Independent Bank Corp: Form 10-Q for the period ended Sep 30, 2024

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction. The following section presents additional information to assess the financial condition and results of operations of Independent Bank Corporation (“IBCP”), its wholly-owned bank, Independent Bank (the “Bank”), and their subsidiaries. This section should be read in conjunction with the Condensed Consolidated Financial Statements. We also encourage you to read our 2023 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”). That report includes a list of risk factors that you should consider in connection with any decision to buy or sell our securities.

Overview. We provide banking services to customers located primarily in Michigan’s Lower Peninsula. We also have a loan production office in Fairlawn, Ohio. As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula.

Recent Developments. Pressures from various global and national macroeconomic conditions, including heightened inflation, uncertainty regarding future interest rates, foreign currency exchange rate fluctuations, recent adverse weather conditions, the continuation of the Russia-Ukraine and Middle East wars, the pending Presidential and Congressional elections, and potential governmental responses to these events, continue to create significant economic uncertainty. The extent to which these pressures may impact our business, results of operations, asset valuations, financial condition, and customers will depend on future developments, which continue to be highly uncertain and difficult to predict. Material adverse impacts may include all or a combination of valuation impairments on our intangible assets, securities available for sale ("AFS"), securities held to maturity ("HTM"), loans, capitalized mortgage loan servicing rights or deferred tax assets.

It is against this backdrop that we discuss our results of operations and financial condition for the third quarter of 2024 as compared to earlier periods.

RESULTS OF OPERATIONS

Summary. We recorded net income of $13.8 million and $17.5 million during the three months ended September 30, 2024 and 2023, respectively. The decrease in 2024 third quarter results as compared to 2023 is due primarily to a $5.7 unfavorable change in the fair value due to price of capitalized mortgage loan servicing rights that was partially offset by a $2.4 million increase in net interest income.

We recorded net income of $48.3 million and $45.3 million during the nine months ended September 30, 2024 and 2023, respectively. The increase in 2024 year-to-date results as compared to 2023 is primarily due to an increase in net-interest income and a decrease in the provision for credit losses that were partially offset by increases in non-interest expense and income tax expense and a decrease in non-interest income.

Key performance ratios

Net interest income. Net interest income is the most important source of our earnings and thus is critical in evaluating our results of operations. Changes in our net interest income are primarily influenced by our level of interest-earning assets and the income or yield that we earn on those assets and the manner and cost of funding our interest-earning assets. Certain macro-economic factors can also influence our net interest income such as the level and direction of interest rates, the difference between short-term and long-term interest rates (the steepness of the yield curve) and the general strength of the economies in which we are doing business. Finally, risk management plays an important role in our level of net interest income. The ineffective management of credit risk and interest-rate risk in particular can adversely impact our net interest income.

Our net interest income totaled $41.9 million during the third quarter of 2024, an increase of $2.4 million, or 6.2% from the year-ago period. This increase primarily reflects a $93.6 million increase in average interest-earning assets and a 14 basis point increase in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”).

For the first nine months of 2024, net interest income totaled $123.4 million, an increase of $7.2 million, or 6.2% from 2023. This increase primarily reflects a $145.3 million, or 3.0% increase in average interest-earning assets and a nine basis point increase in our net interest margin.

The increase in average interest-earning assets in both the three and nine month periods in 2024 as compared to the same periods in 2023 primarily reflects growth in commercial and mortgage loans funded from a decrease in securities available for sale and an increase in deposits.

The increases in our net interest margin during the three and nine month periods in 2024 is attributed to increases in interest income as a percent of average interest-earning assets ("Asset Yield") that were only partially offset by increases in interest expense as a percent of average interest-earning assets ("Cost of Funds"). These increases are primarily attributed to the increases in the federal funds rate since January of 2023. Our Asset Yield has been positively impacted by new loans being originated at higher rates than existing loans being paid off as well as a shift in earning asset mix from generally lower rate investment securities to higher rate loans while our Cost of Funds has been negatively impacted by changes in funding mix (such as shifting from non-interest bearing deposits to interest-bearing deposits and an increase in time deposits) as well as higher deposit pricing sensitivity to the increases in interest rates discussed above. This change in funding mix and pricing is expected to continue to impact our Cost of Funds during the fourth quarter of 2024. See Asset/liability management.

