, 2022 compared to $93.6 million at June 30, 2022 and $93.0 million at September 30, 2021. The allowance for credit losses as a percentage of loans was 1.22% (1.23% excluding PPP loans) at September 30, 2022, compared to 1.20% (1.21% excluding PPP loans) at June 30, 2022 and 1.23% (1.28% excluding PPP loans) at September 30, 2021. The allowance for credit losses was 443.43% of nonperforming loans at September 30, 2022, compared to 363.23% at June 30, 2022 and 240.45% at September 30, 2021. The allowance for credit losses was 506.86% of nonaccrual loans at September 30, 2022, compared to 395.39% of nonaccrual loans at June 30, 2022 and compared to 260.23% at September 30, 2021. The increase in the allowance for credit losses from June 30, 2022 to September 30, 2022 was primarily due to the deterioration in the forecast of economic conditions, which increased the level of expected credit losses and the increase in loan balances. The increase in allowance for credit losses from September 30, 2021 to September 30, 2022 was primarily due to the slight deterioration in the economic forecast and the increase in loan balances. 39 Table of Contents The provision for loan losses was $4.5 million for three months ended September 30, 2022, compared to $4.4 million in the prior quarter and a net benefit of $3.3 million for the same period in the prior year. Provision expense increased slightly from the prior quarter driven by modest deterioration of the macro-economic forecasts and providing for loan growth. Provision expense increased from the same period in the prior year driven by providing for loan growth and an increase in the level of allowance for loan losses resulting from less favorable economic forecasts in the current quarter relative to improved economic forecasts that took place at the end of the third quarter in 2021. Net charge-offs totaled $1.3 million during the three months ended September 30, 2022, compared to net charge-offs of $0.8 million during the second quarter of 2022 and $2.2 million in the third quarter of 2021. Net charge-offs to average loans was 7 bps for the three months ended September 30, 2022, compared to 4 bps for the second quarter of 2022 and 11 bps for the three months ended September 30, 2021. The provision for loan losses was $9.5 million for the nine months ended September 30, 2022, compared to a net benefit of $11.4 million for the nine months ended September 30, 2021. Provision expense increased from the same period in the prior year due primarily to deteriorated economic condition forecast in the current year as compared to significant improvements experienced in the economic condition forecast in the prior year and loan growth experienced during the current year. Net charge-offs totaled $4.7 million during the nine months ended September 30, 2022, compared to net charge-offs of $5.6 million during the nine months ended September 30, 2021. As of September 30, 2022, the unfunded commitment reserve totaled $5.3 million, compared to $5.1 million as of June 30, 2022 and $5.3 million as of September 30, 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. September 30, 2022 December 31, 2021 (Dollars in thousands) Amount % Amount % Nonaccrual loans: Commercial $ 9,427 49 % $ 15,942 53 % Residential 4,907 26 % 8,862 29 % Consumer 1,756 9 % 1,511 5 % Troubled debt restructured loans 3,008 16 % 3,970 13 % Total nonaccrual loans $ 19,098 100 % $ 30,285 100 % Loans over 90 days past due and still accruing: Commercial $ - - $ - - Residential 1,184 43 % 808 33 % Consumer 1,548 57 % 1,650 67 % Total loans over 90 days past due and still accruing $ 2,732 100 % $ 2,458 100 % Total nonperforming loans $ 21,830 $ 32,743 OREO - 167 Total nonperforming assets $ 21,830 $ 32,910 Total nonaccrual loans to total loans 0.24 % 0.40 % Total nonperforming loans to total loans 0.28 % 0.44 % Total nonperforming assets to total assets 0.19 % 0.27 % Total allowance for loan losses to total nonperforming loans 443.43 % 280.98 % Total allowance for loan losses to nonaccrual loans 506.86 % 303.78 % 40 Table of Contents Total nonperforming assets were $21.8 million at September 30, 2022, compared to $32.9 million at December 31, 2021 and $39.5 million at September 30, 2021. Nonperforming loans at September 30, 2022 were $21.8 million, or 0.28% of total loans (0.28% 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 $38.7 million, or 0.51% of total loans (0.53% excluding PPP loan originations) at September 30, 2021. The decrease in nonperforming loans primarily resulted from a reduction in commercial and residential mortgage nonaccrual loans. Total nonaccrual loans were $19.1 million or 0.24% of total loans at September 30, 2022, compared to $30.3 million or 0.40% of total loans at December 31, 2021 and compared to $35.7 million or 0.47% of total loans at September 30, 2021. Past due loans as a percentage of total loans was 0.30% at September 30, 2022 (0.29% excluding PPP loan originations), up from 0.29% at December 31, 2021 (0.29% excluding PPP loan originations) and up from 0.46% at September 30, 2021 (0.48% excluding PPP loan originations). In addition to nonperforming loans discussed above, the Company has also identified approximately $58.4 million in potential problem loans at September 30, 2022 as compared to $74.9 million at December 31, 2021 and $106.3 million at September 30, 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 September 30, 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 September 30, 2022, 8.5% 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 $9.92 billion at September 30, 2022, down $0.32 billion, or 3.1%, from December 31, 2021. Total average deposits increased $0.41 billion, or 4.3%, from the same period last year. The growth was driven primarily by an increase of $195.8 million, or 5.6%, in demand deposits, combined with an increase in interest-bearing deposits