TRICO BANCSHARES / 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS Cautionary Statements Regarding Forward-Looking Information The statements contained herein that are not historical facts are forward-looking statements based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There can be no assurance that future developments affecting us will be the same as those anticipated by management. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in, or implied or projected by, such forward-looking statements. These risks and uncertainties include, but are not limited to, the following: the strength of the United States economy in general and the strength of the local economies in which we conduct operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the impact of changes in financial services policies, laws and regulations; technological changes; weather, natural disasters and other catastrophic events that may or may not be caused by climate change and their effects on economic and business environments in which the Company operates; the continuing adverse impact on the U.S. economy, including the markets in which we operate, due to the length, severity, magnitude and duration of the COVID-19 global pandemic, and the impact of a slowing U.S. economy and increased unemployment on the performance of our loan portfolio, the market value of our investment securities, the availability of sources of funding and the demand for our products; the costs or effects of mergers, acquisitions or dispositions we may make, such as our pending acquisition of Valley Republic Bancorp, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions, and/or the failure to effectively integrate an acquisition target into our operations; the possibility that the merger between us and Valley will not close when expected or at all because required regulatory, shareholder, or other approvals are not received or other conditions to the closing are not satisfied on a timely basis or at all, or are obtained subject to conditions that are not anticipated (and the risk that required regulatory approvals may result in the imposition of conditions that could adversely affect the combined company or the expected benefits of the proposed transaction); the occurrence of any event, change, or other circumstances that could give rise to the right of one or both of the parties to terminate the definitive merger agreement between the Company and Valley; the risk that any announcements relating to the merger could have adverse effects on the market price of the common stock of either or both parties to the transaction; changes in the economy, which could materially impact credit quality trends and the ability to generate loans and gather deposits, including the pace of the recovery following the COVID-19 pandemic; the ability of us to execute our business plan in new lending markets; the future operating or financial performance of the Company, including our outlook for future growth, changes in the level of our nonperforming assets and charge-offs; the appropriateness of the allowance for credit losses including the timing and effects of the implementation of the current expected credit losses model; any deterioration in values of California real estate, both residential and commercial; the effect of changes in accounting standards and practices; possible other-than-temporary impairment of securities held by us; changes in consumer spending, borrowing and savings habits; our ability to attract deposits and other sources of liquidity; changes in the financial performance and/or condition of our borrowers; our noninterest expense and the efficiency ratio; competition and innovation with respect to financial products and services by banks, financial institutions and non-traditional providers including retail businesses and technology companies; the challenges of integrating and retaining key employees; the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; a failure in or breach of our operational or security systems or infrastructure, or those of our third-party vendors or other service providers, including as a result of cyber-attacks and the cost to defend against such attacks; the effect of a fall in stock market prices on our brokerage and wealth management businesses; and our ability to 39 Table of Contents manage the risks involved in the foregoing. Additional factors that could cause results to differ materially from those described above can be found under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2020, which is on file with the Securities and Exchange Commission (the “SEC”) and available in the “Investor Relations” section of our website, https://www.tcbk.com/investor-relations and in other documents we file with the SEC. Annualized, pro forma, projections and estimates are not forecasts and may not reflect actual results. General As TriCo Bancshares (referred to in this report as “we”, “our” or the “Company”) has not commenced any business operations independent of Tri Counties Bank (the “Bank”), the following discussion pertains primarily to the Bank. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Within Management’s Discussion and Analysis of Financial Condition and Results of Operations, interest income, net interest income, net interest yield, and efficiency ratio are generally presented on a fully tax-equivalent (“FTE”) basis. The Company believes the use of these non-generally accepted accounting principles (non-GAAP) measures provides additional clarity in assessing its results, and the presentation of these measures on a FTE basis is a common practice within the banking industry. Interest income and net interest income are shown on a non-FTE basis in the Part I - Financial Information section of this Form 10-Q, and a reconciliation of the FTE and non-FTE presentations is provided below in the discussion of net interest income. Critical Accounting Policies and Estimates The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those that materially affect the financial statements and are related to the adequacy of the allowance for loan losses, investments, mortgage servicing rights, fair value measurements, retirement plans and intangible assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A detailed discussion related to the Company’s accounting policies including those related to estimates on the allowance for loan losses, other than temporary impairment of investments and impairment of intangible assets, can be found in Note 1 of the consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2020. Geographical Descriptions For the purpose of describing the geographical location of the Company’s operations, the Company has defined northern California as that area of California north of, and including, Stockton to the east and San Jose to the west; central California as that area of the state south of Stockton and San Jose, to and including, Bakersfield to the east and San Luis Obispo to the west; and southern California as that area of the state south of Bakersfield and San Luis Obispo. Recent Developments On July 22, 2021, the Company entered into a definitive agreement with Valley Republic Bancorp (“Valley”) to acquire Valley and its wholly-owned subsidiary, Valley Republic Bank. Under the terms of the agreement, Valley shareholders will receive 0.95 of a share of TriCo’s common stock in exchange for each share of Valley’s common stock, subject to certain potential adjustments. The aggregate merger consideration of $184.8 million includes $180.6 million in TriCo stock to be issued to Valley common shareholders and $4.2 million to be paid in cash to Valley restricted stock and option holders. The merger is expected to qualify as a tax-free reorganization. The proposed transaction is expected to close in the coming months, subject to satisfaction of customary closing conditions, including regulatory approvals and shareholder approval from Valley’s shareholders. The transaction is expected to be 5.5% accretive to TriCo’s earnings per share in 2022, with 1.6% dilution to tangible book value per share, and a tangible book value earnback of 2.0 years. The earnings per share accretion estimates are based on anticipated cost savings of approximately 17% of Valley’s non-interest expense and does not include any benefits from potential revenue synergies which may result, although opportunities have been identified. For additional information about the proposed acquisition of Valley, see the Company’s Current Report on Form 8-K filed with the SEC on July 27, 2021,the definitive agreement filed therewith, and the Form S-4 and subsequent Form S-4/A filed with the SEC on October 20, 2021 and October 27, 2021, respectively. 