Our net interest income is also impacted by our level of non-accrual loans. In the third quarter and first nine months of 2024, non-accrual loans averaged $4.5 million and $4.1 million, respectively. In the third quarter and first nine months of 2023, non-accrual loans averaged $4.4 million and $4.0 million, respectively. In addition, in the third quarter and first nine months of 2024 we had net recoveries of $0.12 million and $0.51 million, respectively of unpaid interest on loans placed on or taken off non-accrual or on loans previously charged-off compared to net recoveries of $0.09 million and $0.47 million, respectively, during the same periods in 2023.

Average Balances and Tax Equivalent Rates

(Dollars in thousands)

(1) Interest on tax-exempt loans and securities available for sale is presented on a fully tax equivalent basis assuming a marginal tax rate of 21%.

(2) Annualized

Average Balances and Tax Equivalent Rates

(Dollars in thousands)

(1) Interest on tax-exempt loans and securities available for sale is presented on a fully tax equivalent basis assuming a marginal tax rate of 21%.

(2) Annualized

Reconciliation of Non-GAAP Financial Measures

(Dollars in thousands)

(1) Annualized.

Provision for credit losses. The provision for credit losses was an expense of $1.49 million and an expense of $1.35 million for the three months ended September 30, 2024 and 2023, respectively. During the nine-month periods ended September 30, 2024 and 2023, the provision for credit losses was an expense of $2.25 million and a expense of $6.83 million, respectively. The provision reflects our assessment of the allowance for credit losses (the “ACL”) taking into consideration factors such as loan growth, loan mix, levels of non-performing and classified loans, economic conditions and loan net charge-offs. While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors. See “Portfolio Loans and asset quality” for a discussion of the various components of the ACL and their impact on the provision for credit losses in 2024.

The year-to-date provision for credit losses on loans in 2024 compared to 2023, decreased $0.44 million. The provision for credit losses on securities HTM in 2024 and 2023 was an expense (credit) of $(1.15) million and $2.99 million, respectively. The change in provision for credit losses on securities HTM reflects a charge-off in the first quarter of 2023 and a subsequent partial recovery during the first quarter of 2024 of one corporate security (Signature Bank). See “Securities” below and note #3 to the Condensed Consolidated Financial Statements.

Non-interest income. Non-interest income is a significant element in assessing our results of operations. Non-interest income totaled $9.5 million during the third quarter of 2024 compared to $15.6 million in the third quarter of 2023. For the first nine months of 2024, non-interest income totaled $37.2 million compared to $41.6 million for the first nine months of 2023.

The components of non-interest income are as follows:

Non-Interest Income

(In thousands)

Service charges on deposit accounts decreased by $0.2 million and $0.4 million in the third quarter and first nine months of 2024, respectively, compared to the same periods in 2023 due primarily to decreases in non-sufficient funds occurrences (and related fees).

Mortgage loan activity is summarized as follows:

Mortgage Loan Activity

(Dollars in thousands)

(1) Mortgage loan sales in the third quarters of 2024 and 2023 include $6.6 million and zero, respectively, of portfolio loan transactions. Mortgage loan sales during the first nine months of 2024 and 2023 include $14.7 million and $41.2 million, respectively, of portfolio loan transactions. These transactions were performed for interest rate risk purposes.

Mortgage loans originated decreased in 2024 as compared to 2023 due primarily to higher mortgage loan interest rates in 2024 reducing this activity. Mortgage loans sold, excluding portfolio loan sales, were relative unchanged in 2024 as compared to 2023.

The volume of loans sold is dependent upon our ability to originate mortgage loans as well as the demand for fixed-rate obligations and other loans that we choose to not put into portfolio because of our established interest-rate risk parameters. (See “Portfolio Loans and asset quality.”) Net gains on mortgage loans are also dependent upon economic and competitive factors as well as our ability to effectively manage exposure to changes in interest rates and thus can often be a volatile part of our overall revenues.

