WASHINGTON TRUST BANCORP INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the Corporation’s Audited Consolidated Financial Statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2021, and in conjunction with the condensed Unaudited Consolidated Financial Statements and notes thereto included in Item 1 of this report. Operating results for the three and nine months ended September 30, 2022 are not necessarily indicative of the results for the full-year ended December 31, 2022 or any future period. Forward-Looking Statements This report contains statements that are “forward-looking statements.” We may also make forward-looking statements in other documents we file with the SEC, in our annual reports to shareholders, in press releases and other written materials, and in oral statements made by our officers, directors or employees. You can identify forward-looking statements by the use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “outlook,” “will,” “should,” and other expressions that predict or indicate future events and trends and which do not relate to historical matters. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to be materially different than the anticipated future results, performance or achievements expressed or implied by the forward-looking statements. Some of the factors that might cause these differences include the following: • changes in political, business and economic conditions, including inflation; • interest rate changes or volatility, as well as changes in the balance and mix of loans and deposits; • changes in loan demand and collectability; • the possibility that future credits losses are higher than currently expected due to changes in economic assumptions or adverse economic developments; • ongoing volatility in national and international financial markets; • reductions in the market value or outflows of wealth management AUA; • decreases in the value of securities and other assets; • increases in defaults and charge-off rates; • changes in the size and nature of our competition; • changes in legislation or regulation and accounting principles, policies and guidelines; • operational risks including, but not limited to, changes in information technology, cybersecurity incidents, fraud, natural disasters, war, terrorism, civil unrest, the ongoing COVID-19 pandemic, and future pandemics; • reputational risks; and • changes in the assumptions used in making such forward-looking statements. In addition, the factors described under “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the SEC, may result in these differences. You should carefully review all of these factors and you should be aware that there may be other factors that could cause these differences. These forward-looking statements were based on information, plans and estimates at the date of this report, and we assume no obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events or other changes. Overview The Corporation offers a comprehensive product line of banking and financial services to individuals and businesses, including commercial, residential and consumer lending, retail and commercial deposit products, and wealth management services through its offices in Rhode Island, eastern Massachusetts and Connecticut; its ATMs; telephone banking; mobile banking and its internet website (www.washtrust.com). Our largest source of operating income is net interest income, which is the difference between interest earned on loans and securities and interest paid on deposits and borrowings. In addition, we generate noninterest income from a number of sources, including wealth management services, mortgage banking activities and deposit services. Our principal noninterest -44- Management's Discussion and Analysis expenses include salaries and employee benefit costs, outsourced services provided by third party vendors, occupancy and facility-related costs and other administrative expenses. We continue to leverage our strong regional brand to build market share and remain steadfast in our commitment to provide superior service. We believe the key to future growth is providing customers with convenient in-person service and digital banking solutions. In July 2022, we opened a new commercial lending office in New Haven, Connecticut. In August 2022, we opened a new full-service branch in Cumberland, Rhode Island. In addition, we recently announced that we submitted applications to establish a branch office in three northern Rhode Island locations in 2023 to further expand our branch footprint and serve the broader Rhode Island community. The three branch offices will be located in Barrington, Providence and Smithfield, Rhode Island and are subject to federal, state, local, and regulatory approvals. Risk Management The Corporation has a comprehensive ERM program through which the Corporation identifies, measures, monitors and controls current and emerging material risks. The Board of Directors is responsible for oversight of the ERM program. The ERM program enables the aggregation of risk across the Corporation and ensures the Corporation has the tools, programs and processes in place to support informed decision making, to anticipate risks before they materialize and to maintain the Corporation’s risk profile consistent with its risk strategy. The Board of Directors has approved an enterprise risk management policy that addresses each category of risk. The risk categories include: credit risk, interest rate risk, liquidity risk, price and market risk, compliance risk, strategic and reputation risk, and operational risk. A description of each risk category is provided below. Credit risk represents the possibility that borrowers or other counterparties may not repay loans or other contractual obligations according to their terms due to changes in the financial capacity, ability and willingness of such borrowers or counterparties to meet their obligations. In some cases, the collateral securing payment of the loans may be sufficient to assure repayment, but in other cases the Corporation may experience significant credit losses which could have an adverse effect on its operating results. The Corporation makes various assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and counterparties and the value of the real estate and other assets serving as collateral for the repayment of loans. Credit risk also exists with respect to investment securities. For further discussion regarding the credit risk and the credit quality of the Corporation’s loan portfolio, see Note 4 and Note 5 to the Unaudited Consolidated Financial Statements. For further discussion regarding credit risk associated with unfunded commitments, see Note 17 to the Unaudited Consolidated Financial Statements. For further discussion regarding the Corporation’s securities portfolio, see Note 3 to the Unaudited Consolidated Financial Statements. Interest rate risk is the risk of loss to future earnings due to changes in interest rates. It exists because the repricing frequency and magnitude of interest-earning assets and interest-bearing liabilities are not identical. See the “Asset/Liability Management and Interest Rate Risk” section below for additional disclosure. Liquidity risk is the risk that the Corporation will not have the ability to generate adequate amounts of cash for it to meet its maturing liability obligations and customer loan demand. For detailed disclosure regarding liquidity management, see the “Liquidity and Capital Resources” section below. Price and market risk refers to the risk of loss arising from adverse changes in interest rates and other relevant market rates and prices, such as equity prices. Interest rate risk, discussed above, is the most significant market risk to which the Corporation is exposed. The Corporation is also exposed to financial market risk and housing market risk. Compliance risk represents the risk of regulatory sanctions or financial loss resulting from the failure to comply with laws, rules and regulations and standards of good banking practice. Activities which may expose the Corporation to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, adherence to all applicable laws and regulations, and employment and tax matters. Strategic and reputation risk represent the risk of loss due to impairment of reputation, failure to fully develop and execute business plans, and failure to assess existing and new opportunities and threats in business, markets, and products. -45- Management's Discussion and Analysis Operational risk is the risk of loss due to human behavior, inadequate or failed internal systems and controls, and external influences such as market conditions, fraudulent activities, natural disasters and security risks. ERM is an overarching program that includes all areas of the Corporation. A framework approach is utilized to assign responsibility and to ensure that the various business units and activities involved in the risk management life-cycle are effectively integrated. The Corporation has adopted the “three lines of defense” strategy that is an industry best practice for ERM. Business units are the first line of defense in managing risk. They are responsible for identifying, measuring, monitoring, and controlling current and emerging risks. They report on and escalate their concerns. Corporate functions such as Credit Risk Management, Financial Administration, Information Assurance and Compliance, represent the second line of defense. They are responsible for policy setting and for reviewing and challenging the risk management activities of the business units. They collaborate closely with business units on planning and resource allocation with respect to risk management. Internal Audit and third party credit review represent the third line of defense. They provide independent assurance to the Board of Directors of the effectiveness of the first and second lines in fulfilling their risk management responsibilities. For additional factors that could adversely impact Washington Trust’s future results of operations and financial condition, see the section labeled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, as updated by our Quarterly Reports on Form 10-Q and other filings submitted to the SEC. -46- Management's Discussion and Analysis Results of Operations The following table presents a summarized consolidated statement of operations: (Dollars in thousands) Three Months Nine Months Change Change Periods ended September 30, 2022 2021 $ % 2022 2021 $ % Net interest income $42,042 $36,070 $5,972 17 % $114,648 $103,695 $10,953 11 % Noninterest income 15,803 20,520 (4,717) (23) 48,814 67,087 (18,273) (27) Total revenues 57,845 56,590 1,255 2 163,462 170,782 (7,320) (4) Provision for credit losses 800 — 800 100 (2,100) (2,000) (100) (5) Noninterest expense 33,067 32,520 547 2 95,363 100,245 (4,882) (5) Income before income taxes 23,978 24,070 (92) — 70,199 72,537 (2,338) (3) Income tax expense 5,310 5,319 (9) — 15,091 15,855 (764) (5) Net income $18,668 $18,751 ($83) — % $55,108 $56,682 ($1,574) (3 %) The following table presents a summary of performance metrics and ratios: Three Months Nine Months Periods ended September 30, 2022 2021 2022 2021 Diluted earnings per common share $1.08 $1.07 $3.16 $3.24 Return on average assets (net income divided by average assets) 1.19 % 1.26 % 1.23 % 1.30 % Return on average equity (net income available for common shareholders divided by average equity) 15.16 % 13.37 % 14.35 % 13.93 % Net interest income as a percentage of total revenues 73 % 64 % 70 % 61 % Noninterest income as a percentage of total revenues 27 % 36 % 30 % 39 % Net income totaled $18.7 million and $55.1 million, respectively, for the three and nine months ended September 30, 2022, compared to $18.8 million and $56.7 million, respectively, for the same periods in 2021. In 2022, growth in net interest income was driven by higher yields on, and growth in, average interest-earning assets, partially offset by a higher cost of funds. The decline in noninterest income reflected lower mortgage banking revenues resulting from an overall reduction in mortgage origination and sales activity, and lower wealth management asset-based revenues attributable to recent declines in the financial markets. The provision for credit losses recognized in 2022 provided for loan growth and was also reflective of low loss rates, strong asset and credit quality metrics and our current estimate of forecasted economic conditions. We experienced modest increases across a variety of noninterest expense categories, however declines in debt prepayment penalties and