40 Table of Contents Financial Highlights Performance highlights and other developments for the Company as of or for the three and nine months ended September 30, 2021 included the following: • For the three and nine months ended September 30, 2021, the Company’s return on average assets was 1.30% and 1.48%, respectively, and the return on average equity was 11.02% and 12.42%, respectively. • Organic loan growth, excluding PPP, totaled $30.7 million (2.6% annualized) for the current quarter and $335.7 million (7.6%) for the trailing twelve-month period. • For the current quarter, net interest margin was 3.50% on a tax equivalent basis as compared to 3.72% in the quarter ended September 30, 2020, and a decrease of 8 basis points from 3.58% in the trailing quarter. • The efficiency ratio was 52.87% for the nine months ended September 30, 2021, as compared to 59.59% for the same period of the prior year. • As of September 30, 2021, the Company reported total loans, total assets and total deposits of $4.89 billion, $8.46 billion and $7.24 billion, respectively. As a direct result of the considerable deposit growth in the last 6 quarters, the loan to deposit ratio was 67.54% as of September 30, 2021, as compared to 73.21% at December 31, 2020 and 76.12% at September 30, 2020. • The average rate of interest paid on deposits, including non-interest-bearing deposits, remained at 0.05% for the third quarter of 2021 as compared with 0.05% for the trailing quarter, and decreased by 4 basis points from the average rate paid of 0.09% during the same quarter of the prior year. • The balance of PPP loans outstanding at September 30, 2021 totaled $157.5 million and the balance of SBA fees remaining to be accreted totaled $6.0 million. Approximately 98% of all round one and 25% of all round two PPP loans have been forgiven and repaid by the SBA. • Noninterest income related to service charges and fees was $11.3 million and $32.7 million for the three and nine month periods ended September 30, 2021, an increase of 7.6% and 17.7% when compared to the same periods in 2020. • Gains generated from the origination and sale of mortgage loans were $1,814,000 in the third quarter of 2021 as compared with $2,847,000 and $3,035,000 during the trailing quarter and same quarter of the prior year. • The reversal of provision for credit losses for loans and debt securities was $1.4 million during the quarter ended September 30, 2021, as compared to a reversal of provision expense of $0.3 million during the trailing quarter ended June 30, 2021, and a provision expense totaling $7.6 million for the three month period ended September 30, 2020. • The allowance for credit losses to total loans was 1.72% as of September 30, 2021, compared to 1.93% as of December 31, 2020, and 1.81% as of September 30, 2020. Non-performing assets to total assets were 0.37% at September 30, 2021, as compared to 0.43% as of June 30, 2021, and 0.34% at September 30, 2020. SBA Paycheck Protection Program and COVID Deferrals In March 2020, the Small Business Administration ("SBA") Paycheck Protection Program ("PPP") was created to help small businesses keep workers employed during the COVID-19 crisis. The Company originated loans under this program beginning in April, 2020 through July, 2020 (Round 1). Following the SBA's announcement of a second round of PPP lending with streamlined requirements for both borrowers and lenders in December 2020, the Company resumed accepting applications in January, 2021 (Round 2). The SBA ended PPP and did not accept new borrowing applications, effective May 31, 2021. As of September 30, 2021, the total gross balance outstanding of PPP loans was $157,461,000 as compared to total PPP originations of $640,410,000. In connection with the origination of these loans, the Company earned approximately $25,299,000 in loan fees, offset by deferred loan costs of approximately $1,245,000, the net of which will be recognized over the earlier of loan maturity (between 24-60 months), repayment or receipt of forgiveness confirmation. As of September 30, 2021, there was approximately $6,013,000 in net deferred fee income remaining to be recognized. During the three and nine months ended September 30, 2021, the Company recognized $2,984,000 and $10,306,000, respectively in fees on PPP loans as compared with $2,603,000 and $4,959,000 for the three and nine months ended September 30, 2020, respectively. 41 Table of Contents The following is a summary of PPP loan related information as of the periods indicated: (dollars in thousands) September 30, 2021 June 30, 2021 March 31, 2021 December 31, 2020 September 30, 2020 Total number of PPP loans outstanding 1,449 2,209 2,484 2,310 2,924 PPP loan balance (Round 1 origination), gross $ 9,302 $ 51,547 $ 193,958 $ 333,982 $ 437,793 PPP loan balance (Round 2 origination), gross 148,159 197,035 176,316 n/a n/a Total PPP loans, gross outstanding $ 157,461 $ 248,582 $ 370,274 $ 333,982 $ 437,793 PPP deferred loan fees (Round 1 origination) $ 40 $ 477 $ 2,358 $ 7,212 $ 11,846 PPP deferred loan fees (Round 2 origination) 5,973 8,513 7,072 n/a n/a Total PPP deferred loan fees outstanding $ 6,013 $ 8,990 $ 9,430 $ 7,212 $ 11,846 COVID Deferrals Following the passage of the CARES Act legislation, the "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus" was issued by federal bank regulators, which offers temporary relief from troubled debt restructuring accounting for loan payment deferrals for certain customers whose businesses are experiencing economic hardship due to Coronavirus. The applicable period for this relief, originally expected to expire on December 31, 2020, was extended through 2021 by way of the Consolidated Appropriations Act. The following is a summary of COVID related loan customer modifications with outstanding balances as of September 30, 2021: Modification Type Deferral Term (in thousands) Modified Loan Balances Outstanding % of Total Category of Loans Interest Only Deferral Principal and Interest Deferral 90 Days 180 Days Other Commercial real estate: CRE non-owner occupied $ 22,264 1.5 % 100.0 % — % 17.4 % 65.6 % 17.0 % CRE owner occupied 1,243 0.2 100.0 — — — 100.0 Multifamily — — — — — — — Farmland — — — — — — — Total commercial real estate loans 23,507 0.7 — — 16.5 62.2 21.4 Consumer loans — — — — — — — Commercial and industrial 550 0.1 100.0 — — — 100.0 Construction — — — — — — — Agriculture production — — — — — — — Leases — — — — — — — Total modifications $ 24,057 0.5 % 100.0 % — % 16.1 % 60.8 % 23.1 % Of the remaining balance outstanding as of September 30, 2021, $5,665,000 is related to second deferrals which are expected to conclude their modification period during 2021, and the remainder of deferrals are expected to conclude in the first quarter of 2022. However, as long as the current pandemic and recessionary economic conditions continue, it is possible that additional borrowers may request an initial or subsequent modification to their loan terms. 42 Table of Contents TRICO BANCSHARES Financial Summary (In thousands, except per share amounts; unaudited) Three months ended September 30, Nine months ended September 30, 2021 2020 2021 2020 Net interest income $ 68,233 $ 63,454 $ 201,756 $ 191,305 Reversal of (provision for) credit losses 1,435 (7,649) 7,755 (37,963) Non-interest income 15,095 15,137 47,162 38,614 Non-interest expense (45,807) (46,714) (131,596) (137,013) Provision for income taxes (11,534) (6,622) (35,644) (13,786) Net income $ 27,422 $ 17,606 $ 89,433 $ 41,157 Per Share Data: Basic earnings per share $ 0.92 $ 0.59 $ 3.01 $ 1.37 Diluted earnings per share $ 0.92 $ 0.59 $ 2.99 $ 1.37 Dividends paid $ 0.25 $ 0.22 $ 0.75 $ 0.66 Book value at period end $ 33.05 $ 30.31 Average common shares outstanding 29,714 29,764 29,720 29,971 Average diluted common shares outstanding 29,851 29,844 29,887 30,083 Shares outstanding at period end 29,715 29,769 At period end: Loans 4,887,496 4,826,338 Total investment securities 2,333,015 1,473,935 Total assets 8,458,030 7,449,799 Total deposits 7,236,822 6,340,588 Other borrowings 45,601 27,055 Shareholders’ equity 982,014 902,262 Financial Ratios: During the period: Return on average assets (annualized) 1.30 % 0.95 % 1.48 % 0.79 % Return on average equity (annualized) 11.02 % 7.79 % 12.42 % 6.13 % Net interest margin (1) (annualized) 3.50 % 3.72 % 3.61 % 4.02 % Efficiency ratio 54.97 % 59.44 % 52.87 % 59.59 % Average equity to average assets 11.82 % 12.18 % 11.89 % 12.86 % At end of period: Equity to assets 11.61 % 12.11 % Total capital to risk-adjusted assets 15.41 % 15.23 % (1) Fully taxable equivalent (FTE) The Company announced net income of $27,422,000 for the quarter ended September 30, 2021, compared to $28,362,000 and $17,606,000 during the quarters ended June 30, 2021 and September 30, 2020, respectively. Diluted earnings per share were $0.92, $0.95 and $0.59 for the quarters ended September 30, 2021, June 30, 2021 and September 30, 2020, respectively. Results of Operations The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and the Bank’s financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the Condensed Consolidated Financial Statements of the Company and the Notes thereto located at Item 1 of this report. 