Net gains on mortgage loans totaled $2.2 million and $2.1 million during the third quarters of 2024 and 2023, respectively. For the first nine months of 2024 and 2023, net gains on mortgage loans totaled $4.9 million and $5.5 million, respectively. The decrease from the prior year to date period was primarily due to a decrease in mortgage loans sold.

Our Loan Sales Margin is impacted by several factors including competition and the manner in which the loan is sold. Net gains on mortgage loans are also impacted by recording fair value accounting adjustments. Excluding these fair value accounting adjustments, the Loan Sales Margin would have been 1.40% and 2.14% in the third quarters of 2024 and 2023, respectively, and 1.38% and 1.10% for the comparative 2024 and 2023 year-to-date periods, respectively. The decline in the Loan Sales Margin (excluding fair value adjustments) in the third quarter of 2024 was generally due to lower primary-to-secondary market pricing spreads as market interest rates rose in 2024 (relative to 2023) which were impacted by the decrease in salable mortgage loan volumes.

Gain on equity securities at fair value totaled $2.7 million during the first nine months of 2024. This gain is the consequence of the exchange of our shares of Visa Class B-1 common stock on May 6, 2024 into a combination of Visa Class C common stock and Visa Class B-2 common stock. With the completion of this exchange, we were able to sell our Visa Class C common stock (as it was convertible into publicly traded Visa Class A common stock) while the Visa Class B-2 common stock continues to be held and carried at zero. See note #13 to the Condensed Consolidated Financial Statements.

We recorded a net loss of $0.4 million and a net loss of $0.2 million on securities AFS for the first nine months of 2024 and 2023, respectively. We recorded no credit related charges in either 2024 or 2023 on securities AFS. See “Securities” below and note #3 to the Condensed Consolidated Financial Statements.

Mortgage loan servicing, net, generated income (expense) of $(3.1) million and $2.7 million in the third quarters of 2024 and 2023, respectively. For the first nine months of 2024 and 2023, mortgage loan servicing, net, generated income of $1.7 million and $7.1 million, respectively. The significant variances in mortgage loan servicing, net are primarily due to changes in the fair value of capitalized mortgage loan servicing rights associated with changes in interest rates and the associated expected future prepayment levels and expected float rates.

Mortgage loan servicing, net activity is summarized in the following table:

Mortgage Servicing Revenue

(In thousands)

Activity related to capitalized mortgage loan servicing rights is as follows:

Capitalized Mortgage Loan Servicing Rights

(In thousands)

72

At September 30, 2024 we were servicing approximately $3.55 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 4.08% and a weighted average service fee of approximately 25.5 basis points. Capitalized mortgage loan servicing rights at September 30, 2024 totaled $40.2 million, representing approximately 113.2 basis points on the related amount of mortgage loans serviced for others.

Other income in the table above decreased by $0.1 million and $0.8 million in the third quarter and first nine months of 2024, respectively, compared to the same prior year periods. The decrease in the third quarter of 2024 was primarily due to the prior year including a one time gain on the sale of an office building and a decrease in certain internet banking fees no longer being charged that were partially offset by higher commercial loan swap fees. The decrease from the prior year to date period was primarily due to the prior year including one time gains on the sale of an office building and a purchase credit impaired loan as well as a decrease in certain internet banking fees no longer being charged.

Non-interest expense. Non-interest expense is an important component of our results of operations. We strive to efficiently manage our cost structure.

Non-interest expense increased by $0.5 million to $32.6 million and increased by $2.9 million to $98.1 million during the three- and nine-month periods ended September 30, 2024, respectively, compared to the same periods in 2023.

The components of non-interest expense are as follows:

Non-Interest Expense

(In thousands)

Compensation and employee benefits expenses, in total, increased $0.1 million on a quarterly comparative basis and increased $2.2 million for the first nine months of 2024 compared to the same periods in 2023.