volume-related mortgage originator compensation expense resulted in an overall decline in year-to-date noninterest expenses in 2022. -47- Management's Discussion and Analysis Average Balances / Net Interest Margin - Fully Taxable Equivalent Basis The following table presents average balance and interest rate information. Tax-exempt income is converted to a FTE basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. Unrealized gains (losses) on available for sale securities and changes in fair value on mortgage loans held for sale are excluded from the average balance and yield calculations. Nonaccrual loans, as well as interest recognized on these loans, are included in amounts presented for loans. Three months ended September 30, 2022 2021 Change (Dollars in thousands) Average Balance Interest Yield/ Rate Average Balance Interest Yield/ Rate Average Balance Interest Yield/ Rate Assets: Cash, federal funds sold and short-term investments $92,708 $503 2.15 $179,574 $56 0.12 ($86,866) $447 2.03 Mortgage loans held for sale 34,503 361 4.15 41,261 298 2.87 (6,758) 63 1.28 Taxable debt securities 1,150,674 6,061 2.09 1,045,997 3,683 1.40 104,677 2,378 0.69 FHLB stock 25,377 88 1.38 18,909 95 1.99 6,468 (7) (0.61) Commercial real estate 1,692,374 17,974 4.21 1,648,972 12,209 2.94 43,402 5,765 1.27 Commercial & industrial 630,360 7,114 4.48 736,073 7,886 4.25 (105,713) (772) 0.23 Total commercial 2,322,734 25,088 4.29 2,385,045 20,095 3.34 (62,311) 4,993 0.95 Residential real estate 2,045,833 17,379 3.37 1,623,913 13,511 3.30 421,920 3,868 0.07 Home equity 269,654 2,804 4.13 252,938 2,043 3.20 16,716 761 0.93 Other 15,299 171 4.43 19,822 247 4.94 (4,523) (76) (0.51) Total consumer 284,953 2,975 4.14 272,760 2,290 3.33 12,193 685 0.81 Total loans 4,653,520 45,442 3.87 4,281,718 35,896 3.33 371,802 9,546 0.54 Total interest-earning assets 5,956,782 52,455 3.49 5,567,459 40,028 2.85 389,323 12,427 0.64 Noninterest-earning assets 259,347 351,678 (92,331) Total assets $6,216,129 $5,919,137 $296,992 Liabilities and Shareholders’ Equity: Interest-bearing demand deposits (in-market) $267,670 $822 1.22 $206,237 $51 0.10 $61,433 $771 1.12 NOW accounts 871,038 212 0.10 782,963 129 0.07 88,075 83 0.03 Money market accounts 1,137,875 2,231 0.78 1,014,204 586 0.23 123,671 1,645 0.55 Savings accounts 582,513 100 0.07 530,956 70 0.05 51,557 30 0.02 Time deposits (in-market) 797,199 1,983 0.99 672,012 1,695 1.00 125,187 288 (0.01) Interest-bearing in-market deposits 3,656,295 5,348 0.58 3,206,372 2,531 0.31 449,923 2,817 0.27 Wholesale brokered demand deposits 31,014 166 2.12 — — — 31,014 166 2.12 Wholesale brokered time deposits 381,984 1,142 1.19 722,233 258 0.14 (340,249) 884 1.05 Wholesale brokered deposits 412,998 1,308 1.26 722,233 258 0.14 (309,235) 1,050 1.12 Total interest-bearing deposits 4,069,293 6,656 0.65 3,928,605 2,789 0.28 140,688 3,867 0.37 FHLB advances 549,729 3,234 2.33 317,766 872 1.09 231,963 2,362 1.24 Junior subordinated debentures 22,681 206 3.60 22,681 92 1.61 — 114 1.99 Total interest-bearing liabilities 4,641,703 10,096 0.86 4,269,052 3,753 0.35 372,651 6,343 0.51 Noninterest-bearing demand deposits 944,153 952,676 (8,523) Other liabilities 143,043 142,562 481 Shareholders’ equity 487,230 554,847 (67,617) Total liabilities and shareholders’ equity $6,216,129 $5,919,137 $296,992 Net interest income (FTE) $42,359 $36,275 $6,084 Interest rate spread 2.63 2.50 0.13 Net interest margin 2.82 2.58 0.24 -48- Management's Discussion and Analysis Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency: (Dollars in thousands) Three months ended September 30, 2022 2021 Change Commercial loans $317 $205 $112 Nine months ended September 30, 2022 2021 Change (Dollars in thousands) Average Balance Interest Yield/ Rate Average Balance Interest Yield/ Rate Average Balance Interest Yield/ Rate Assets: Cash, federal funds sold and short-term investments $128,606 $769 0.80 $160,350 $121 0.10 ($31,744) $648 0.70 Mortgage loans held for sale 29,985 851 3.79 53,307 1,144 2.87 (23,322) (293) 0.92 Taxable debt securities 1,106,632 15,209 1.84 997,741 10,366 1.39 108,891 4,843 0.45 FHLB stock 15,745 218 1.85 24,265 338 1.86 (8,520) (120) (0.01) Commercial real estate 1,648,061 43,360 3.52 1,638,200 35,269 2.88 9,861 8,091 0.64 Commercial & industrial 628,574 19,456 4.14 794,091 23,865 4.02 (165,517) (4,409) 0.12 Total commercial 2,276,635 62,816 3.69 2,432,291 59,134 3.25 (155,656) 3,682 0.44 Residential real estate 1,875,175 46,376 3.31 1,531,529 39,248 3.43 343,646 7,128 (0.12) Home equity 257,814 6,753 3.50 255,959 6,220 3.25 1,855 533 0.25 Other 15,995 550 4.60 20,301 742 4.89 (4,306) (192) (0.29) Total consumer 273,809 7,303 3.57 276,260 6,962 3.37 (2,451) 341 0.20 Total loans 4,425,619 116,495 3.52 4,240,080 105,344 3.32 185,539 11,151 0.20 Total interest-earning assets 5,706,587 133,542 3.13 5,475,743 117,313 2.86 230,844 16,229 0.27 Noninterest-earning assets 268,744 346,514 (77,770) Total assets $5,975,331 $5,822,257 $153,074 Liabilities and Shareholders’ Equity: Interest-bearing demand deposits (in-market) $255,014 $1,114 0.58 $190,979 $196 0.14 $64,035 $918 0.44 NOW accounts 867,464 492 0.08 747,385 350 0.06 120,079 142 0.02 Money market accounts 1,193,599 3,984 0.45 958,812 1,852 0.26 234,787 2,132 0.19 Savings accounts 570,129 246 0.06 513,110 211 0.05 57,019 35 0.01 Time deposits (in-market) 800,037 5,997 1.00 687,278 5,822 1.13 112,759 175 (0.13) Interest-bearing in-market deposits 3,686,243 11,833 0.43 3,097,564 8,431 0.36 588,679 3,402 0.07 Wholesale brokered demand deposits 17,197 212 1.65 — — — 17,197 212 1.65 Wholesale brokered time deposits 396,465 1,677 0.57 655,165 982 0.20 (258,700) 695 0.37 Wholesale brokered deposits 413,662 1,889 0.61 655,165 982 0.20 (241,503) 907 0.41 Total interest-bearing deposits 4,099,905 13,722 0.45 3,752,729 9,413 0.34 347,176 4,309 0.11 FHLB advances 285,590 3,891 1.82 438,213 3,253 0.99 (152,623) 638 0.83 Junior subordinated debentures 22,681 443 2.61 22,681 278 1.64 — 165 0.97 Total interest-bearing liabilities 4,408,176 18,056 0.55 4,213,623 12,944 0.41 194,553 5,112 0.14 Noninterest-bearing demand deposits 925,433 918,760 6,673 Other liabilities 129,967 147,244 (17,277) Shareholders’ equity 511,755 542,630 (30,875) Total liabilities and shareholders’ equity $5,975,331 $5,822,257 $153,074 Net interest income (FTE) $115,486 $104,369 $11,117 Interest rate spread 2.58 2.45 0.13 Net interest margin 2.71 2.55 0.16 -49- Management's Discussion and Analysis Interest income amounts presented in the preceding table include the following adjustments for taxable equivalency: (Dollars in thousands) Nine months ended September 30, 2022 2021 Change Commercial loans $838 $674 $164 Net Interest Income Net interest income, the primary source of our operating income, totaled $42.0 million and $114.6 million, respectively, for the three and nine months ended September 30, 2022, compared to $36.1 million and $103.7 million, respectively, for the same periods in 2021. Net interest income is affected by the level of and changes in interest rates, and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Prepayment penalty income associated with loan payoffs is included in net interest income. The following discussion presents net interest income on an FTE basis by adjusting income and yields on tax-exempt loans and securities to be comparable to taxable loans and securities. The analysis of net interest income, NIM and the yield on loans may be impacted by the periodic recognition of prepayment penalty fee income associated with commercial loan payoffs. Prepayment penalty fee income amounted to $30 thousand (or 0 basis point benefit to NIM) and $168 thousand (or 1 basis point benefit to NIM), respectively, for the three and nine months ended September 30, 2022. There was no prepayment penalty fee income recognized in the third quarter of 2021 and $934 thousand (or 2 basis points benefit to NIM) recognized in the nine months ended September 30, 2021. The analysis of net interest income, NIM and the yield on loans is also impacted by changes in the level of net amortization of premiums and discounts on securities and loans, which is included in interest income. Changes in market interest rates affect the level of loan prepayments and the receipt of payments on mortgage-backed securities. Prepayment speeds generally increase as market interest rates decline and decrease as market interest rates rise. Changes in prepayment speeds could increase or decrease the level of net amortization of premiums and discounts, thereby affecting interest income. Additionally, as PPP loans were forgiven by the SBA, related unamortized net fee balances were accelerated and amortized, increasing net interest income. As noted in the Unaudited Consolidated Statements of Cash Flows, net amortization of premiums and discounts on securities and loans (a net reduction to interest income) amounted to $2.5 million for the nine months ended September 30, 2022, compared $2.7 million for the same period in 2021. Accelerated amortization of net deferred fee balances on PPP loans forgiven by the SBA amounted to $21 thousand (or 0 basis point benefit to NIM) and $1.2 million (or 3 basis points benefit to NIM), respectively, for the three and nine months ended September 30, 2022. This compared to $2.0 million (or 13 basis points benefit to NIM) and $4.3 million (or 11 basis points benefit to NIM), respectively, for the same periods in 2021. FTE net interest income for the three and nine months ended September 30, 2022 amounted to $42.4 million and $115.5 million, respectively, up by $6.1 million and $11.1 million, respectively, from the same periods in 2021. Increases in asset yields outpaced increases in funding costs, contributing $4.3 million and $6.9 million, respectively, of net interest income for the three and nine months ended September 30, 2022. In the three months ended September 30, 2022, growth in average interest-earning assets, net of increased average interest-bearing liability balances, contributed approximately $1.8 million of net interest income. In the nine months ended September 30, 2022, growth in average interest-earning assets and declines in average interest-bearing liability balances contributed approximately $4.2 million of net interest income. NIM was 2.82% and 2.71%, respectively, for the three and nine months ended September 30, 2022, compared to 2.58% and 2.55%, respectively, for the same periods in 2021 as NIM benefited from higher market interest rates. Total average securities for the three and nine months ended September 30, 2022 increased by $104.7 million and $108.9 million, respectively, from the average balances for the same periods a year earlier. The FTE rate of return on the securities portfolio for the three and nine months ended September 30, 2022 was 2.09% and 1.84%, respectively, compared to 1.40% and 1.39%, respectively, for the same periods in 2021, reflecting the impact of higher market interest rates in 2022. Total average loan balances for the three and nine months ended September 30, 2022 increased by $371.8 million and $185.5 million, respectively, from the average loan balances for the comparable 2021 periods. The increase reflected growth -50- Management's Discussion and Analysis in average residential real estate loan balances, partially offset by a decline in commercial & industrial loans due to PPP loans that were forgiven by the SBA. The yield on total loans for the three and nine months ended September 30, 2022 was 3.87% and 3.52%, respectively, compared to 3.33% and 3.32%, respectively, in the corresponding periods in 2021. The yield on total loans may be impacted by the periodic recognition of commercial loan prepayment fee income, as well as the accelerated amortization of net deferred fee balances on PPP loans when such loans were forgiven by the SBA. Excluding the impact of these items for both periods, the yield on total loans for the three and nine months ended September 30, 2022 was 3.87% and 3.48%, respectively, up from 3.14% and 3.16%, respectively, for the same periods in 2021, reflecting higher market interest rates. The average balance of FHLB advances for the three and nine months ended September 30, 2022 increased by $232.0 million and decreased by $152.6 million, respectively, compared to the average balances for the same periods in 2021. The average rate paid on such advances for the three and nine months ended September 30, 2022 was 2.33% and 1.82%, respectively, up from 1.09% and 0.99%, respectively, for the same periods in 2021, reflecting recent increases in market interest rates. Included in total average