43 Table of Contents Net Interest Income The Company’s primary source of revenue is net interest income, or the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. Following is a summary of the components of FTE net income for the periods indicated (dollars in thousands): Three months ended (in thousands) September 30, 2021 June 30, 2021 $ Change % Change Interest income $ 69,628 $ 68,479 $ 1,149 1.7 % Interest expense (1,395) (1,396) 1 (0.1) % Fully tax-equivalent adjustment (FTE) (1) 265 255 10 3.9 % Net interest income (FTE) $ 68,498 $ 67,338 $ 1,160 1.7 % Net interest margin (FTE) 3.50 % 3.58 % Acquired loans discount accretion, net: Amount (included in interest income) $ 2,034 $ 2,566 $ (532) Net interest margin less effect of acquired loan discount accretion (1) 3.40 % 3.44 % (0.04) % PPP loans yield, net: Amount (included in interest income) $ 3,507 $ 3,179 $ 328 Net interest margin less effect of PPP loan yield (1) 3.42 % 3.61 % (0.19) % Acquired loans discount accretion and PPP loan yield, net: (1) Amount (included in interest income) $ 5,541 $ 5,745 $ (204) Net interest margin less effect of acquired loan discount accretion and PPP loan yield (1) 3.31 % 3.47 % (0.16) % Three months ended September 30, (in thousands) 2021 2020 $ Change % Change Interest income $ 69,628 $ 65,438 $ 4,190 6.4 % Interest expense (1,395) (1,984) 589 (29.7) % Fully tax-equivalent adjustment (FTE) (1) 265 254 11 4.3 % Net interest income (FTE) $ 68,498 $ 63,708 $ 4,790 7.5 % Net interest margin (FTE) 3.50 % 3.72 % Acquired loans discount accretion, net: Amount (included in interest income) $ 2,034 $ 1,876 $ 158 Net interest margin less effect of acquired loan discount accretion (1) 3.40 % 3.61 % (0.21) % PPP loans yield, net: Amount (included in interest income) $ 3,507 $ 2,603 $ 904 Net interest margin less effect of PPP loan yield (1) 3.42 % 3.81 % (0.39) % Acquired loans discount accretion and PPP loan yield, net: (1) Amount (included in interest income) $ 5,541 $ 4,479 $ 1,062 Net interest margin less effect of acquired loan discount accretion and PPP loan yield (1) 3.31 % 3.70 % (0.39) % 44 Table of Contents Nine months ended September 30, (in thousands) 2021 2020 $ Change % Change Interest income $ 206,023 $ 199,103 $ 6,920 3.5 % Interest expense (4,267) (7,798) 3,531 (45.3) % Fully tax-equivalent adjustment (FTE) (1) 797 811 (14) (1.7) % Net interest income (FTE) $ 202,553 $ 192,116 $ 10,437 5.4 % Net interest margin (FTE) 3.61 % 4.02 % Acquired loans discount accretion, net: Amount (included in interest income) $ 6,311 $ 6,211 $ 100 Net interest margin less effect of acquired loan discount accretion (1) 3.50 % 3.91 % (0.41) % PPP loans yield, net: Amount (included in interest income) $ 12,549 $ 4,959 $ 7,590 Net interest margin less effect of PPP loan yield (1) 3.53 % 4.07 % (0.54) % Acquired loans discount accretion and PPP loan yield, net: Amount (included in interest income) $ 18,860 $ 11,170 $ 7,690 Net interest margin less effect of acquired loans discount and PPP loan yield (1) 3.41 % 3.91 % (0.50) % (1) Certain information included herein is presented on a fully tax-equivalent (FTE) basis and/or to present additional financial details which may be desired by users of this financial information. The Company believes the use of this non-generally accepted accounting principles (non-GAAP) measure provides additional clarity in assessing its results, and the presentation of these measures is a common practice within the banking industry. Loans may be acquired at a premium or discount to par value, in which case, the premium is amortized (subtracted from) or accreted (added to) interest income over the remaining life of the loan. Generally, as time goes on, the effects of loan discount accretion and loan premium amortization decrease as the purchased loans mature or pay off early. Upon the early pay off of a loan, any remaining unaccreted discount or unamortized premium is immediately taken into interest income; and as loan payoffs may vary significantly from quarter to quarter, so may the impact of discount accretion and premium amortization on interest income. As a result of the increase in interest rates, the prepayment rate of portfolio loans, inclusive of those acquired at a premium or discount, declined during the third quarter of 2021. During the three months ended September 30, 2021, June 30, 2021, and September 30, 2020, purchased loan discount accretion was $2,034,000, $2,566,000, and $1,876,000, respectively. 45 Table of Contents Summary of Average Balances, Yields/Rates and Interest Differential The following table presents, for the three month periods indicated, information regarding the Company’s consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income from average interest-earning assets and resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual loans only to the extent cash payments have been received and applied to interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate (dollars in thousands). For the three months ended September 30, 2021 September 30, 2020 Average Balance Interest Income/ Expense Rates Earned /Paid Average Balance Interest Income/ Expense Rates Earned /Paid Assets: Loans, excluding PPP $ 4,684,492 $ 57,218 4.85 % $ 4,389,672 $ 55,436 5.02 % PPP loans 213,430 3,507 6.52 % 437,892 2,603 2.36 % Investment securities - taxable 2,019,283 7,741 1.52 % 1,261,793 6,376 2.01 % Investment securities - nontaxable (1) 130,028 1,147 3.50 % 114,419 1,102 3.83 % Total investments 2,149,311 8,888 1.64 % 1,376,212 7,478 2.16 % Cash at Federal Reserve and other banks 710,936 280 0.16 % 611,719 175 0.11 % Total interest-earning assets 7,758,169 69,893 3.57 % 6,815,495 65,692 3.83 % Other assets 589,942 565,466 Total assets $ 8,348,111 $ 7,380,961 Liabilities and shareholders’ equity: Interest-bearing demand deposits $ 1,507,697 $ 116 0.03 % $ 1,339,797 $ 56 0.02 % Savings deposits 2,407,368 328 0.05 % 2,075,077 484 0.09 % Time deposits 321,381 411 0.51 % 387,922 872 0.89 % Total interest-bearing deposits 4,236,446 855 0.08 % 3,802,796 1,412 0.15 % Other borrowings 48,330 6 0.05 % 33,750 4 0.05 % Junior subordinated debt 57,891 534 3.66 % 57,475 568 3.93 % Total interest-bearing liabilities 4,342,667 1,395 0.13 % 3,894,021 1,984 0.20 % Noninterest-bearing deposits 2,900,817 2,475,842 Other liabilities 117,601 112,112 Shareholders’ equity 987,026 898,986 Total liabilities and shareholders’ equity $ 8,348,111 $ 7,380,961 Net interest spread (2) 3.45 % 3.63 % Net interest income and interest margin (3) $ 68,498 3.50 % $ 63,708 3.72 % (1) Fully taxable equivalent (FTE) (2) Net interest spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of i nterest-earning assets, then annualized based on the number of days in the given period. Net interest income (FTE) during the three months ended September 30, 2021 increased $4,790,000 or 7.5% to $68,498,000 compared to $63,708,000 for the quarter ended September 30, 2020. Over the same period, net interest margin decreased 22 basis points to 3.50% as compared to 3.72% in the comparative 2020 period. The 22 basis point decrease is primarily attributed to a 17 basis point decrease in non-PPP loan yields, which yielded 4.85% as of September 30, 2021 as compared to 5.02% for the quarter ended September 30, 2020. The following table presents, for the nine month periods indicated, information regarding the Company’s consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income from average interest-earning assets and resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual loans only to the extent cash payments have been received and applied to interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate (dollars in thousands). 