of $219.1 million, or 3.5%, due to growth in NOW deposit accounts and savings deposit accounts, partly offset by a decrease in time accounts. Borrowed Funds The Company’s borrowed funds consist of short-term borrowings and long-term debt. Short-term borrowings totaled $74.6 million at September 30, 2022 compared to $97.8 million at December 31, 2021. Long-term debt was $3.3 million at September 30, 2022 compared to $14.0 million at 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 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, 2022 and December 31, 2021 the subordinated debt net of unamortized issuance costs was $98.8 million and $98.5 million, respectively. Capital Resources Stockholders’ equity of $1.16 billion represented 9.94% of total assets at September 30, 2022 compared with $1.25 billion, or 10.41% of total assets, as of December 31, 2021. Stockholders’ equity decreased $93.9 million from December 31, 2021 driven by the $160.2 million decrease in accumulated other comprehensive income due primarily to the change in market value of securities available for sale, dividends declared of $36.9 million and the repurchase of common stock of $14.7 million, partly offset by net income of $115.9 million for the nine months ending September 30, 2022. The deferred tax asset related to the unrealized losses in investment securities increased $53.6 million from December 31, 2021. The Company purchased 400,000 shares of its common stock in the first and second quarter of 2022 at an average price of $36.78 per share under its previously announced share repurchase program. As of September 30, 2022, there were 1,600,000 shares available for repurchase under this plan authorized on December 20, 2021 and set to expire on December 31, 2023. 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 2022 cash dividend of $0.30 per share at a meeting held on October 24, 2022. The dividend, which represents an increase of $0.02 per share, or 7.1%, from the amount paid in the fourth quarter of 2021 will be paid on December 15, 2022 to stockholders of record as of December 1, 2022. 41 Table of Contents As the capital ratios in the following table indicate, the Company remained “well capitalized” at September 30, 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 September 30, 2022 December 31, 2021 Tier 1 leverage ratio 10.21 % 9.41 % Common equity tier 1 capital ratio 12.17 % 12.25 % Tier 1 capital ratio 13.27 % 13.43 % Total risk-based capital ratio 15.50 % 15.73 % Cash dividends as a percentage of net income 31.85 % 30.82 % Per common share: Book value $ 27.00 $ 28.97 Tangible book value (1) $ 20.25 $ 22.26 Tangible equity ratio (2) 7.64 % 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 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. 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. 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 (e.g., 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 200 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 repricing and rolling over at lower yields at a faster pace than interest-bearing liabilities decline and/or reach their floors. In the rising rate scenarios, net interest income is projected to experience an 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, money market deposit accounts and time accounts. Net interest income for the next twelve months in the +200/+100/-200 bp scenarios, as described above, is within the internal policy risk limits of not more than a 7.5% reduction 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, 2022 balance sheet position: Interest Rate Sensitivity Analysis Change in interest rates Percent change in (in bps points) net interest income +200 3.78% +100 2.02% -200 (5.72%) The Company anticipates that the trajectory of net interest income will continue to 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, Fed Funds increases of 300 bps so far in 2022 and expectations for continued 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. 43 Table of Contents Liquidity Risk Liquidity risk arises from the possibility that the Company 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, along with 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 September 30, 2022, the Company’s Basic Surplus measurement was 19.1% of total assets, or $2.22 billion, as compared to the December 31, 2021 Basic Surplus of 28.5%, or $3.43 billion, and was above the Company’s minimum of 5% (calculated at $582.0 million and $600.6 million, of period end total assets as September 30, 2022 and December 31, 2021, respectively) set forth in its liquidity policies. At September 30, 2022 and December 31, 2021, Federal Home Loan Bank (“FHLB”) advances outstanding totaled $3.3 million and $14.0 million, respectively. At September 30, 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 $1.70 billion at September 30, 2022 and $1.67 billion at December 31, 2021. In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $0.92 billion and $1.00 billion at September 30, 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 $1.98 billion at September 30, 2022 and $2.03 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 September 30, 2022 and December 31, 2021, the Bank had the capacity to borrow $588.2 million and $580.8 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 $2.88 billion at September 30, 2022 and $2.89 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 considers its Basic Surplus position to be strong. However, certain events may adversely impact the Company’s liquidity position in 2022. Higher interest rates could result in deposit declines as depositors have alternative opportunities for yield on their excess funds. 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, 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 September 30, 2022, approximately $133.2 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.