interest-bearing deposits were wholesale brokered deposits, which decreased by $309.2 million and $241.5 million, respectively, from the same periods in 2021. The average rate paid on wholesale brokered deposits for the three and nine months ended September 30, 2022 was 1.26% and 0.61%, respectively, compared to 0.14% and 0.20%, respectively, for the same periods in 2021, reflecting recent increases in market interest rates. Average in-market interest-bearing deposits, which excludes wholesale brokered deposits, for the three and nine months ended September 30, 2022 increased by $449.9 million and $588.7 million, respectively, from the average balances for the same periods in 2021. The increases reflected growth across all deposit categories. The average rate paid on in-market interest-bearing deposits for the three and nine months ended September 30, 2022 increased by 27 basis points and 7 basis points, respectively, from the same periods in 2021, reflecting recent increases in market interest rates. The average balance of noninterest-bearing demand deposits for the three and nine months ended September 30, 2022 decreased by $8.5 million and increased by $6.7 million, respectively, from the average balance for the same periods in 2021. -51- Management's Discussion and Analysis Volume / Rate Analysis - Interest Income and Expense (FTE Basis) The following table presents certain information on an FTE basis regarding changes in our interest income and interest expense for the period indicated. The net change attributable to both volume and rate has been allocated proportionately. (Dollars in thousands) Three Months Ended September 30, 2022 vs. 2021 Nine Months Ended September 30, 2022 vs. 2021 Change Due to Change Due to Volume Rate Net Change Volume Rate Net Change Interest on Interest-Earning Assets: Cash, federal funds sold and other short-term investments ($39) $486 $447 ($28) $676 $648 Mortgage loans held for sale (55) 118 63 (592) 299 (293) Taxable debt securities 401 1,977 2,378 1,221 3,622 4,843 FHLB stock 27 (34) (7) (118) (2) (120) Commercial real estate 331 5,434 5,765 213 7,878 8,091 Commercial & industrial (1,181) 409 (772) (5,104) 695 (4,409) Total commercial (850) 5,843 4,993 (4,891) 8,573 3,682 Residential real estate 3,576 292 3,868 8,545 (1,417) 7,128 Home equity 141 620 761 46 487 533 Other (52) (24) (76) (150) (42) (192) Total consumer 89 596 685 (104) 445 341 Total loans 2,815 6,731 9,546 3,550 7,601 11,151 Total interest income 3,149 9,278 12,427 4,033 12,196 16,229 Interest on Interest-Bearing Liabilities: Interest-bearing demand deposits (in-market) 23 748 771 88 830 918 NOW accounts 17 66 83 46 96 142 Money market accounts 80 1,565 1,645 535 1,597 2,132 Savings accounts 6 24 30 13 22 35 Time deposits (in-market) 305 (17) 288 888 (713) 175 Interest-bearing in-market deposits 431 2,386 2,817 1,570 1,832 3,402 Wholesale brokered demand deposits 166 — 166 212 — 212 Wholesale brokered time deposits (174) 1,058 884 (516) 1,211 695 Wholesale brokered deposits (8) 1,058 1,050 (304) 1,211 907 Total interest-bearing deposits 423 3,444 3,867 1,266 3,043 4,309 FHLB advances 923 1,439 2,362 (1,410) 2,048 638 Junior subordinated debentures — 114 114 — 165 165 Total interest expense 1,346 4,997 6,343 (144) 5,256 5,112 Net interest income (FTE) $1,803 $4,281 $6,084 $4,177 $6,940 $11,117 Provision for Credit Losses The provision for credit losses results from management’s review of the adequacy of the ACL. The ACL is management’s estimate of expected lifetime credit losses as of the reporting date and includes consideration of current forecasted economic conditions. Estimating an appropriate level of ACL necessarily involves a high degree of judgment. The Corporation recorded a positive provision for credit losses (or a charge) of $800 thousand for the three months ended September 30, 2022, compared to no provision for credit losses recognized in the third quarter of 2021. On a year-to-date basis, the Corporation recognized a negative provision for credit losses (or a benefit) of $2.1 million in 2022, compared to a negative provision (or a benefit) of $2.0 million in 2021. The year-to-date negative provision recognized in 2022 was reflective of low loss rates, strong asset and credit quality metrics, our current estimate of forecasted economic conditions, and also provided for loan growth. The year-to-date negative provision recorded in 2021 largely reflected an improvement in -52- Management's Discussion and Analysis forecasted economic conditions following higher credit provisioning in 2020, which was attributable to the emergence of the COVID-19 pandemic. Net charge-offs totaled $54 thousand for the three months ended September 30, 2022, compared to $168 thousand for the same period in 2021. Net recoveries totaled $104 thousand for the nine months ended September 30, 2022, compared to net charge-offs of $444 thousand for the same period in 2021. The ACL on loans was $36.9 million, or 0.76% of total loans, at September 30, 2022, compared to an ACL on loans of $39.1 million, or 0.91% of total loans, at December 31, 2021. See additional discussion under the caption “Asset Quality” for further information on the ACL on loans. Noninterest Income Noninterest income is an important source of revenue for Washington Trust. The principal categories of noninterest income are shown in the following table: (Dollars in thousands) Three Months Nine Months Change Change Periods ended September 30, 2022 2021 $ % 2022 2021 $ % Noninterest income: Wealth management revenues $9,525 $10,455 ($930) (9 %) $30,122 $30,778 ($656) (2 %) Mortgage banking revenues 2,047 6,373 (4,326) (68) 7,630 24,294 (16,664) (69) Card interchange fees 1,287 1,265 22 2 3,754 3,714 40 1 Service charges on deposit accounts 819 673 146 22 2,250 1,917 333 17 Loan related derivative income 1,041 728 313 43 2,011 2,370 (359) (15) Income from bank-owned life insurance 684 618 66 11 1,900 1,781 119 7 Other income 400 408 (8) (2) 1,147 2,233 (1,086) (49) Total noninterest income $15,803 $20,520 ($4,717) (23 %) $48,814 $67,087 ($18,273) (27 %) Noninterest Income Analysis Revenue from wealth management services represented 62% of total noninterest income for the nine months ended September 30, 2022, compared to 46% for the same period in 2021. A substantial portion of wealth management revenues is dependent on the value of wealth management AUA and is closely tied to the performance of the financial markets. This portion of wealth management revenues is referred to as “asset-based” and includes trust and investment management fees. Wealth management revenues also include “transaction-based” revenues, such as commissions and other service fees that are not primarily derived from the value of assets. The categories of wealth management revenues are shown in the following table: (Dollars in thousands) Three Months Nine Months Change Change Periods ended September 30, 2022 2021 $ % 2022 2021 $ % Wealth management revenues: Asset-based revenues $9,302 $10,224 ($922) (9 %) $29,154 $29,798 ($644) (2 %) Transaction-based revenues 223 231 (8) (3) 968 980 (12) (1) Total wealth management revenues $9,525 $10,455 ($930) (9 %) $30,122 $30,778 ($656) (2 %) Wealth management revenues for the three and nine months ended September 30, 2022 decreased by $930 thousand and $656 thousand, respectively, from the same periods in 2021, reflecting decreases in asset-based revenues. The change in asset-based revenues correlated with the change in average AUA balances. The average balance of AUA for the three and nine months ended September 30, 2022 decreased by approximately 11% and 2%, respectively, from the average balance for the same periods in 2021. -53- Management's Discussion and Analysis The following table presents the changes in wealth management AUA balances: (Dollars in thousands) Three Months Nine Months Periods ended September 30, 2022 2021 2022 2021 Wealth management assets under administration: Balance at the beginning of period $6,650,097 $7,441,519 $7,784,211 $6,866,737 Net investment (depreciation) appreciation & income (239,762) (4,830) (1,444,785) 572,506 Net client asset (outflows) inflows (87,578) 6,707 (16,669) 4,153 Balance at the end of period $6,322,757 $7,443,396 $6,322,757 $7,443,396 Wealth management AUA amounted to $6.3 billion at September 30, 2022. Wealth management AUA balances declined in 2022, primarily due to net investment depreciation as a result of recent declines in the financial markets. Recently, four client-facing wealth management advisors in our registered investment adviser subsidiary resigned. These four employees were associated with approximately $1.0 billion of AUA as of September 30, 2022. From October 1, 2022 through November 4, 2022, we have been notified of client AUA withdrawals of approximately $546 million. We estimate a decline in annual revenues of approximately $3.2 million associated with these withdrawals. Washington Trust could experience additional AUA outflows in upcoming months associated with the departure of the former advisors. Mortgage banking revenues represented 16% of total noninterest income for the nine months ended September 30, 2022, compared to 36% for the same period in 2021. These revenues are dependent on mortgage origination volume and are sensitive to interest rates and the condition of housing markets. The composition of mortgage banking revenues and the volume of loans sold to the secondary market are shown in the following table: (Dollars in thousands) Three Months Nine Months Change Change Periods ended September 30, 2022 2021 $ % 2022 2021 $ % Mortgage banking revenues: Realized gains on loan sales, net (1) $1,718 $5,750 ($4,032) (70 %) $6,962 $28,057 ($21,095) (75 %) Changes in fair value, net (2) (226) 467 (693) (148) (798) (3,964) 3,166 80 Loan servicing fee income, net (3) 555 156 399 256 1,466 201 1,265 629 Total mortgage banking revenues $2,047 $6,373 ($4,326) (68 %) $7,630 $24,294 ($16,664) (69 %) Loans sold to the secondary market (4) $75,324 $173,861 ($98,537) (57 %) $285,193 $756,438 ($471,245) (62 %) (1) Includes gains on loan sales, commission income on loans originated for others, servicing right gains, and gains (losses) on forward loan commitments. (2) Represents fair value changes on mortgage loans held for sale and forward loan commitments. (3) Represents loan servicing fee income, net of servicing right amortization and valuation adjustments. (4) Includes brokered loans (loans originated for others). For the three and nine months ended September 30, 2022, mortgage banking revenues were down by $4.3 million and $16.7 million, respectively, compared to the same periods in 2021. The decline in mortgage banking revenues was mainly attributable to a decline in sales volume and a reduction in the sales yield. Mortgage loans sold to the secondary market totaled $75.3 million and $285.2 million, respectively, for the three and nine months ended September 30, 2022, compared to $173.9 million and $756.4 million, respectively, for the same periods in 2021, reflecting an overall reduction in mortgage origination and sales activity, as well as a shift to a higher proportion of loans originated for retention in portfolio in 2022. Mortgage banking revenues were also impacted by changes in the fair value of mortgage loans held for sale and forward loan commitments, which are primarily based on current market prices in the secondary market and correlate to changes in the size of the mortgage pipeline. In addition, the decline in mortgage banking revenues was partially offset by higher net loan servicing fee income associated with loans sold with servicing retained. The increase in net loan servicing fee income was largely due to lower amortization of servicing rights, reflecting lower prepayment speeds on the serviced mortgage portfolio. -54- Management's Discussion and Analysis Other income for the nine months ended September 30, 2022 decreased by $1.1 million from the same period in 2021, due to $1.0 million of income associated with a litigation settlement that was recognized in the first quarter of 2021. Noninterest Expense The following table presents noninterest expense comparisons: (Dollars in thousands) Three Months Nine Months Change Change Periods ended September 30, 2022 2021 $ % 2022 2021 $ % Noninterest expense: Salaries and employee benefits $21,609 $22,162 ($553) (2 %) $62,992 $65,771 ($2,779) (4 %) Outsourced services 3,552 3,294 258 8 10,169 9,711 458 5 Net occupancy 2,234 2,134 100 5 6,708 6,304 404 6 Equipment 939 977 (38) (4) 2,795 2,946 (151) (5) Legal, audit and professional fees 693 767 (74) (10) 2,140 2,042 98 5 FDIC