Compensation expense increased by $0.2 million and $0.1 million in the third quarter and first nine months of 2024, respectively, compared to the same periods in 2023. These comparative increases in 2024 were primarily due to salary increases that were predominantly effective on January 1, 2024 that were only partially offset by a decrease in mortgage lending and other retail personnel.

Performance-based compensation increased by $0.5 million and $2.4 million in the third quarter and first nine months of 2024, respectively, compared to the same periods in 2023. The increases were primarily due to higher expected incentive compensation payout for salaried and hourly employees.

Payroll taxes and employee benefits decreased by $0.6 million and $0.3 million in the third quarter and first nine months of 2024, respectively, compared to the same periods in 2023. The decreases were primarily due to decreases in employee medical insurance costs and a mortgage loan origination related incentive due to lower loan volumes.

Data processing expense increased by $0.3 million and $0.9 million in the third quarter and first nine months of 2024, respectively, compared to the same prior year periods due in part to core data processor annual asset growth and CPI related cost increases as well as new solutions implemented during this time frame.

Advertising increased by $0.2 million and $0.6 million in the third quarter and first nine months of 2024, respectively, compared to the same prior year periods due primarily to modifications in strategic marketing spend as well as costs related to certain website redesign initiatives.

Taxes licenses and fees increased by $0.1 million and $0.2 million in the third quarter and first nine months of 2024, respectively, compared to the same periods in 2023 due primarily to higher Michigan Corporate Income Tax expense as the result of an increase in tax base.

Costs (recoveries) related to unfunded lending commitments decreased by $0.3 million and $0.8 million in the third quarter and first nine months of 2024, respectively compared to the same prior year periods. These decreases are due to decreases in the changes to both the balance of lending commitments and the loss rates applied to those lending commitments.

Income tax expense. We recorded an income tax expense of $3.5 million and $11.9 million in the third quarter and the first nine months of 2024, respectively. This compares to an income tax expense of $4.1 million and $10.4 million in the third quarter and the first nine months of 2023, respectively. The changes in expense in the third quarter and first nine months of 2024 compared to the same periods in 2023 are primarily due to changes in pretax income.

Our actual income tax expense is different than the amount computed by applying our statutory income tax rate to our income before income tax primarily due to tax-exempt interest income, tax-exempt income from the increase in the cash surrender value on life insurance, and differences in the value of stock awards that vest and stock options that are exercised as compared to the initial fair values that were expensed.

We assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. The ultimate realization of this asset is primarily based on generating future income. We concluded at September 30, 2024 and 2023 and at December 31, 2023, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

FINANCIAL CONDITION

Summary. Our total assets decreased by $4.5 million during the first nine months of 2024. Loans, excluding loans held for sale, were $3.94 billion at September 30, 2024, compared to $3.79 billion at December 31, 2023. Commercial loans and mortgage loans each increased while installment loans decreased during the first nine months of 2024. (See “Portfolio Loans and asset quality.”) Securities available for sale and securities held to maturity together totaled $932.3 million at September 30, 2024, a decline of $101.1 million since December 31, 2023.

Deposits totaled $4.63 billion at September 30, 2024, an increase of $4.0 million from December 31, 2023. The increase in deposits from December 31, 2023, is due to increases in savings and interest-bearing checking, reciprocal and time deposits that were partially off set by a decrease in non-interest bearing deposits as well as scheduled maturities of brokered time deposits.

Securities. We maintain diversified securities portfolios, which include obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions, residential and commercial mortgage-backed securities, asset-backed securities, corporate securities, trust preferred securities and foreign government securities (that are denominated in U.S. dollars). We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow.

We believe that the unrealized losses on securities AFS are temporary in nature and are expected to be recovered within a reasonable time period. Based upon our liquidity and capital resources (as explained in more detail below under "Liquidity and capital resources"), we believe that we have the ability and intent to hold securities with unrealized losses to maturity or until such time as the unrealized losses reverse.(See “Asset/liability management.”)