46 Table of Contents ANALYSIS OF CHANGE IN NET INTEREST MARGIN ON EARNING ASSETS (unaudited, dollars in thousands) Nine months ended September 30, 2021 Nine months ended September 30, 2020 Average Balance Income/ Expense Yield/ Rate Average Balance Income/ Expense Yield/ Rate Assets Loans, excluding PPP $ 4,580,292 $ 168,916 4.93 % $ 4,360,942 $ 167,747 5.14 % PPP loans 300,006 12,549 5.59 % 244,196 4,959 2.71 % Investments-taxable 1,838,023 21,324 1.55 % 1,249,823 22,637 2.42 % Investments-nontaxable (1) 129,057 3,453 3.58 % 117,745 3,515 3.99 % Total investments 1,967,080 24,777 1.68 % 1,367,568 26,152 2.55 % Cash at Federal Reserve and other banks 656,912 578 0.12 % 403,252 1,056 0.35 % Total earning assets 7,504,290 206,820 3.68 % 6,375,958 199,914 4.19 % Other assets, net 591,983 595,617 Total assets $ 8,096,273 $ 6,971,575 Liabilities and shareholders’ equity Interest-bearing demand deposits $ 1,476,987 $ 269 0.02 % $ 1,293,071 $ 289 0.03 % Savings deposits 2,318,169 965 0.06 % 1,971,348 2,190 0.15 % Time deposits 327,562 1,386 0.57 % 409,005 3,297 1.08 % Total interest-bearing deposits 4,122,718 2,620 0.08 % 3,673,424 5,776 0.21 % Other borrowings 40,732 15 0.05 % 26,223 13 0.07 % Junior subordinated debt 57,790 1,632 3.78 % 57,374 2,009 4.68 % Total interest-bearing liabilities 4,221,240 4,267 0.14 % 3,757,021 7,798 0.28 % Noninterest-bearing deposits 2,790,828 2,197,315 Other liabilities 121,334 120,486 Shareholders’ equity 962,871 896,753 Total liabilities and shareholders’ equity $ 8,096,273 $ 6,971,575 Net interest rate spread (1) (2) 3.54 % 3.91 % Net interest income and margin (1) (3) $ 202,553 3.61 % $ 192,116 4.02 % (1) Fully taxable equivalent (FTE). All yields and rates are calculated using specific day counts for the period and year as applicable. (2) Net interest spread is the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets. Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid The following table sets forth, for the period identified, a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components. Three months ended September 30, 2021 compared with three months ended September 30, 2020 (in thousands) Volume Rate Total Increase (decrease) in interest income: Loans, including PPP $ 1,298 $ 1,388 $ 2,686 Investment securities (1) 11,287 (9,877) 1,410 Cash at Federal Reserve and other banks 27 78 105 Total interest-earning assets 12,612 (8,411) 4,201 Increase (decrease) in interest expense: Interest-bearing demand deposits 8 52 60 Savings deposits 75 (231) (156) Time deposits (148) (313) (461) Other borrowings 2 — 2 Junior subordinated debt 4 (38) (34) Total interest-bearing liabilities (59) (530) (589) Increase (decrease) in net interest income $ 12,671 $ (7,881) $ 4,790 Nine months ended September 30, 2021 compared with nine months ended September 30, 2020 (in thousands) Volume Rate Total Increase (decrease) in interest income: Loans, including PPP $ 10,607 $ (1,848) $ 8,759 Investment securities (1) 28,822 (30,197) (1,375) Cash at Federal Reserve and other banks 666 (1,144) (478) Total interest-earning assets 40,095 (33,189) 6,906 Increase (decrease) in interest expense: Interest-bearing demand deposits 41 (61) (20) Savings deposits 390 (1,615) (1,225) Time deposits (660) (1,251) (1,911) Other borrowings 8 (6) 2 Junior subordinated debt 15 (392) (377) Total interest-bearing liabilities (206) (3,325) (3,531) Increase (decrease) in net interest income $ 40,301 $ (29,864) $ 10,437 ( (1) Fully taxable equivalent (FTE) The following commentary regarding net interest income, interest income and interest expense may be best understood while referencing the Summary of Average Balances, Yields/Rates and Interest Differential and the Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid shown above. Net interest income (FTE) during the three months ended September 30, 2021 increased $4,790,000 or 7.5% to $68,498,000 compared to $63,708,000 during the three months ended September 30, 2020. The overall increase in net interest income (FTE) was due to largely an increase in average loan volume, including PPP, and related yield earned on loans, which combined resulted in an improvement totaling $2,686,000. Investment securities also contributed $1,410,000 in additional yield. Declining interest rates also continued to benefit the interest expense on deposits, resulting in a decrease of $589,000 in related costs. Net interest income (FTE) during the nine months ended September 30, 2021 increased $10,437,000 or 5.4% to $202,553,000 compared to $192,116,000 during the nine months ended September 30, 2020. The overall increase in net interest income (FTE) was due to an increase in average loan volume, including PPP, which net of the impact of declining yields resulted in a change totaling $8,759,000. Declining interest rates also continued to benefit the yield expense on deposits, resulting in a decrease of 3,531,000 in related expense. As an offset, depressed interest rates on investment securities continue to incentive pre-payment on existing debt and promote new debt issuances being purchased with lower coupon yields, resulting in a decline of $1,375,000 in yield during the nine month period. 47 Table of Contents Asset Quality and Loan Loss Provisioning During the three months ended September 30, 2021, the Company recorded a reversal of provision for credit losses of $1,435,000, as compared to a reversal of provision for credit losses of $260,000 during the trailing quarter, and a provision expense of $7,649,000 during the third quarter of 2020. The following table presents details of the provision for credit losses for the periods indicated: Three months ended (in thousands) September 30, 2021 June 30, 2021 March 31, 2021 December 31, 2020 September 30, 2020 Addition to (reversal of) allowance for credit losses $ (1,495) $ (145) $ (6,240) $ 4,450 $ 7,649 Addition to (reversal of) unfunded loan commitments 60 (115) 180 400 — Total provision for credit losses $ (1,435) $ (260) $ (6,060) $ 4,850 $ 7,649 Three months ended Nine months ended (dollars in thousands) September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020 Balance, beginning of period $ 86,062 $ 79,739 $ 91,847 $ 30,616 Impact from adoption of ASU 2016-13 — — — 18,913 Provision for (reversal of) credit losses (1,495) 7,649 (7,880) 37,738 Loans charged-off (1,582) (194) (2,195) (1,195) Recoveries of previously charged-off loans 1,321 381 2,534 1,503 Balance, end of period $ 84,306 $ 87,575 $ 84,306 $ 87,575 The allowance for credit losses (ACL) was $84,306,000 as of September 30, 2021, a net decrease of $1,756,000 over the immediately preceding quarter. The reversal of allowance for credit losses of $1,495,000 was necessary as net charge-offs totaling $261,000 during the quarter were less than the required changes in quantitative and qualitative reserve components. More specifically, the quantitative reserve required under the cohort model reduced required reserves by $1,762,000, in addition to a decrease in specific reserves on impaired totals of $874,000 as of quarter end. The Company utilizes a forecast period of approximately eight quarters and obtains the forecast data from publicly available sources as of the balance sheet date. This forecast data continues to evolve and included improving shifts in the magnitude of changes for both the unemployment and GDP factors leading up to the balance sheet date. However, management notes that the majority of economic forecasts utilized in the ACL calculation have remained directionally consistent with preceding quarters, as general economic conditions continue to improve, albeit at a pace slower than expected due to unforeseen disruptions in the supply chain and increasing energy prices. In addition, management notes that the level of governmental assistance provided through PPP as well as other programs during the last several quarters has been unprecedented. As a result, management continues to believe that certain credit weakness are likely present in the overall economy and that it is appropriate to maintain a reserve level that incorporates such risk factors. Loans past due 30 days or more increased by $1,247,000 during the quarter ended September 30, 2021 to $10,539,000, as compared to $9,292,000 at June 30, 2021. Non-performing loans were $28,790,000 at September 30, 2021, a decrease of $3,915,000 and $5,827,000, respectively, from $32,705,000 and $22,963,000 as of June 30, 2021, and September 30, 2020, respectively. The following table illustrates the total loans by risk rating and their respective percentage of total loans for the periods presented. September 30, % of Total Loans June 30, % of Total Loans September 30, % of Total Loans (dollars in thousands) 2021 2021 2020 Risk Rating: Pass $ 4,698,475 96.1 % $ 4,756,381 96.2 % $ 4,630,266 95.9 % Special Mention 138,699 2.9 % 130,232 2.6 % 147,343 3.1 % Substandard 50,322 1.0 % 58,281 1.2 % 48,729 0.9 % Total $ 4,887,496 $ 4,944,894 $ 4,826,338 Classified loans to total loans 1.03 % 1.18 % 1.01 % Loans past due 30+ days to total loans 0.22 % 0.19 % 0.22 % The Company's loan portfolio for non-classified loans (loans graded special mention or better) remains consistent for the quarter ended September 30, 2021, as compared to the trailing quarter June 30, 2021, representing 99.0% and 98.8% of total loans outstanding, respectively. Loans risk graded special mention increased by approximately $8,466,000 during the quarter ended September 30, 2021 as compared to the trailing quarter, while loans risk graded substandard decreased by $8,047,000 over the same period. 