deposit insurance costs 430 482 (52) (11) 1,198 1,201 (3) — Advertising and promotion 799 559 240 43 1,874 1,341 533 40 Amortization of intangibles 215 223 (8) (4) 648 674 (26) (4) Debt prepayment penalties — — — — — 4,230 (4,230) (100) Other 2,596 1,922 674 35 6,839 6,025 814 14 Total noninterest expense $33,067 $32,520 $547 2 % $95,363 $100,245 ($4,882) (5 %) Noninterest Expense Analysis Salaries and employee benefits expense, the largest component of noninterest expense, for the three and nine months ended September 30, 2022 decreased by $553 thousand and $2.8 million, respectively, compared to the same periods in 2021. This included volume-related decreases in mortgage originator compensation expense, annual merit increases and higher staffing levels. Debt prepayment penalty expense for the nine months ended September 30, 2021 totaled $4.2 million, due to the prepayment of higher-yielding FHLB advances. There were no such debt prepayments in the comparable period in 2022. Other expense for the three and nine months ended September 30, 2022 increased by $674 thousand and $814 thousand, respectively, compared to the same periods in 2021, reflecting modest increases across a variety of other noninterest expense categories. Income Taxes The following table presents the Corporation’s income tax provision and applicable tax rates for the periods indicated: (Dollars in thousands) Three Months Nine Months Periods ended September 30, 2022 2021 2022 2021 Income tax expense $5,310 $5,319 $15,091 $15,855 Effective income tax rate 22.1 % 22.1 % 21.5 % 21.9 % The effective income tax rates for the three and nine months ended September 30, 2022 and 2021 differed from the federal rate of 21%, primarily due to state income tax expense, partially offset by the benefits of tax-exempt income, income from BOLI, federal tax credits and the recognition of excess tax expense or benefits associated with the settlement of share-based awards. -55- Management's Discussion and Analysis The decrease in the effective tax rate for the nine months ended September 30, 2022 compared to the same period in 2021 largely reflected an increase in benefits from federal tax credits and a decrease in state tax expense, partially offset by a decrease in benefits from tax-exempt income. The Corporation’s net deferred tax assets amounted to $62.1 million at September 30, 2022, compared to $14.0 million at December 31, 2021. The Corporation has determined that a valuation allowance is not required for any of the deferred tax assets since it is more-likely-than-not that these assets will be realized primarily through future reversals of existing taxable temporary differences or by offsetting projected future taxable income. Net deferred tax assets increased in 2022, largely reflecting increases in deferred tax assets associated with the declines in fair value of securities available for sale and cash flow hedges that were primarily attributable to relative changes in market interest rates. Segment Reporting The Corporation manages its operations through two reportable business segments, consisting of Commercial Banking and Wealth Management Services. See Note 14 to the Unaudited Consolidated Financial Statements for additional disclosure related to business segments. Commercial Banking The following table presents a summarized statement of operations for the Commercial Banking business segment: (Dollars in thousands) Three Months Nine Months Change Change Periods ended September 30, 2022 2021 $ % 2022 2021 $ % Net interest income $42,038 $36,085 $5,953 16 % $114,709 $103,737 $10,972 11 % Provision for credit losses 800 — 800 100 (2,100) (2,000) (100) 5 Net interest income after provision for credit losses 41,238 36,085 5,153 14 116,809 105,737 11,072 10 Noninterest income 6,043 9,962 (3,919) (39) 18,174 35,032 (16,858) (48) Noninterest expense 24,746 24,278 468 2 71,278 76,530 (5,252) (7) Income before income taxes 22,535 21,769 766 4 63,705 64,239 (534) (1) Income tax expense 4,878 4,725 153 3 13,423 13,810 (387) (3) Net income $17,657 $17,044 $613 4 % $50,282 $50,429 ($147) — % Net interest income for the Commercial Banking segment for the three and nine months ended September 30, 2022, increased by $6.0 million and $11.0 million, respectively, from the same periods in 2021. Net interest income largely benefited from higher yields on and growth in average interest-earning assets, partially offset by a higher cost of funds. The Corporation recorded a positive provision for credit losses (or a charge) of $800 thousand for the three months ended September 30, 2022, compared to no provision for the same period in 2021. For the nine months ended September 30, 2022, the Corporation recorded a negative provision for credit losses (or a benefit) of $2.1 million, compared to a negative provision (or a benefit) of $2.0 million for the same period in 2021. See additional discussion under the caption “Provision for Credit Losses.” Noninterest income derived from the Commercial Banking segment for the three and nine months ended September 30, 2022 was down by $3.9 million and $16.9 million, respectively, from the comparable periods in 2021, primarily due to lower mortgage banking revenues. See additional discussion regarding mortgage banking revenues under the caption “Noninterest Income” above. Commercial Banking noninterest expenses for the three months ended September 30, 2022 were up by $468 thousand from the same period in 2021. For the nine months ended September 30, 2022, noninterest expenses for the commercial banking segment were down by $5.3 million from the same period in 2021, largely reflecting decreases in debt prepayment penalties and salaries and employee benefits expense. See additional discussion under the caption “Noninterest Expense” above. -56- Management's Discussion and Analysis Wealth Management Services The following table presents a summarized statement of operations for the Wealth Management Services business segment: (Dollars in thousands) Three Months Nine Months Change Change Periods ended September 30, 2022 2021 $ % 2022 2021 $ % Net interest expense $4 ($15) $19 127 % ($61) ($42) ($19) 45 % Noninterest income 9,760 10,558 (798) (8) 30,640 32,055 (1,415) (4) Noninterest expense 8,321 8,242 79 1 24,085 23,715 370 2 Income before income taxes 1,443 2,301 (858) (37) 6,494 8,298 (1,804) (22) Income tax expense 432 594 (162) (27) 1,668 2,045 (377) (18) Net income $1,011 $1,707 ($696) (41 %) $4,826 $6,253 ($1,427) (23 %) For the three and nine months ended September 30, 2022, noninterest income derived from the Wealth Management Services segment decreased by $798 thousand and $1.4 million, respectively, from the same periods in 2021, reflecting a decrease in asset-based revenues. The decline in year-to-date revenues also included income of $1.0 million associated with a litigation settlement that was recognized in the first quarter of 2021. See further discussion under the caption “Noninterest Income” above. For the three and nine months ended September 30, 2022, noninterest expenses for the Wealth Management Services segment increased by $79 thousand and $370 thousand, respectively, from the comparable periods in 2021. These included modest changes across a variety of noninterest expense categories. Financial Condition Summary The following table presents selected financial condition data: (Dollars in thousands) Change September 30, 2022 December 31, 2021 $ % Cash and due from banks $130,066 $175,259 ($45,193) (26 %) Total securities 982,573 1,042,859 (60,286) (6) Total loans 4,848,873 4,272,925 575,948 13 Allowance for credit losses on loans 36,863 39,088 (2,225) (6) Total assets 6,408,051 5,851,127 556,924 10 Total deposits 5,069,857 4,980,051 89,806 2 FHLB advances 700,000 145,000 555,000 383 Total shareholders’ equity 432,274 564,808 (132,534) (23) Total assets amounted to $6.4 billion at September 30, 2022, up by $556.9 million, or 10%, from the end of 2021, due to loan growth. Cash and due from banks balances declined by $45.2 million, or 26%, from the end of 2021, including a reduction in cash collateral pledged to derivative counterparties and lower cash balances with correspondent banks. See Note 9 to the Unaudited Consolidated Financial Statements for additional disclosure regarding derivative financial instruments. The securities portfolio decreased by $60.3 million, or 6%, from the end of 2021, reflecting a temporary decline in fair value and routine pay-downs on mortgage-backed securities, partially offset by purchases of debt securities. Total loans increased by $575.9 million, or 13%, from the end of 2021, led by growth in the residential real estate portfolio. -57- Management's Discussion and Analysis Total deposits increased by $89.8 million, or 2%, from the end of 2021, with an increase of $161.9 million, or 4%, in in-market deposits partially offset by a decrease of $72.1 million, or 14%, in wholesale brokered deposits. FHLB advances increased by $555.0 million, or 383%, from December 31, 2021. Higher levels of wholesale funding were utilized to fund loan growth and purchases of debt securities. Shareholders’ equity decreased by $132.5 million, or 23%, largely reflecting a decline in the AOCL component of shareholders' equity due to decreases in the fair value of available for sale debt securities and cash flow hedges that were primarily attributable to relative changes in market interest rates. Securities I nvestment security activity is monitored by the Investment Committee, the members of which also sit on the ALCO. Asset and liability management objectives are the primary influence on the Corporation’s investment activities. However, the Corporation also recognizes that there are certain specific risks inherent in investment activities. The securities portfolio is managed in accordance with regulatory guidelines and established internal corporate investment policies that provide limitations on specific risk factors such as market risk, credit risk and concentration, liquidity risk and operational risk to help monitor risks associated with investing in securities. Reports on the activities conducted by the Investment Committee and the ALCO are presented to the Board of Directors on a regular basis. The Corporation’s securities portfolio is managed to generate interest income, to implement interest rate risk management strategies, and to provide a readily available source of liquidity for balance sheet management. Securities are designated as either available for sale, held to maturity or trading at the time of purchase. The Corporation does not have securities designated as held to maturity and does not maintain a portfolio of trading securities. Securities available for sale may be sold in response to changes in market conditions, prepayment risk, rate fluctuations, liquidity, or capital requirements. Debt securities available for sale are reported at fair value, with any unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of tax, until realized. Determination of Fair Value The Corporation uses an independent pricing service to obtain quoted prices. The prices provided by the independent pricing service are generally based on observable market data in active markets. The determination of whether markets are active or inactive is based upon the level of trading activity for a particular security class. Management reviews the independent pricing service’s documentation to gain an understanding of the appropriateness of the pricing methodologies. Management also reviews the prices provided by the independent pricing service for reasonableness based upon current trading levels for similar securities. If the prices appear unusual, they are re-examined and the value is either confirmed or revised. In addition, management periodically performs independent price tests of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of September 30, 2022 and December 31, 2021, management did not make any adjustments to the prices provided by the pricing service. Our fair value measurements generally utilize Level 2 inputs, representing quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and model-derived valuations in which all significant input assumptions are observable in active markets. See Notes 3 and 10 to the Unaudited Consolidated Financial Statements for additional information regarding the determination of fair value of investment securities. -58- Management's Discussion and Analysis Securities Portfolio The carrying amounts of securities held are as follows: (Dollars in thousands) September 30, 2022 December 31, 2021 Amount % Amount % Available for Sale Debt Securities: Obligations of U.S. government-sponsored enterprises $197,855 20 % $196,454 19 % Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises 764,264 78 824,962 79 Individual name issuer trust preferred debt securities 8,800 1 9,138 1 Corporate bonds 11,654 1 12,305 1 Total available for sale debt securities $982,573 100 % $1,042,859 100 % The securities portfolio amounted to $1.0 billion, or 15% of total assets, as of September 30, 2022 compared to $1.0 billion, or 18% of total assets, as of December 31, 2021. The largest component of the securities portfolio is mortgage-backed securities, all of which are issued by U.S. government agencies or U.S. government-sponsored enterprises. The securities portfolio decreased by $60.3 million, or 6%, from the end of 2021, reflecting a temporary decline in the fair value of available for sale securities and routine pay-downs on mortgage-backed securities. These decreases were partially offset by purchases of U.S. government agency and U.S. government-sponsored debt securities, including mortgage-backed securities, totaling $214.6 million, with a weighted average yield of 3.45%. The carrying amount of available for sale debt securities included net unrealized losses of $183.2 million and $8.9 million, respectively, as of September 30, 2022 and December 31, 2021. The decline in fair value of available for sale debt securities from the end of 2021 was primarily concentrated in obligations of U.S. government agencies and U.S. government-sponsored enterprises, including mortgage-backed securities, and primarily attributable to relative changes in interest rates since the time of purchase. See Note 3 to the Unaudited Consolidated Financial Statements for additional information. Loans Total loans amounted to $4.8 billion at September 30, 2022, up by $575.9 million, or 13.5%, from the end of 2021, led by growth in the residential real estate portfolio. The following is a summary of loans: (Dollars in thousands) September 30, 2022 December 31, 2021 Amount % Amount % Commercial: Commercial real estate (1) $1,762,687 36 % $1,639,062 38 % Commercial & industrial (2) 652,758 14 641,555 15 Total commercial 2,415,445 50 2,280,617 53 Residential Real Estate: Residential real estate (3) 2,144,098 44 1,726,975 40 Consumer: Home equity 273,742 6 247,697 6 Other (4) 15,588 — 17,636 1 Total consumer 289,330 6 265,333 7 Total loans $4,848,873 100 % $4,272,925 100 % (1) CRE consists of commercial mortgages primarily secured by income-producing property, as well as construction and development loans. Construction and development loans are made to businesses for land development or the on-site construction of industrial, commercial, or residential buildings. (2) C&I consists of loans to businesses and individuals, a portion of which are fully or partially collateralized by real estate. C&I also includes PPP loans. (3) Residential real estate consists of mortgage and homeowner construction loans secured by one- to four-family residential properties. (4) Other consists of loans to individuals secured by general aviation aircraft and other personal installment loans. -59- Management's Discussion and Analysis COVID-19 Pandemic Related The Corporation elected to account for eligible loan modifications under Section 4013 of the CARES Act, as amended by the CRRSA Act. Eligible loan modifications from March 1, 2020 through January 1, 2022 made in response to the COVID-19 pandemic were not required to be classified as TDRs. During this period of time, we processed loan payment deferral modifications, or “deferments”, on 654 loans totaling $727.7 million. The vast majority of the deferments qualified as eligible loan modifications and were not classified as TDRs. All of these loans with qualified deferments exited their payment deferral period prior to March 31, 2022. Commercial Loans The commercial loan portfolio represented 50% of total loans at September 30, 2022. In making commercial loans, we may occasionally solicit the participation of other banks. The Bank also participates in commercial loans originated by other banks. In such cases, these loans are individually underwritten by us using standards similar to those employed for our self-originated loans. Our participation in commercial loans originated by other banks amounted to $431.9 million and $451.6 million, respectively, at September 30, 2022 and December 31, 2021. Our participation in commercial loans originated by other banks also includes shared national credits. Shared national credits are defined as participation in loans or loan commitments of at least $100.0 million that are shared by three or more banks. Commercial loans fall into two main categories, CRE and C&I loans. CRE loans consist of commercial mortgages secured by real property where the primary source of repayment is derived from rental income associated with the property or the proceeds of the sale, refinancing or permanent financing of the property. CRE loans also include construction loans made to businesses for land development or the on-site construction of industrial, commercial, or residential buildings. C&I loans primarily provide working capital, equipment financing and financing for other business-related purposes. C&I loans are frequently collateralized by equipment, inventory, accounts receivable, and/or general business assets. A portion of the Bank’s C&I loans is also collateralized by real estate. C&I loans also include PPP loans that are fully guaranteed by the U.S. government, tax-exempt loans made to states and political subdivisions, as well as industrial development or revenue bonds issued through quasi-public corporations for the benefit of a private or non-profit entity where that entity rather than the governmental entity is obligated to pay the debt service. Commercial Real Estate Loans CRE loans totaled $1.8 billion at September 30, 2022, up by $123.6 million, or 8%, from the balance at December 31, 2021. Loan originations and advances of approximately $420 million were partially offset by payoffs and pay-downs. Included in CRE loans were construction and development loans with carrying values of $118.3 million and $122.4 million, respectively, as of September 30, 2022 and December 31, 2021. Shared national credit balances outstanding included in the CRE loan portfolio totaled $8.1 million at September 30, 2022. The balance was included in the pass-rated category of commercial loan credit quality and current with respect to contractual payment terms at September 30, 2022. The following table presents a summary of CRE loans by property location: (Dollars in thousands) September 30, 2022 December 31, 2021 Outstanding Balance % of Total Outstanding Balance % of Total Connecticut $674,816 38 % $643,182 39 % Massachusetts 529,364 30 464,018 28 Rhode Island 396,869 23 408,496 25 Subtotal 1,601,049 91 1,515,696 92 All other states 161,638 9 123,366 8 Total $1,762,687 100 % $1,639,062 100 % -60- Management's Discussion and Analysis The following table presents a summary of CRE loans by property type segmentation: (Dollars in thousands) September 30, 2022 December 31, 2021 Count Outstanding Balance % of Total Count Outstanding Balance % of Total CRE Portfolio Segmentation: Retail 109 $441,631 25 % 121 $389,487 24 % Multi-family dwelling 123 429,796 24 127 474,229 29 Office 55 253,816 14 57 216,602 13 Hospitality 32 196,503 11 31 184,990 11 Industrial and warehouse 39 176,081 10 35 137,254 8 Healthcare 15 138,475 8 13 128,189 8 Commercial mixed use 20 43,235 2 20 38,978 2 Other 36 83,150 6 36 69,333 5 Total CRE loans 429 $1,762,687 100 % 440 $1,639,062 100 % Average CRE loan size $4,109 $3,725 Largest individual CRE loan outstanding $65,424 $39,945 Commercial and Industrial Loans C&I loans amounted to $652.8 million at September 30, 2022, up by $11.2 million, or 2%, from the balance at December 31, 2021. This included a net reduction in PPP loans of $36.6 million, reflecting loans forgiven by the SBA. Excluding PPP loans, C&I loans increased by approximately $47.8 million, with loan originations and advances of $99 million, partially offset by payoffs and pay-downs. As of September 30, 2022, the carrying value of PPP loans was $1.4 million and included net unamortized loan origination fee balances of $58 thousand. The carrying value of PPP loans at December 31, 2021 was $38.0 million. Shared national credit balances outstanding included in the C&I loan portfolio totaled $40.3 million at September 30, 2022. All of these loans were included in the pass-rated category of commercial loan credit quality and were current with respect to contractual payment terms at September 30, 2022. -61- Management's Discussion and Analysis The following table presents a summary of C&I loan by industry segmentation: (Dollars in thousands) September 30, 2022 December 31, 2021 Count Outstanding Balance % of Total Count Outstanding Balance % of Total C&I Portfolio Segmentation: Healthcare and social assistance 70 $194,128 30 % 101 $174,376 27 % Owner occupied and other real estate 162 71,431 11 185 72,957 11 Manufacturing 54 55,489 9 65 55,341 9 Transportation and warehousing 20 50,597 8 31 35,064 5 Retail 55 49,365 8 79 47,290 7 Educational services 20 48,208 7 28 52,211 8 Finance and insurance 58 31,579 5 59 31,279 5 Entertainment and recreation 24 26,050 4 37 32,087 5 Information 8 22,258 3 14 25,045 4 Accommodation and food services 49 17,499 3 114 28,320 4 Professional, scientific and technical 37 6,357 1 69 8,912 1 Public administration 12 4,223 1 16 5,441 1 Other 164 75,574 10 281 73,232 13 Total C&I loans 733 $652,758 100 % 1,079 $641,555 100 % Average C&I loan size $891 $595 Largest individual C&I loan outstanding $27,671 $18,721 Residential Real Estate Loans The residential real estate loan portfolio represented 44% of total loans at September 30, 2022. Residential real estate loans held in portfolio amounted to $2.1 billion at September 30, 2022, up by $417.1 million, or 24%, from the balance at December 31, 2021, reflecting a higher proportion of loans originated for portfolio in 2022. The following is a summary of residential real estate mortgages by property location: (Dollars in thousands) September 30, 2022 December 31, 2021 Amount % of Total Amount % of Total Massachusetts $1,552,728 72 % $1,207,789 70 % Rhode Island 423,070 20 365,831 21 Connecticut 143,701 7 132,430 8 Subtotal 2,119,499 99 1,706,050 99 All other states 24,599 1 20,925 1 Total (1) $2,144,098 100 % $1,726,975 100 % (1) Includes residential mortgage loans purchased from and serviced by other financial institutions totaling $62.7 million and $78.7 million, respectively, as of September 30, 2022 and December 31, 2021. Residential real estate loans are originated both for sale to the secondary market as well as for retention in the Bank’s loan portfolio. We also originate residential real estate loans for various investors in a broker capacity, including conventional mortgages and reverse mortgages. -62- Management's Discussion and Analysis The table below presents residential real estate loan origination activity: (Dollars in thousands) Three Months Nine Months Periods ended September 30, 2022 2021 2022 2021 Amount % of Total Amount % of Total Amount % of Total Amount % of Total Originations for retention in portfolio (1) $225,132 74 % $205,293 52 % $653,295 71 % $581,905 44 % Originations for sale to the secondary market (2) 77,242 26 190,702 48 270,320 29 744,589 56 Total $302,374 100 % $395,995 100 % $923,615 100 % $1,326,494 100 % (1) Includes the full commitment amount of homeowner construction loans. (2) Includes brokered loans (loans originated for others). The table below presents residential real estate loan sales activity: (Dollars in thousands) Three Months Nine Months Periods ended September 30, 2022 2021 2022 2021 Amount % of Total Amount % of Total Amount % of Total Amount % of Total Loans sold with servicing rights retained $34,659 46 % $108,445 62 % $72,764 26 % $570,370 75 % Loans sold with servicing rights released (1) 40,665 54 65,416 38 212,429 74 186,068 25 Total $75,324 100 % $173,861 100 % $285,193 100 % $756,438 100 % (1) Includes brokered loans (loans originated for others). Residential real estate loan origination, refinancing and sales activity decreased year-over-year in response to increases in market interest rates. Loans are sold with servicing retained or released. Loans sold with servicing rights retained result in the capitalization of servicing rights. Loan servicing rights are included in other assets and are subsequently amortized as an offset to mortgage banking revenues over the estimated period of servicing. The