On April 1, 2022, we transferred certain securities AFS with an amortized cost and unrealized loss at the date of transfer of $418.1 million and $26.5 million, respectively to securities HTM. The transfer was made at fair value, with the unrealized loss becoming part of the purchase discount which will be accreted over the remaining life of the securities. The other comprehensive loss component is separated from the remaining available for sale securities and is accreted over the remaining life of the securities transferred. Based upon our liquidity and capital resources (as explained in more detail below under "Liquidity and capital resources"), we believe that we have the ability and intent to hold these securities until they mature, at which time we would receive full value for these securities.

Securities Available for Sale

(In thousands)

Securities Held to Maturity

(In thousands)

(1) Represents the remaining unrealized loss to be accreted on securities that were transferred from AFS to HTM on April 1, 2022.

Securities AFS in unrealized loss positions are evaluated quarterly for impairment related to credit losses. For securities AFS in an unrealized loss position, we first assess whether we intend to sell, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For securities AFS that do not meet this criteria, we evaluate whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, we consider the extent to which fair value is less than amortized cost, adverse conditions specifically related to the security and the issuer and the impact of changes in market interest rates on the market value of the security, among other factors. If this assessment indicates that a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an ACL is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income (loss), net of applicable taxes. No ACL for securities AFS was needed at September 30, 2024. The decrease in unrealized losses during the first nine months of 2024 is primarily attributed to lower interest rates, pay downs of security balances, par reversion and the narrowing of certain interest rate spreads. See note #3 to the Condensed Consolidated Financial Statements included within this report for further discussion.

For securities HTM an ACL is maintained at a level which represents our best estimate of expected credit losses. This ACL is a contra asset valuation account that is deducted from the carrying amount of securities HTM to present the net amount expected to be collected. Securities HTM are charged off against the ACL when deemed uncollectible. Adjustments to the ACL are reported in our Condensed Consolidated Statements of Operations in provision for credit loss. We measure expected credit losses on securities HTM on a collective basis by major security type with each type sharing similar risk characteristics. With regard to U.S. Government-sponsored agency and mortgage-backed securities (residential and commercial), all these securities are issued by a U.S. government-sponsored entity and have an implicit or explicit government guarantee; therefore, no allowance for credit losses has been recorded for these securities. With regard to obligations of states and political subdivisions, private label-mortgage-backed, corporate and trust preferred securities HTM, we consider (1) issuer bond ratings, (2) long-term historical loss rates for given bond ratings, (3) the financial condition of the issuer, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities. During the first quarter of 2023, one corporate security (Signature Bank) defaulted resulting in a $3.0 million provision for credit losses and a corresponding full charge-off. Subsequent to this security's charge-off, a portion of its fair value had recovered and was subsequently sold during the first quarter of 2024 for $1.1 million during which period we recorded that amount as a recovery to the ACL. See note #3 to the Condensed Consolidated Financial Statements included within this report for further discussion.

Sales of securities available for sale were as follows (See “Non-interest income.”):

Sales of Securities Available for Sale

(in thousands)

(In thousands)

Equity Securities at Fair Value

On May 6, 2024, we exchanged 12,566 shares of Visa Inc. Class B-1 common stock (all of the Class B-1 shares we owned) for 2,493 shares of Visa Inc. Class C common stock and 6,283 shares of Visa Inc. Class B-2 common stock pursuant to an exchange offer conducted by Visa. With the completion of the exchange, we recorded a gain related to the Class C shares of $2.677 million based on the conversion privilege of those shares and the closing price of the Class A shares on May 3, 2024 (the exchange expiration date) of $268.49 per share. Subsequent to the exchange, we sold all of our Class C shares for net proceeds of $2.685 million. See note #13 to the Condensed Consolidated Financial Statements included within this report for further discussion.

Portfolio Loans and asset quality. In addition to the communities served by our Bank branch and loan production office network, our principal lending markets also include nearby communities and metropolitan areas. Subject to established underwriting criteria, we also may participate in commercial lending transactions with certain non-affiliated banks and make whole loan purchases from other financial institutions.