48 Table of Contents There was one addition to other real estate owned totaling $560,000, including a $113,000 fair value benefit, during the quarter ended September 30, 2021 and there was one sale for proceeds of approximately $189,000, which generated a net gain of $31,000 for the quarter. As of September 30, 2021, other real estate owned consisted of six properties with a carrying value of approximately $2,650,000. Non-interest Income The following table summarizes the Company’s non-interest income for the periods indicated (in thousands): Three months ended September 30, (in thousands) 2021 2020 $ Change % Change ATM and interchange fees $ 6,516 $ 5,637 $ 879 15.6 % Service charges on deposit accounts 3,608 3,334 274 8.2 % Other service fees 897 805 92 11.4 % Mortgage banking service fees 476 457 19 4.2 % Change in value of mortgage servicing rights (232) 236 (468) (198.3) % Total service charges and fees 11,265 10,469 796 7.6 % Increase in cash value of life insurance 644 773 (129) (16.7) % Asset management and commission income 957 667 290 43.5 % Gain on sale of loans 1,814 3,035 (1,221) (40.2) % Lease brokerage income 183 175 8 4.6 % Sale of customer checks 107 91 16 17.6 % Gain on sale of investment securities — 7 (7) n/m Gain (loss) on marketable equity securities (14) — (14) n/m Other 139 (80) 219 (273.8) % Total other non-interest income 3,830 4,668 (838) (18.0) % Total non-interest income $ 15,095 $ 15,137 $ (42) (0.3) % Non-interest income decreased $42,000 or 0.3% to $15,095,000 during the three months ended September 30, 2021, compared to $15,137,000 during the comparable 2020 quarter. Following the relaxed social distancing guidelines, increased debit card usage benefited ATM and interchange fees, increasing by $879,000, during the recent quarter ended. Conversely, changes in the value of mortgage servicing rights and gain on sale of mortgage loans declined by $468,000 and $1,221,000, respectively, during the three months ended September 30, 2021 as compared to the equivalent period in 2020. The following table presents the key components of non-interest income for the current and prior year periods indicated: Nine months ended September 30, (in thousands) 2021 2020 $ Change % Change ATM and interchange fees $ 18,935 $ 15,913 $ 3,022 19.0 % Service charges on deposit accounts 10,339 10,426 (87) (0.8) % Other service fees 2,682 2,296 386 16.8 % Mortgage banking service fees 1,406 1,386 20 1.4 % Change in value of mortgage servicing rights (691) (2,258) 1,567 (69.4) % Total service charges and fees 32,671 27,763 4,908 17.7 % Increase in cash value of life insurance 2,062 2,203 (141) (6.4) % Asset management and commission income 2,738 2,244 494 22.0 % Gain on sale of loans 7,908 5,662 2,246 39.7 % Lease brokerage income 542 495 47 9.5 % Sale of customer checks 342 303 39 12.9 % Gain on sale of investment securities — 7 (7) n/m Gain (loss) on marketable equity securities (59) 72 (131) (181.9) % Other 958 (135) 1,093 (809.6) % Total other non-interest income 14,491 10,851 3,640 33.5 % Total non-interest income $ 47,162 $ 38,614 $ 8,548 22.1 % Total non-interest income increased by $8,548,000 or 22.1% to $47,162,000 during the nine months ended September 30, 2021, compared to $38,614,000 during the trailing quarter June 30, 2021. Most notably, the historically low rate environment has benefited the production volumes of mortgage loans that are originated and sold for a gain which contributed $2,246,000 to the overall increase in non-interest income. Other non-interest income increased by $1,093,000 or 809.6% for the nine months ended September 30, 2021. The nine months ended 2020 period included a reduction of income totaling $577,000 attributed to decreases in the fair value of assets used to fund acquired deferred compensation plans, as compared to an increase in income totaling $370,000 during the same period in 2021. The remaining changes in non-interest income for the nine months ended September 30, 2021 and 2020 are generally consistent with the changes in the 49 Table of Contents comparable three month periods discussed above. Non-interest Expense The following table summarizes the Company’s non-interest expense for the periods indicated: Three months ended September 30, (in thousands) 2021 2020 $ Change % Change Base salaries, net of deferred loan origination costs $ 17,673 $ 18,754 $ (1,081) (5.8) % Incentive compensation 3,123 2,184 939 43.0 % Benefits and other compensation costs 5,478 8,383 (2,905) (34.7) % Total salaries and benefits expense 26,274 29,321 (3,047) (10.4) % Occupancy 3,771 3,440 331 9.6 % Data processing and software 3,689 3,561 128 3.6 % Equipment 1,336 1,549 (213) (13.8) % Intangible amortization 1,409 1,431 (22) (1.5) % Advertising 966 869 97 11.2 % ATM and POS network charges 1,692 1,314 378 28.8 % Professional fees 1,090 955 135 14.1 % Telecommunications 574 619 (45) (7.3) % Regulatory assessments and insurance 673 538 135 25.1 % Merger and acquisition expense 651 — 651 n/m Postage 156 118 38 32.2 % Operational losses 244 154 90 58.4 % Courier service 286 345 (59) (17.1) % Gain on sale or acquisition of foreclosed assets (144) — (144) n/m (Gain) loss on disposal of fixed assets (19) 22 (41) (186.4) % Other miscellaneous expense 3,159 2,478 681 27.5 % Total other non-interest expense 19,533 17,393 2,140 12.3 % Total non-interest expense $ 45,807 $ 46,714 $ (907) (1.9) % Average full time equivalent staff 1,049 1,105 (56) (5.1) % Non-interest expense decreased by $907,000 or 1.9% to $45,807,000 during the three months ended September 30, 2021 as compared to $46,714,000 for the three months ended September 30, 2020. Salaries, net of deferred loan origination costs, decreased by $1,081,000 to $17,673,000 for the three months ended September 30, 2021. The comparative period in 2020 included approximately $400,000 in non-recurring severance costs from reductions in personnel and a reduction of nearly $745,000 in deferred loan origination costs following a taper of the first round of PPP loan origination volume. Benefits and other compensation expense decreased by $2,905,000 during the three months ended September 30, 2021, primarily the result of decreases in expenses associated with retirement obligations and group insurance costs. Approximately $95,000 of the increase in occupancy expense is attributable to the Company's recently opened loan production offices. 50 Table of Contents The following table presents the key components of non-interest income for the current and prior year periods indicated: Nine months ended September 30, (in thousands) 2021 2020 $ Change % Change Base salaries, net of deferred loan origination costs $ 50,721 $ 53,654 $ (2,933) (5.5) % Incentive compensation 11,025 7,680 3,345 43.6 % Benefits and other compensation costs 16,939 22,314 (5,375) (24.1) % Total salaries and benefits expense 78,685 83,648 (4,963) (5.9) % Occupancy 11,197 10,713 484 4.5 % Data processing and software 10,092 10,585 (493) (4.7) % Equipment 4,060 4,411 (351) (8.0) % Intangible amortization 4,271 4,293 (22) (0.5) % Advertising 2,080 2,065 15 0.7 % ATM and POS network charges 4,489 3,897 592 15.2 % Professional fees 2,730 2,399 331 13.8 % Telecommunications 1,719 1,983 (264) (13.3) % Regulatory assessments and insurance 1,903 993 910 91.6 % Merger and acquisition expense 651 — 651 n/m Postage 478 691 (213) (30.8) % Operational losses 665 559 106 19.0 % Courier service 868 1,013 (145) (14.3) % Gain on sale or acquisition of foreclosed assets (210) (57) (153) 268.4 % (Gain) loss on disposal of fixed assets (445) 37 (482) (1302.7) % Other miscellaneous expense 8,363 9,783 (1,420) (14.5) % Total other non-interest expense 52,911 53,365 (454) (0.9) % Total non-interest expense $ 131,596 $ 137,013 $ (5,417) (4.0) % Average full-time equivalent staff 1,031 1,129 (98) (8.7) % The changes in non-interest expense for the nine months ended September 30, 2021 and 2020 are generally consistent with the changes in the comparable three month periods discussed above. Changes in