net balance of capitalized servicing rights amounted to $9.2 million and $9.8 million, respectively, as of September 30, 2022 and December 31, 2021. The balance of residential mortgage loans serviced for others, which are not included in the Unaudited Consolidated Balance Sheets, amounted to $1.5 billion as of both September 30, 2022 and December 31, 2021. Consumer Loans Consumer loans include home equity loans and lines of credit and personal installment loans. Home equity lines of credit and home equity loans represented 95% of the total consumer portfolio at September 30, 2022. Our home equity line and home equity loan origination activities are conducted primarily in southern New England. The Bank estimates that approximately 55% of the combined home equity lines of credit and home equity loan balances are first lien positions or subordinate to other Washington Trust mortgages. The consumer loan portfolio totaled $289.3 million at September 30, 2022, up by $24.0 million, or 9%, from December 31, 2021, reflecting increases in home equity lines and loans. Purchased consumer loans, consisting of loans to individuals secured by general aviation aircraft, amounted to $8.9 million and $9.4 million, respectively, at September 30, 2022 and December 31, 2021. -63- Management's Discussion and Analysis Asset Quality Nonperforming Assets Nonperforming assets include nonaccrual loans and OREO. The following table presents nonperforming assets and additional asset quality data: (Dollars in thousands) Sep 30, 2022 Dec 31, 2021 Commercial: Commercial real estate $— $— Commercial & industrial — — Total commercial — — Residential Real Estate: Residential real estate 11,700 13,576 Consumer: Home equity 422 627 Other — — Total consumer 422 627 Total nonaccrual loans 12,122 14,203 OREO, net — — Total nonperforming assets $12,122 $14,203 Nonperforming assets to total assets 0.19 % 0.24 % Nonperforming loans to total loans 0.25 % 0.33 % Total past due loans to total loans 0.16 % 0.24 % Accruing loans 90 days or more past due $— $— Total nonperforming assets decreased by $2.1 million from December 31, 2021, reflecting a decline in nonaccrual loans. Nonaccrual Loans During the nine months ended September 30, 2022, the Corporation made no changes in its practices or policies concerning the placement of loans into nonaccrual status. The following table presents the activity in nonaccrual loans: (Dollars in thousands) Three Months Nine Months For the periods ended September 30, 2022 2021 2022 2021 Balance at beginning of period $12,414 $10,481 $14,203 $13,197 Additions to nonaccrual status 521 2,583 1,106 3,854 Loans returned to accruing status (400) — (699) (877) Loans charged-off (63) (249) (122) (630) Payments, payoffs and other changes (350) (1,839) (2,366) (4,568) Balance at end of period $12,122 $10,976 $12,122 $10,976 -64- Management's Discussion and Analysis The following table presents additional detail on nonaccrual loans: (Dollars in thousands) September 30, 2022 December 31, 2021 Days Past Due Days Past Due Over 90 Under 90 Total % (1) Over 90 Under 90 Total % (1) Commercial: Commercial real estate $— $— $— — % $— $— $— — % Commercial & industrial — — — — — — — — Total commercial — — — — — — — — Residential Real Estate: Residential real estate 5,430 6,270 11,700 0.55 4,662 8,914 13,576 0.79 Consumer: Home equity 50 372 422 0.15 108 519 627 0.25 Other — — — — — — — — Total consumer 50 372 422 0.15 108 519 627 0.24 Total nonaccrual loans $5,480 $6,642 $12,122 0.25 % $4,770 $9,433 $14,203 0.33 % (1) Percentage of nonaccrual loans to the total loans outstanding within the respective category. There were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at September 30, 2022. As of both September 30, 2022 and December 31, 2021, the composition of nonaccrual loans was 100% residential and consumer. Nonaccrual residential real estate mortgage loans amounted to $11.7 million at September 30, 2022, down by $1.9 million from the end of 2021. As of September 30, 2022, the balance of nonaccrual residential mortgage loans was predominately secured by properties in Massachusetts, Connecticut and Rhode Island. Included in total nonaccrual residential real estate loans at September 30, 2022 were four loans purchased for portfolio and serviced by others amounting to $1.1 million. Management monitors the collection efforts of its third party servicers as part of its assessment of the collectability of nonperforming loans. Troubled Debt Restructurings In the course of resolving problem loans, the Corporation may choose to restructure the contractual terms of certain loans. A loan that has been modified or renewed is considered to be a TDR when two conditions are met: (1) the borrower is experiencing financial difficulty and (2) concessions are made for the borrower’s benefit that would not otherwise be considered for a borrower or a transaction with similar credit risk characteristics. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit the Corporation by increasing the ultimate probability of collection. TDRs are classified as accruing or non-accruing based on management’s assessment of the collectability of the loan. Loans that are already on nonaccrual status at the time of the restructuring generally remain on nonaccrual status for approximately six months before management considers such loans for return to accruing status. Accruing restructured loans are placed into nonaccrual status if and when the borrower fails to comply with the restructured terms and management deems it unlikely that the borrower will return to a status of compliance in the near term and full collection of principal and interest is in doubt. TDRs are reported as such for at least one year from the date of the restructuring. In years after the restructuring, a TDR is removed from this classification if the restructuring did not involve a below-market rate concession and the loan is performing in accordance with its modified contractual terms for a reasonable period of time. As of September 30, 2022, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured in a TDR. See Note 2 for discussion on ASU No. 2022-02, a recently issued accounting pronouncement that is pending adoption. ASU -65- Management's Discussion and Analysis No. 2022-02, which becomes effective on January 1, 2023, updates the accounting treatment and related disclosure requirements for TDRs. As noted above under the caption “Loans,” the Corporation elected to account for eligible loan modifications under Section 4013 of the CARES Act, as amended by the CRRSA Act. Loan modifications that did not qualify for the TDR accounting relief provided under the CARES Act were classified as TDRs. The following table sets forth information on TDRs as of the dates indicated. The amounts below consist of unpaid principal balance, net of charge-offs and unamortized deferred loan origination fees and costs. Accrued interest is not included in the carrying amounts set forth below. (Dollars in thousands) Sep 30, 2022 Dec 31, 2021 Accruing TDRs Commercial: Commercial real estate $3,609 $10,603 Commercial & industrial 844 2,792 Total commercial 4,453 13,395 Residential Real Estate: Residential real estate 2,204 2,372 Consumer: Home equity 557 561 Other — — Total consumer 557 561 Accruing TDRs 7,214 16,328 Nonaccrual TDRs Commercial: Commercial real estate — — Commercial & industrial — — Total commercial — — Residential Real Estate: Residential real estate 2,819 2,748 Consumer: Home equity 71 71 Other — — Total consumer 71 71 Nonaccrual TDRs 2,890 2,819 Total TDRs $10,104 $19,147 As of September 30, 2022, the composition of TDRs was 44% commercial and 56% residential and consumer, compared to 70% commercial and 30% residential and consumer at December 31, 2021. TDRs amounted to $10.1 million at September 30, 2022, down by $9.0 million from the end of 2021. The net decline reflected a pay-down of $6.5 million on one accruing CRE TDR loan and the declassification from TDR status of one accruing C&I loan with a carrying value of $2.8 million that was declassified in accordance with policy. The ACL included specific reserves for TDRs of $132 thousand at September 30, 2022, compared to $148 thousand at December 31, 2021. -66- Management's Discussion and Analysis Past Due Loans The following table presents past due loans by category: (Dollars in thousands) September 30, 2022 December 31, 2021 Amount % (1) Amount % (1) Commercial: Commercial real estate $— — % $— — % Commercial & industrial 4 — 3 — Total commercial 4 — 3 — Residential Real Estate: Residential real estate 7,256 0.34 9,622 0.56 Consumer: Home equity 252 0.09 765 0.31 Other 17 0.11 21 0.12 Total consumer 269 0.09 786 0.30 Total past due loans $7,529 0.16 % $10,411 0.24 % (1) Percentage of past due loans to the total loans outstanding within the respective category. As of both September 30, 2022 and December 31, 2021, the composition of past due loans (loans past due 30 days or more) was essentially 100% residential and consumer. Total past due loans decreased by $2.9 million from the end of 2021. Total past due loans included $7.1 million of nonaccrual loans as of September 30, 2022, compared to $9.4 million as of December 31, 2021. All loans 90 days or more past due at September 30, 2022 and December 31, 2021 were classified as nonaccrual. Potential Problem Loans The Corporation classifies certain loans as “substandard,” “doubtful,” or “loss” based on criteria consistent with guidelines provided by banking regulators. Potential problem loans include classified accruing commercial loans that were less than 90 days past due at September 30, 2022 and other loans for which known information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as nonperforming at some time in the future. Potential problem loans are not included in the amounts of nonaccrual or TDRs presented above. They are assessed for loss exposure using the methods described in Note 4 to the Unaudited Consolidated Financial Statements under the caption “Credit Quality Indicators.” Management cannot predict the extent to which economic conditions or other factors may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured, or require an increased allowance coverage and provision for credit losses on loans. Management has identified two loans associated with one C&I relationship with carrying values totaling $722 thousand as potential problem loans at September 30, 2022. These two loans were current with respect to payment terms at September 30, 2022. There were no potential problem loans identified at December 31, 2021. Allowance for Credit Losses on Loans The ACL on loans is management’s estimate, at the reporting date, of expected credit losses over the expected life of the loans. The ACL on loans is established through a provision for credit losses recognized in earnings. The ACL on loans is reduced by charge-offs on loans and is increased by recoveries of amounts previously charged off. The Corporation’s general practice is to identify problem credits early and recognize full or partial charge-offs as promptly as practicable when it is determined that the collection of loan principal is unlikely. Full or partial charge-offs on collateral dependent individually analyzed loans are recognized when the collateral is deemed to be insufficient to support the carrying -67- Management's Discussion and Analysis value of the loan. The Corporation does not recognize a recovery when new appraisals indicate a subsequent increase in value. Appraisals are generally obtained with values determined on an “as is” basis from independent appraisal firms for real estate collateral dependent commercial loans in the process of collection or when warranted by other deterioration in the borrower’s credit status. New appraisals are generally obtained for TDRs or nonaccrual loans or when management believes it is warranted. The Corporation has continued to maintain appropriate professional standards regarding the professional qualifications of appraisers and has an internal review process to monitor the quality of appraisals. For residential real estate loans and real estate collateral dependent consumer loans that are in the process of collection, valuations are obtained from independent appraisal firms with values determined on an “as is” basis. The following table presents additional detail on the Corporation’s loan portfolio and associated allowance: (Dollars in thousands) September 30, 2022 December 31, 2021 Loans Related Allowance Allowance / Loans Loans Related Allowance Allowance / Loans Individually analyzed loans $12,024 $652 5.42 % $21,080 $682 3.24 % Pooled (collectively evaluated) loans 4,836,849 36,211 0.75 4,251,845 38,406 0.90 Total $4,848,873 $36,863 0.76 % $4,272,925 $39,088 0.91 % Management employs a process and methodology to estimate the ACL on loans that evaluates both quantitative and qualitative factors. The methodology for evaluating quantitative factors consists of two basic components. The first component involves pooling loans into portfolio segments for loans that share similar risk characteristics. The second component involves individually analyzed loans that do not share similar risk characteristics with loans that are pooled into portfolio segments. The ACL for individually analyzed loans is measured using a DCF method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or, if the loan was collateral dependent, at the fair value of the collateral. The ACL for pooled loans is measured utilizing a DCF methodology to estimate credit losses for each pooled portfolio segment. The methodology incorporates a probability of default and loss given default framework. Loss given default is estimated based on historical credit loss experience. Probability of default is estimated using a regression model that incorporates econometric factors. Management utilizes forecasted econometric factors with a one-year reasonable and supportable forecast period and one-year straight-line reversion period in order to estimate the probability of default for each loan portfolio segment. The DCF methodology combines the probability of default, the loss given default, prepayment speeds and remaining life of the loan to estimate a reserve for each loan. The sum of all the loan level reserves are aggregated for each portfolio segment and a loss rate factor is derived. Quantitative loss factors for pooled loans are also supplemented by certain qualitative risk factors reflecting management’s view of how losses may vary from those represented by quantitative loss rates. The ACL on loans amounted to $36.9 million at September 30, 2022, down by $2.2 million from the balance at December 31, 2021. The ACL on loans as a percentage of total loans, also known as the reserve coverage ratio, was 0.76% at September 30, 2022, compared to 0.91% at December 31, 2021. The Corporation recorded a positive provision for credit losses (or a charge) of $800 thousand for the three months ended September 30, 2022, compared to no provision for the same period in 2021. On a year-to-date basis, the Corporation recognized a negative provision for credit losses (or a benefit) of $2.1 million, compared to a negative provision (or a benefit) of $2.0 million for the same period in 2021. The provision for credit losses recognized in 2022 provided for loan growth and was also reflective of low loss rates, strong asset and credit quality metrics and our current estimate of forecasted economic conditions. Net recoveries totaled $54 thousand and $104 thousand, respectively, for the three and nine months ended September 30, 2022. -68- Management's Discussion and Analysis The ACL on loans is an estimate and ultimate losses may vary from management’s estimate. Deteriorating conditions or assumptions could lead to further increases in the ACL on loans; conversely, improving conditions or assumptions could lead to further reductions in the ACL on loans. The following table presents the allocation of the ACL on loans by portfolio segment. The total ACL on loans is available to absorb losses from any segment of the loan portfolio. (Dollars in thousands) September 30, 2022 December 31, 2021 Allocated ACL ACL to Loans Loans to Total Portfolio (1) Allocated ACL ACL to Loans Loans to Total Portfolio (1) Commercial: Commercial real estate $17,611 1.00 % 36 % $18,933 1.16 % 38 % Commercial & industrial 10,347 1.59 14 10,832 1.69 15 Total commercial 27,958 1.16 50 29,765 1.31 53 Residential Real Estate: Residential real estate 7,447 0.35 44 7,860 0.46 40 Consumer: Home equity 1,071 0.39 6 1,069 0.43 6 Other 387 2.48 — 394 2.23 1 Total consumer 1,458 0.50 6 1,463 0.55 7 Total allowance for credit losses on loans at end of period $36,863 0.76 % 100 % $39,088 0.91 % 100 % (1) Percentage of loans outstanding in respective category to total loans outstanding. Sources of Funds Our sources of funds include in-market deposits, wholesale brokered deposits, FHLB advances, other borrowings and proceeds from the sales, maturities and payments of loans and investment securities. The Corporation uses funds to originate and purchase loans, purchase investment securities, conduct operations, expand the branch network and pay dividends to shareholders. Deposits The Corporation offers a wide variety of deposit products to consumer and business customers. Deposits provide an important source of funding for the Bank, as well as an ongoing stream of fee revenue. The Bank is a participant in the DDM program, ICS program and the CDARS program. The Bank uses these deposit sweep services to place customer and client funds into interest-bearing demand accounts, money market accounts, and/or time deposits issued by other participating banks. Customer and client funds are placed at one or more participating banks to ensure that each deposit customer is eligible for the full amount of FDIC insurance. As a program participant, we receive reciprocal amounts of deposits from other participating banks. We consider these reciprocal deposit balances to be in-market deposits as distinguished from traditional wholesale brokered deposits. -69- Management's Discussion and Analysis The following table presents a summary of deposits: (Dollars in thousands) Change September 30, 2022 December 31, 2021 $ % Noninterest-bearing demand deposits $938,572 $945,229 ($6,657) (1 %) Interest-bearing demand deposits (in market) 273,231 251,032 22,199 9 NOW accounts 869,984 867,138 2,846 — Money market accounts 1,146,826 1,072,864 73,962 7 Savings accounts 600,568 555,177 45,391 8 Time deposits (in-market) 797,505 773,383 24,122 3 In-market deposits 4,626,686 4,464,823 161,863 4 Wholesale brokered demand deposits 31,044 — 31,044 100 Wholesale brokered time deposits 412,127 515,228 (103,101) (20) Wholesale brokered deposits 443,171 515,228 (72,057) (14) Total deposits $5,069,857 $4,980,051 $89,806 2 % In-market deposits were up by $161.9 million, or 4%, from the balance at December 31, 2021, while wholesale brokered deposits declined by $72.1 million, or 14%. Total deposits amounted to $5.1 billion at September 30, 2022, up by $89.8 million, or 2%, from December 31, 2021. Borrowings Borrowings primarily consist of FHLB advances, which are used as a source of funding for liquidity and interest rate risk management purposes. FHLB advances totaled $700.0 million at September 30, 2022, up by $555.0 million, or 383%, from the balance at the end of 2021, as higher levels of wholesale funding were utilized to fund loan growth and purchases of debt securities. For additional information regarding FHLB advances see Note 7 to the Unaudited Consolidated Financial Statements. Liquidity and Capital Resources Liquidity Management Liquidity is the ability of a financial institution to meet maturing liability obligations and customer loan demand. The Corporation’s primary source of liquidity is in-market deposits, which funded approximately 77% of total average assets in the nine months ended September 30, 2022. While the generally preferred funding strategy is to attract and retain low-cost deposits, the ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and brokered deposits), cash flows from the investment securities portfolios and loan repayments. Securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs, although management has no intention to do so at this time. The Corporation has a detailed liquidity funding policy and a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. Management employs stress testing methodology to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of “business as usual” cash flows. In management’s estimation, risks are concentrated in two major categories: (1) runoff of in-market deposit balances; and (2) unexpected drawdown of loan commitments. Of the two categories, potential runoff of deposit balances would have the most significant impact on contingent liquidity. Our stress test scenarios, therefore, emphasize attempts to quantify deposits at risk over selected time horizons. In addition to these unexpected outflow risks, several other “business as usual” factors enter into the calculation of the adequacy of contingent liquidity including: (1) payment proceeds from loans and investment securities; (2) maturing debt obligations; and (3) maturing time deposits. The Corporation has established collateralized borrowing capacity with the FRBB and also maintains additional collateralized borrowing capacity with the FHLB in excess of levels used in the ordinary course of business. Borrowing capacity is impacted by the amount and type of assets available to be pledged. -70- Management's Discussion and Analysis The table below presents unused funding capacity by source as of the dates indicated: (Dollars in thousands) September 30, 2022 December 31, 2021 Additional Funding Capacity: Federal Home Loan Bank of Boston (1) $967,133 $1,642,377 Federal Reserve Bank of Boston (2) 24,392 16,919 Unencumbered investment securities 672,024 702,963 Total $1,663,549 $2,362,259 (1) As of September 30, 2022 and December 31, 2021, loans with a carrying value of $2.3 billion and $2.2 billion, respectively, and securities available for sale with carrying values of $121.4 million and $163.2 million, respectively, were pledged to the FHLB resulting in this additional borrowing capacity. (2) As of September 30, 2022 and December 31, 2021, loans with a carrying value of $17.8 million and $8.2 million, respectively, and securities available for sale with a carrying value of $12.8 million and $13.5 million, respectively, were pledged to the FRBB for the discount window resulting in this additional unused borrowing capacity. In addition to the amounts presented above, the Bank also had access to a $40.0 million unused line of credit with the FHLB, as well as a $102.0 million standby letter of credit with the FHLB. The ALCO establishes and monitors internal liquidity measures to manage liquidity exposure. Liquidity remained within target ranges established by the ALCO during the nine months ended September 30, 2022. Based on its assessment of the liquidity considerations described above, management believes the Corporation’s sources of funding meet anticipated funding needs. Net cash provided by operating activities amounted to $71.8 million for the nine months ended September 30, 2022, reflecting net income of $55.1 million and mortgage banking related adjustments to reconcile net income to net cash provided by operating activities. Net cash used in investing activities totaled $723.8 million for the nine months ended September 30, 2022, reflecting an increase in loans, outflows to fund purchases of debt securities and a purchase of BOLI. These outflows were partially offset by net inflows from maturities, calls and principal payments of debt securities. For the nine months ended September 30, 2022, net cash provided by financing activities amounted to $606.3 million, with a net increase in FHLB advances and growth in deposits, partially offset by the payment of dividends to shareholders and purchases of treasury stock. See the Unaudited Consolidated Statements of Cash Flows for further information about sources and uses of cash. In the normal course of business, the Corporation engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. Such transactions are used to meet the financing needs of its customers and to manage the exposure to fluctuations in interest rates. These financial transactions include commitments to extend credit, standby letters of credit, forward loan commitments, loan related derivative contracts and interest rate risk management contracts. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. The Corporation’s credit policies with respect to interest rate contracts with commercial borrowers, commitments to extend credit, and standby letters of credit are similar to those used for loans. Interest rate risk management contracts with other counterparties are generally subject to bilateral collateralization terms. For additional information on derivative financial instruments and financial instruments with off-balance sheet risk see Notes 9 and 17 to the Unaudited Consolidated Financial Statements. Capital Resources Total shareholders’ equity amounted to $432.3 million at September 30, 2022, down by $132.5 million from December 31, 2021. The decline reflected a decrease of $151.8 million in the AOCL component of shareholders' equity, due to decreases in the fair value of available for sale debt securities and cash flow hedges primarily attributable to relative changes in market interest rates. In addition, the decline also reflected $28.3 million in dividend declarations and a net increase in treasury stock repurchases of $8.2 million, partially offset by net income of $55.1 million. The Corporation declared a quarterly dividend of 54 cents per share for the three months ended September 30, 2022, compared to 52 cents per share declared for the same period in 2021. On a year-to-date basis, dividend declarations totaled $1.62 per share in 2022, compared to $1.56 per share in 2021. -71- Management's Discussion and Analysis The ratio of total equity to total assets was 6.75% at September 30, 2022, compared to a ratio of 9.65% at December 31, 2021. Book value per share at September 30, 2022 and December 31, 2021 was $25.17 and $32.59, respectively. The Bancorp and the Bank are subject to various regulatory capital requirements and are considered “well capitalized” with a total risk-based capital ratio of 12.65% at September 30, 2022, compared to 14.01% at December 31, 2021. See Note 8 to the Unaudited Consolidated Financial Statements for additional discussion of regulatory capital requirements and the election of the ASC 326 phase-in option provided by regulatory guidance, which phases in the impact of ASC 326 on regulatory capital over a three-year period that commenced January 1, 2022. Asset/Liability Management and Interest Rate Risk Interest rate risk is the risk of loss to future earnings due to changes in interest rates. The ALCO is responsible for establishing policy guidelines on liquidity and acceptable exposure to interest rate risk. Periodically, the ALCO reports on the status of liquidity and interest rate risk matters to the Bank’s Board of Directors. The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with the Corporation’s liquidity, capital adequacy, growth, risk and profitability goals. The Corporation utilizes the size and duration of the investment securities portfolio, the size and duration of the wholesale funding portfolio, off-balance sheet interest rate contracts and the pricing and structure of loans and deposits, to manage interest rate risk. The off-balance sheet interest rate contracts may include interest rate swaps, caps and floors. These interest rate contracts involve, to varying degrees, credit risk and interest rate risk. Credit risk is the possibility that a loss may occur if a counterparty to a transaction fails to perform according to terms of the contract. The notional amount of the interest rate contracts is the amount upon which interest and other payments are based. The notional amount is not exchanged, and therefore, should not be taken as a measure of credit risk. See Notes 9 and 17 to the Unaudited Consolidated Financial Statements for additional information. The ALCO uses income simulation to measure interest rate risk inherent in the Corporation’s on-balance sheet and off-balance sheet financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 12-month horizon, a 13- to 24-month horizon and a 60-month horizon. The simulations assume that the size and general composition of the Corporation’s balance sheet remain static over the simulation horizons, with the exception of certain deposit mix shifts from low-cost core savings to higher-cost time deposits in selected interest rate scenarios. Additionally, the simulations take into account the specific repricing, maturity, call options, and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios. The characteristics of financial instrument classes are reviewed periodically by the ALCO to ensure their accuracy and consistency. The ALCO reviews simulation results to determine whether the Corporation’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. As of September 30, 2022 and December 31, 2021, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Corporation. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where both interest rates and the composition of the Corporation’s balance sheet remain stable for a 60-month period. In addition to measuring the change in net interest income as compared to an unchanged rate scenario, the ALCO also measures the trend of both net interest income and NIM over a 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios. The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest rate risk exposure, including scenarios showing the effect of steepening or flattening changes in the yield curve of up to 500 basis points, as well as parallel changes in interest rates of up to 400 basis points. Because income simulations assume that the Corporation’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts. The following table sets forth the estimated change in net interest income from an unchanged rate scenario over the periods indicated for parallel changes in market interest rates using the Corporation’s on- and off-balance sheet financial instruments as of September 30, 2022 and December 31, 2021. Interest rates are assumed to shift by a parallel 100, 200 or 300 basis points upward or 100 basis points downward over a 12-month period, except for core savings deposits, which are assumed to shift by lesser amounts due to their relative historical insensitivity to market interest rate movements. Further, deposits are -72- Management's Discussion and Analysis assumed to have certain minimum rate levels below which they will not fall. It should be noted that the rate scenarios shown do not necessarily reflect the ALCO’s view of the “most likely” change in interest rates over the periods indicated. September 30, 2022 December 31, 2021 Months 1 - 12 Months 13 - 24 Months 1 - 12 Months 13 - 24 100 basis point rate decrease (1.68) % (0.01) % (1.32) % (5.42) % 100 basis point rate increase 0.58 (2.66) 3.34 3.91 200 basis point rate increase 2.23 (3.69) 6.87 8.18 300 basis point rate increase 3.77 (5.42) 10.32 11.72 The ALCO estimates that negative exposure of net interest income to falling rates as compared to an unchanged rate scenario results from a more rapid decline in earning asset yields compared to rates paid on deposits. If market interest rates were to fall and remain lower for a sustained period, certain core savings and time deposit rates could decline more slowly and by a lesser amount than other market interest rates. Asset yields would likely decline more rapidly than deposit costs as current asset holdings mature or reprice, since cash flow from mortgage-related prepayments and redemption of callable securities would increase as market interest rates fall. As of September 30, 2022, the ALCO estimates that positive exposure of net interest income to rising rates in Year 1 as compared to an unchanged rate scenario results from a more rapid projected relative rate of increase in asset yields than funding costs over the near term. For simulation purposes, deposit rate changes are anticipated to lag behind other market interest rates in both timing and magnitude. The ALCO’s estimate of interest rate risk exposure to rising rate environments, including those involving changes to the shape of the yield curve, incorporates certain assumptions regarding the shift in deposit balances from low-cost core savings categories to higher-cost deposit categories, which has characterized a shift in funding mix during the past rising interest rate cycles. As of September 30, 2022, the negative exposure of net interest income to rising rates as compared to an unchanged rate scenario is primarily attributable to a projected increase in funding costs. As market rates increase, ALCO modeling assumes that deposits will shift from low cost to higher cost deposits. This assumption reflects historical operating conditions in rising rate cycles. Although asset yields would increase in a rising interest rate environment, the cumulative impact of relative growth in rate-sensitive higher cost deposit categories and wholesale funds suggests that by Year 2 of rising interest rate scenarios, the increase in the Corporation’s cost of funds could result in a relative decline in net interest margin compared to an unchanged rate scenario. The overall decline in interest rate sensitivity to rising rates from December 31, 2021, as shown in the above table, was largely attributable to a higher level of longer-term fixed rate assets, as well as an increase in the proportion of wholesale funds to total sources of funds at September 30, 2022. Fixed rate assets would not reprice upward in a rising rate environment. Wholesale funds would reprice more quickly and by a greater amount than the repricing of core deposits in response to changes in market interest rates. While the ALCO reviews and updates simulation assumptions and also periodically back-tests the simulation results to ensure that the assumptions are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future NIM. Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of the Corporation’s balance sheet may change to a different degree than estimated. Simulation modeling assumes a static balance sheet, with the exception of certain modeled deposit mix shifts from low-cost core savings deposits to higher-cost time deposits in rising rate scenarios as noted above. As market interest rates declined, the banking industry attracted low-cost core savings deposits. The ALCO recognizes that a portion of these increased levels of low-cost balances could shift into higher yielding alternatives in the future, particularly as interest rates rise and as confidence in financial markets strengthens, and has modeled deposit shifts out of these low-cost categories into higher-cost alternatives in the rising rate simulation scenarios presented above. Deposit balances may also be subject to possible outflow to non-bank alternatives in a rising rate environment, which may cause interest rate sensitivity to differ from the results as presented. Another significant simulation assumption is the sensitivity of core savings deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. The relationship between short-term interest rate changes and core deposit rate and balance changes may differ from the ALCO’s estimates used in income simulation. -73- Management's Discussion and Analysis It should also be noted that the static balance sheet assumption does not necessarily reflect the Corporation’s expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Mortgage-backed securities and residential real estate loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income. The Corporation also monitors the potential change in market value of its available for sale debt securities in changing interest rate environments. The purpose is to determine market value exposure that may not be captured by income simulation, but which might result in changes to the Corporation’s capital position. Results are calculated using industry-standard analytical techniques and securities data. The following table summarizes the potential change in market value of the Corporation’s available for sale debt securities as of September 30, 2022 and December 31, 2021 resulting from immediate parallel rate shifts: (Dollars in thousands) Security Type Down 100 Basis Points Up 200 Basis Points U.S. government-sponsored enterprise securities (callable) $28,038 ($3,760) Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises 55,880 (104,798) Trust preferred debt and other corporate debt securities (18) 7 Total change in market value as of September 30, 2022 $83,900 ($108,551) Total change in market value as of December 31, 2021 $10,166 ($119,505) Critical Accounting Policies and Estimates Estimates and assumptions are necessary in the application of certain accounting policies and procedures and can be susceptible to significant change. Critical accounting policies are defined as those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the Corporation’s financial condition or results of operations. Management considers its accounting policy relating to the ACL on loans to be a critical accounting policy. There have been no significant changes in the Corporation’s critical accounting policies and estimates from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. Recently Issued Accounting Pronouncements See Note 2 to the Unaudited Consolidated Financial Statements for details of recently issued accounting pronouncements and their expected impact on the Corporation’s financial statements.