incentive compensation expense were impacted primarily by increases in net loan growth which, excluding PPP, totaled approximately $335,658,000 for the nine months ended September 30, 2021 as compared to $218,042,000 during the similar nine month period in the prior year. For the nine months ended September 30, 2021, approximately $944,000 of total expenses are attributable to the Company's recently opened loan production offices, of which approximately $824,000 relates to salaries and benefits. Regulatory assessment and insurance expense increased in the current year to date period primarily due to the expiration of credits during the 2020 year and to a lesser extent, the overall balance sheet growth of the Bank. Income Taxes The Company’s effective tax rate was 28.5% for the nine months ended September 30, 2021, as compared to 25.8% for the year ended December 31, 2020. The reduced effective tax rate in the prior year was made possible through the provisions of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) which provided the Company with an opportunity to file amended tax returns and generate proposed refunds of approximately $805,000. While the Company has initiated several tax strategies in anticipation of future tax rate increases, it is not anticipated that any will directly impact the Company's effective tax rate until such rate changes have been legislatively approved. Other differences between the Company's effective tax rate and applicable federal and state statutory rates are due to the proportion of non-taxable revenue and low income housing tax credits as compared to the levels of pre-tax earnings. Financial Condition For financial reporting purposes, the Company does not separately track the changes in assets and liabilities based on branch location or regional geography. The following is a comparison of the quarterly change in certain assets and liabilities: 51 Table of Contents (in thousands) As of September 30, 2021 As of June 30, 2021 $ Change Annualized % Change Ending balances Total assets $ 8,458,030 $ 8,170,365 $ 287,665 14.1 % Total loans 4,887,496 4,944,894 (57,398) (4.6) % Total PPP loans 151,448 239,592 (88,144) (147.2) % Total investments 2,333,015 2,103,575 229,440 43.6 % Total deposits 7,236,822 6,992,053 244,769 14.0 % Total noninterest-bearing deposits 2,943,016 2,843,783 99,233 14.0 % Total other borrowings 45,601 40,559 5,042 49.7 % Organic loan growth, excluding PPP, of $30,746,000 or 2.6% on an annualized basis was realized during the quarter ended September 30, 2021, primarily within commercial real estate. In addition, investment security growth was $229,440,000 or 43.6% on an annualized basis as excess liquidity continued to be put to use in higher yielding earning assets. Earning asset growth was funded by the continued growth of deposit balances which increased during the third quarter of 2021 by $244,769,000 or 14.0% annualized. The following is a comparison of the year over year change in certain assets and liabilities: As of September 30, $ Change % Change (in thousands) 2021 2020 Ending balances Total assets $ 8,458,030 $ 7,449,799 $ 1,008,231 13.5 % Total loans 4,887,496 4,826,338 61,158 1.3 % Total PPP loans 151,448 425,947 (274,499) (64.4) % Total investments 2,333,015 1,473,935 859,080 58.3 % Total deposits 7,236,822 6,340,588 896,234 14.1 % Total noninterest-bearing deposits 2,943,016 2,517,819 425,197 16.9 % Total other borrowings 45,601 27,055 18,546 68.5 % The PPP program and other forms of stimulus payments have increased deposit levels significantly during the 12 months ended September 30, 2021. While excess deposit proceeds are ratably being allocated to the purchase of investment securities with short and medium term durations to improve overall margin, we expect to maintain above average levels of liquidity into 2022, as the economic impacts of COVID-19, Federal economic policy changes, and the extent of future Federal and state stimulus remains uncertain. Investment securities increased to $2,333,015,000 at September 30, 2021, a change of $859,080,000 or 58.3% from $1,473,935,000 at September 30, 2020. Investment Securities Investment securities available for sale increased $681,557,000 to $2,095,821,000 as of September 30, 2021, compared to December 31, 2020. This increase is primarily supported by deposit growth and available cash reserves. There were no sales of investment securities during the three and nine months ended September 30, 2021 and 2020, respectively. The following table presents the available for sale debt securities portfolio by major type as of September 30, 2021 and December 31, 2020: September 30, 2021 December 31, 2020 (in thousands) Fair Value % Fair Value % Debt securities available for sale : Obligations of U.S. government agencies $ 1,244,616 59.4 % $ 812,374 57.4 % Obligations of states and political subdivisions 168,107 8.0 % 129,095 9.1 % Corporate bonds 6,796 0.3 % 2,544 0.2 % Asset backed securities 676,302 32.3 % 470,251 33.3 % Total debt securities available for sale $ 2,095,821 100.0 % $ 1,414,264 100.0 % 52 Table of Contents September 30, 2021 December 31, 2020 (in thousands) Amortized Cost % Amortized Cost % Debt securities held to maturity : Obligations of U.S. government and agencies $ 208,127 95.9 % $ 273,667 96.2 % Obligations of states and political subdivisions 8,852 4.1 % 10,896 3.8 % Total debt securities held to maturity $ 216,979 100.0 % $ 284,563 100.0 % Investment securities held to maturity decreased $67,584,000 to $216,979,000 as of September 30, 2021, as compared to December 31, 2020. This decrease is attributable to calls and principal repayments of $66,880,000, and amortization of net purchase premiums of $704,000. Loans The Company concentrates its lending activities in six principal areas: commercial real estate loans, consumer loans, commercial and industrial loans, construction loans, agriculture production loans and leases. The interest rates charged for the loans made by the Company vary with the degree of risk, the size and maturity of the loans, the borrower’s relationship with the Company and prevailing money market rates indicative of the Company’s cost of funds. The majority of the Company’s loans are direct loans made to individuals, farmers and local businesses. The Company relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions. The Company makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment. The following table shows the Company’s loan balances, net deferred loan costs and discounts, as of the dates indicated: (in thousands) September 30, 2021 December 31, 2020 Commercial real estate $ 3,222,737 65.94 % $ 2,951,902 61.97 % Consumer 1,053,653 21.56 % 952,108 19.99 % Commercial and industrial 345,027 7.06 % 526,327 11.05 % Construction 216,680 4.43 % 284,842 5.98 % Agriculture production 44,410 0.91 % 44,164 0.93 % Leases 4,989 0.10 % 3,784 0.08 % Total loans $ 4,887,496 100.0 % $ 4,763,127 100.0 % As of September 30, 2021 and December 31, 2020, the total gross balance outstanding of PPP loans was $157,461,000 and $333,982,000 as compared to total PPP originations of $640,410,000. In connection with the origination of these loans, the Company earned approximately $25,299,000 in loan fees, offset by deferred loan costs of approximately $1,245,000, the net of which will be recognized over the earlier of loan maturity (between 24-60 months), repayment or receipt of forgiveness confirmation. As of September 30, 2021 and December 31, 2020, there was approximately $6,013,000 and $7,212,000 in net deferred fee income remaining to be recognized. During the three and nine months ended September 30, 2021, the Company recognized $2,984,000 and $10,306,000, respectively in fees on PPP loans. During the three and nine months ended September 30, 2020, the Company recognized $2,603,000 and $4,959,000 in fees on PPP loans. 53 Table of Contents Nonperforming Assets The following tables set forth the amount of the Company’s nonperforming assets ("NPA") as of the dates indicated. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection: (in thousands) September 30, 2021 December 31, 2020 Performing nonaccrual loans $ 26,169 $ 22,896 Nonperforming nonaccrual loans 2,621 3,968 Total nonaccrual loans 28,790 26,864 Loans 90 days past due and still accruing — — Total nonperforming loans 28,790 26,864 Foreclosed assets 2,650 2,844 Total nonperforming assets $ 31,440 $ 29,708 Nonperforming assets to total assets 0.37 % 0.39 % Nonperforming loans to total loans 0.59 % 0.56 % Allowance for credit losses to nonperforming loans 341 % 342 % 54 Table of Contents Changes in nonperforming assets during the three months ended September 30, 2021 (in thousands) Balance at June 30, 2021 New NPA / Valuation Adjustments Pay-downs /Sales /Upgrades Charge-offs/ (1) Write-downs Transfers to Foreclosed Assets Balance at September 30, 2021 Commercial real estate: CRE non-owner occupied $ 8,515 — (784) (18) — $ 7,713 CRE owner occupied 5,610 — (733) — — 4,877 Multifamily 171 4,397 (8) — — 4,560 Farmland 1,346 37 (110) (126) — 1,147 Total commercial real estate loans 15,642 4,434 (1,635) (144) — 18,297 Consumer SFR 1-4 1st DT liens 4,328 — 97 (145) (447) 3,833 SFR HELOCs and junior liens 4,604 217 (787) — — 4,034 Other 113 75 (12) (92) — 84 Total consumer loans 9,045 292 (702) (237) (447) 7,951 Commercial and industrial 3,615 33 (129) (1,112) — 2,407 Construction 4,402 — (4,387) — — 15 Agriculture production — 120 — — — 120 Leases — — — — — — Total nonperforming loans 32,704 4,879 (6,853) (1,493) (447) 28,790 Foreclosed assets 2,248 113 (158) — 447 2,650 Total nonperforming assets $ 34,952 4,992 (7,011) (1,493) — $ 31,440 (1) The table above does not include deposit overdraft charge-offs. Nonperforming assets decreased during the three months ended September 30, 2021 by $3,512,000 (10.0%) to $31,440,000 at September 30, 2021 compared to $34,952,000 at June 30, 2021. The decrease in nonperforming assets during the third quarter of 2021 was primarily the result gross pay-downs of $7,011,000, which included $4,387,000 of construction loans transferred to multifamily, and write-downs of $1,493,000, which were partially offset by new nonperforming assets of $492,000. During the third quarter of 2021, a credit totaling $4,387,000 was transferred from Construction to Multifamily as part of the original contractual terms of the note agreement. Excluding this loan, new non performing loans added during the third quarter totaled just $492,000. Management is actively engaged in the collection and recovery efforts for all nonperforming assets and believes that the specific loan loss reserves associated with these loans is sufficient as of September 30, 2021. Loan charge-offs during the three months ended September 30, 2021 In the third quarter of 2021, the Company recorded $1,493,000 in loan charge-offs and $89,000 in deposit overdraft charge-offs less $1,288,000 in loan recoveries and $33,000 in deposit overdraft recoveries, which collectively resulted in $261,000 of net recoveries. Loan charge-offs within the commercial and industrial portfolio totaled $1,112,000, with $655,000 related to a single borrower and two additional borrowers with charge-offs totaling $199,000 and $100,000, respectively. Concentrated recovery activity included $793,000 from a single CRE owner-occupied borrower and $290,000 from a single commercial and industrial loan. 55 Table of Contents Changes in nonperforming assets during the nine months ended September 30, 2021 (in thousands) Balance at December 31, 2020 New NPA / Valuation Adjustments Pay-downs /Sales /Upgrades Charge-offs/ (1) Write-downs Transfers to Foreclosed Assets Balance at September 30, 2021 Commercial real estate: CRE non-owner occupied $ 3,110 5,776 (1,155) (18) — $ 7,713 CRE owner occupied 4,061 2,135 (1,319) — — 4,877 Multifamily — 4,568 (8) — — 4,560 Farmland 1,538 37 (302) (126) — 1,147 Total commercial real estate loans 8,709 12,516 (2,784) (144) — 18,297 Consumer SFR 1-4 1st DT liens 5,093 44 (610) (145) (549) 3,833 SFR HELOCs and junior liens 6,148 861 (2,975) — — 4,034 Other 167 166 (20) (229) — 84 Total consumer loans 11,408 1,071 (3,605) (374) (549) 7,951 Commercial and industrial 2,183 2,481 (810) (1,447) — 2,407 Construction 4,546 — (4,531) — — 15 Agriculture production 18 120 (18) — — 120 Leases — — — — — — Total nonperforming loans 26,864 16,188 (11,748) (1,965) (549) 28,790 Foreclosed assets 2,844 113 (856) — 549 2,650 Total nonperforming assets $ 29,708 16,301 (12,604) (1,965) — $ 31,440 (1) The table above does not include deposit overdraft charge-offs. Nonperforming assets increased during the nine months ended September 30, 2021 by $1,732,000 (5.8%) to $31,440,000 at September 30, 2021 compared to $29,708,000 at December 31, 2020. Excluding the loan totaling $4,387,000 transferred from Construction to Multifamily, the increase in nonperforming assets during the first nine months of 2021 was primarily the result of new nonperforming loans of $11,801,000, which were partially offset by pay-downs of $8,217,000 and write-downs of $1,965,000. Loan charge-offs during the nine months ended September 30, 2021 During the nine months ended September 30, 2021, the Company recorded $1,965,000 in loan charge-offs and $230,000 in deposit overdraft charge-offs less $2,437,000 in loan recoveries and $97,000 in deposit overdraft recoveries, which collectively resulted in $339,000 of net recoveries. The Components of the Allowance for Credit Losses for Loans The following table sets forth the allowance for credit losses as of the dates indicated: (in thousands) September 30, 2021 June 30, 2021 March 31, 2021 December 31, 2020 September 30, 2020 Allowance for credit losses: Qualitative and forecast factor allowance $ 58,998 $ 58,118 $ 56,500 $ 61,935 $ 56,393 Cohort model allowance reserves 24,475 26,237 27,959 28,462 30,373 Total allowance for credit losses 83,473 84,355 84,459 90,397 86,766 Allowance for individually evaluated loans 833 1,707 1,482 1,450 809 Allowance for PCD loan losses — — — — — Total allowance for credit losses $ 84,306 $ 86,062 $ 85,941 $ 91,847 $ 87,575 Allowance for credit losses for loans / Total loans 1.72 % 1.74 % 1.73 % 1.93 % 1.81 % For additional information regarding the allowance for loan losses, including changes in specific, formula, and environmental factors allowance categories, see “Asset Quality and Loan Loss Provisioning” at “Results of Operations” , above. Based on the current conditions of the loan portfolio, management believes that the $84,306,000 allowance for loan losses at September 30, 2021 is adequate to absorb probable losses inherent in the Bank’s loan portfolio. No assurance can be given, however, that adverse economic conditions or other circumstances will not result in increased losses in the portfolio. 56 Table of Contents The following table summarizes the allocation of the allowance for credit losses between loan types and by percentage of the total allowance for loan losses as of the dates indicated: September 30, 2021 December 31, 2020 September 30, 2020 Commercial real estate $ 50,729 60.2 % 53,693 58.5 % $ 50,294 57.4 % Consumer 23,491 27.9 % 25,148 27.4 % 24,007 27.4 % Commercial and industrial 3,427 4.1 % 4,252 4.6 % 4,534 5.2 % Construction 5,528 6.6 % 7,540 8.2 % 7,640 8.7 % Agriculture production 1,119 1.2 % 1,209 1.3 % 1,093 1.3 % Leases 12 — % 5 — % 7 — % Total allowance for credit losses $ 84,306 100.0 % 91,847 100.0 % $ 87,575 100.0 % The following table summarizes the allocation of the allowance for credit losses as a percentage of the total loans for each loan category as of the dates indicated: September 30, 2021 December 31, 2020 September 30, 2020 Commercial real estate $ 3,222,737 1.57 % $ 2,951,902 1.82 % $ 2,936,422 1.71 % Consumer 1,053,653 2.22 % 952,108 2.62 % 926,835 2.57 % Commercial and industrial 345,027 0.99 % 526,327 0.81 % 633,897 0.72 % Construction 216,680 2.55 % 284,842 2.65 % 284,933 2.68 % Agriculture production 44,410 2.52 % 44,164 2.74 % 40,613 2.69 % Leases 4,989 0.24 % 3,784 0.13 % 3,638 0.19 % Total loans $ 4,887,496 1.72 % $ 4,763,127 1.93 % $ 4,826,338 1.88 % 57 Table of Contents The following table summarizes the activity in the allowance for credit losses for the periods indicated: Three months ended September 30, Nine months ended September 30, (in thousands) 2021 2020 2021 2020 Allowance for credit losses: Balance at beginning of period $ 86,062 $ 79,739 $ 91,847 $ 30,616 Impact of adoption from ASU 2016-13 — — — 18,913 Provision for (reversal of) loan losses (1,495) 7,649 (7,880) 37,738 Loans charged-off: Commercial real estate: CRE non-owner occupied — — — — CRE owner occupied (18) — (18) — Multifamily — — — — Farmland (126) — (126) — Consumer: SFR 1-4 1st DT liens (145) (2) (145) (13) SFR HELOCs and junior liens — — — (23) Other (181) (98) (460) (471) Commercial and industrial (1,112) (94) (1,446) (688) Construction — — — — Agriculture production — — — — Leases — — — — Total loans charged-off (1,582) (194) (2,195) (1,195) Recoveries of previously charged-off loans: Commercial real estate: CRE non-owner occupied 10 23 12 223 CRE owner occupied 793 1 794 3 Multifamily — — — — Farmland — — — — Consumer: Home equity lines 1 2 12 414 Home equity loans 63 126 860 265 Other consumer 97 85 262 253 Commercial and industrial 355 142 570 323 Construction — — — — Agriculture production 2 2 24 22 Leases — — — — Total recoveries of previously charged-off loans 1,321 381 2,534 1,503 Net (charge-offs) recoveries (261) 187 339 308 Balance at end of period $ 84,306 $ 87,575 $ 84,306 $ 87,575 Average total loans $ 4,897,922 $ 4,827,564 $ 4,880,298 $ 4,605,138 Ratios (annualized): Net recoveries (charge-offs) during period to average loans outstanding during period (0.02) % 0.02 % 0.01 % 0.01 % Provision for credit losses (benefit from reversal of) to average loans outstanding during period (0.12) % 0.63 % (0.32) % 1.64 % 58 Table of Contents Foreclosed Assets, Net of Allowance for Losses The following table details the components and summarize the activity in foreclosed assets, net of allowances for losses, for the nine months ended September 30, 2021: (in thousands) Balance at December 31, 2020 Sales Valuation Adjustments Transfers from Loans Balance at September 30, 2021 Land & construction $ 154 $ — $ — $ — $ 154 Residential real estate 1,507 (868) 125 549 1,313 Commercial real estate 1,183 — — — 1,183 Total foreclosed assets $ 2,844 $ (868) $ 125 $ 549 $ 2,650 Deposits During the three and nine months ended September 30, 2021, the Company’s deposits increased by $244,769,000 and $730,888,000, respectively, to $7,236,822,000 at quarter ended. Included in the September 30, 2021 and December 31, 2020 certificate of deposit balances are $10,000,000, respectively, from the State of California. The Company participates in a deposit program offered by the State of California whereby the State may make deposits at the Company’s request subject to collateral and creditworthiness constraints. The negotiated rates on these State deposits are generally more favorable than other wholesale funding sources available to the Company. Off-Balance Sheet Arrangements See Note 7 to the condensed consolidated financial statements at Item 1 of Part I of this report for information about the Company’s commitments and contingencies including off-balance-sheet arrangements. Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by Management. On February 25, 2021 the Board of Directors approved the authorization to repurchase up to 2,000,000 shares of the Company's common stock (the 2021 Repurchase Plan), which approximated 6.7% of the shares outstanding as of the approval date. The actual timing of any share repurchases will be determined by the Company's management and therefore the total value of the shares to be purchased under the program is subject to change. The 2021 Repurchase Plan has no expiration date (in accordance with applicable laws and regulations) and during the three and nine month periods September 30, 2021, the Company repurchased zero and 63,317 shares with a market value of $2,831,000, respectively. In connection with approval of the 2021 Repurchase Plan, the Company’s previous repurchase program adopted on November 12, 2019 (the 2019 Repurchase Plan) was terminated. Under the 2019 Repurchase Plan, during the nine months ended September 30, 2021, the Company repurchased 223 shares with a market value of approximately $8,000. The Company repurchased 858,717 shares during 2020. The Company’s primary capital resource is shareholders’ equity, which totaled $982,014,000 at September 30, 2021. This amount represents an increase of $24,241,000 during the quarter ended June 30, 2021, primarily as a result of net income of $28,362,000, plus an increase in accumulated other comprehensive income of $5,206,000, offset by $7,430,000 in cash dividends paid on common stock. The Company’s ratio of equity to total assets was 11.8% and 12.1% as of September 30, 2021 and December 31, 2020, respectively. We believe that the Company and the Bank were in compliance with applicable minimum capital requirements set forth in the final Basel III Capital rules as of September 30, 2021. The following summarizes the Company’s ratios of capital to risk-adjusted assets as of the dates indicated: September 30, 2021 December 31, 2020 Ratio Minimum Regulatory Requirement Ratio Minimum Regulatory Requirement Total risk based capital 15.4 % 10.5 % 15.2 % 10.5 % Tier I capital 14.2 % 8.5 % 14.0 % 8.5 % Common equity Tier 1 capital 13.2 % 7.0 % 12.9 % 7.0 % Leverage 9.9 % 4.0 % 9.9 % 4.0 % 59 Table of Contents See Note 8 and Note 14 to the condensed consolidated financial statements at Item 1 of Part I of this report for additional information about the Company’s capital resources. As of September 30, 2021, we had an effective shelf registration statement on file with the Securities and Exchange Commission that allows us to issue various types of debt securities, as well as common stock, preferred stock, warrants, depositary shares representing fractional interest in shares of preferred stock, purchase contracts and units from time to time in one or more offerings. Each issuance under the shelf registration statement will require the filing of a prospectus supplement identifying the amount and terms of the securities to be issued. The registration statement does not limit the amount of securities that may be issued thereunder. Our ability to issue securities is subject to market conditions and other factors including, in the case of our debt securities, our credit ratings and compliance with current and prospective covenants in credit agreements. Liquidity The Company’s principal source of asset liquidity is cash at the Federal Reserve Bank of San Francisco (“Federal Reserve”) and other banks and marketable investment securities available for sale. As of September 30, 2021, Federal Reserve cash reserve ratios continue to be temporarily reduced to zero as a response to the COVID-19 pandemic. The Company’s profitability during the first nine months of 2021 generated cash flows from operations of $99,919,000 compared to $78,584,000 during the first nine months of 2020. Net cash used by investing activities was $752,929,000 for the nine months ended September 30, 2021, compared to net cash from investing activities of $639,947,000 during the nine months ending 2020. Financing activities provided $723,695,000 during the nine months ended September 30, 2021, compared to $937,438,000 used during the nine months ended June 30, 2020. During the nine months ended September 30, 2021 deposit balance increases of $730,888,000 were the largest contributor to the source of funding that facilitated net loan growth of $124,369,000 and net investment security growth of $613,913,000, compared to a decrease of $973,594,000 for financing activity during the same period in 2020. The changes in contractual obligations of the Company and Bank, to include but not limited to term subordinated debt, operating leases, deferred compensation and supplemental retirement plans as well as off-balance sheet commitments such as unfunded loans and letters of credit have remained relatively unchanged when compared to the similar balances or totals as of December 31, 2020. The Company maintains a collateralized line of credit with the FHLB. Based on the FHLB stock requirements at September 30, 2021, this line provided for maximum borrowings of $2.22 billion of which none was outstanding. As of September 30, 2021, the Company had designated investment securities with a fair value of $75,998,000 and loans totaling $3.46 billion as potential collateral under this collateralized line of credit with the FHLB. The Company maintains a collateralized line of credit with the Federal Reserve Bank of San Francisco (“FRB”). As of December 31, 2020, this line provided for maximum borrowings of $157,884,000 of which none was outstanding. As of December 31, 2020, the Company has designated investment securities with fair value of $8,100 and loans totaling $328,011,000 as potential collateral under this collateralized line of credit with the FRB. The principal cash requirements of the Company are dividends on common stock when declared. The Company is dependent upon the payment of cash dividends by the Bank to service its commitments. Shareholder dividends are expected to continue subject to the Board’s discretion and continuing evaluation of capital levels, earnings, asset quality and other factors. The Company expects that the cash dividends paid by the Bank to the Company will be sufficient to meet this payment schedule. Dividends from the Bank are subject to certain regulatory restrictions. Dividends paid used $22,291,000 and $19,758,000 of cash during the nine months ended September 30, 2021 and 2020, respectively. The Company’s liquidity is dependent on dividends received from the Bank. Dividends from the Bank are subject to certain regulatory restrictions.