The senior management and board of directors of our Bank retain authority and responsibility for credit decisions and we have adopted uniform underwriting standards. Our loan committee structure and the loan review process attempt to provide requisite controls and promote compliance with such established underwriting standards. However, there can be no assurance that our lending procedures and the use of uniform underwriting standards will prevent us from incurring significant credit losses in our lending activities.

We generally retain loans that may be profitably funded within established risk parameters. (See “Asset/liability management.”) As a result, we may hold adjustable-rate and fixed rate jumbo mortgage loans as Portfolio Loans, while 15- and 30-year fixed-rate conforming mortgage loans are generally sold to mitigate exposure to changes in interest rates. (See “Non-interest income.”) The growth in mortgage loans during the first nine months of 2024 has primarily been attributed to the origination of adjustable-rate mortgage loans and advances on adjustable rate construction mortgage loans and home equity lines of credit. (See “Asset/liability management.”).

A summary of our Portfolio Loans follows:

(In thousands)

(1) Includes both residential and non-residential commercial loans secured by real estate.

(2) Includes loans secured by multi-family residential and non-farm, non-residential property.

Non-performing assets

(Dollars in thousands)

Non-performing loans have declined modestly as a percent of Portfolio Loans since year-end 2023, reflecting our ongoing collection efforts. Our collection and resolution efforts have generally resulted in a positive trend in non-performing loans.

Other real estate and repossessed assets totaled $0.78 million and $0.57 million at September 30, 2024, and December 31, 2023, respectively.

We will place a loan that is 90 days or more past due on non-accrual, unless we believe the loan is both well secured and in the process of collection. Accordingly, we have determined that the collection of the accrued and unpaid interest on any loans that are 90 days or more past due and still accruing interest is probable.

The following tables reflect activity in our ACL on loans, securities and unfunded lending commitments as well as the allocation of our ACL on loans.

Allowance for credit losses on loans and unfunded lending commitments

(Dollars in thousands)

Allocation of the Allowance for Credit Losses on Loans

(Dollars in thousands)

Some loans will not be repaid in full. Therefore, an ACL on loans is maintained at a level which represents our best estimate of expected credit losses. Our ACL on loans is comprised of three principal elements: (i) specific analysis of individual loans identified during the review of the loan portfolio, (ii) pooled analysis of loans with similar risk characteristics based on historical experience, adjusted for current conditions, reasonable and supportable forecasts, and expected prepayments, and (iii) additional allowances based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios. See note #4 to the Condensed Consolidated Financial Statements included within this report for further discussion on the ACL on loans.

While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.

The ACL increased $2.8 million to $57.4 million at September 30, 2024 from $54.7 million at December 31, 2023, and was equal to 1.46% and 1.44% of total Portfolio Loans at September 30, 2024, and December 31, 2023, respectively.

Since December 31, 2023, the ACL related to specific loans increased $1.2 million due primarily to one commercial loan addition during the first quarter of 2024. The ACL related to pooled analysis of loans and subjective factors increased $1.1 million and $0.5 million, respectively due primarily to loan growth.

Deposits and borrowings. Historically, the loyalty of our customer base has allowed us to price deposits competitively, contributing to a net interest margin that generally compares favorably to our peers. However, we still face a significant amount of competition for deposits within many of the markets served by our branch network, which limits our ability to materially increase deposits without adversely impacting the weighted-average cost of core deposits.

To attract new core deposits, we have implemented various account acquisition strategies as well as branch staff sales training. Account acquisition initiatives have historically generated increases in customer relationships. Over the past several years, we have also expanded our treasury management products and services for commercial businesses and municipalities or other governmental units and have also increased our sales calling efforts in order to attract additional deposit relationships from these sectors. We view long-term core deposit growth as an important objective. Core deposits generally provide a more stable and lower cost source of funds than alternative sources such as short-term borrowings. (See “Liquidity and capital resources.”)

Deposits totaled $4.63 billion and $4.62 billion at September 30, 2024, and December 31, 2023, respectively. The increase in deposits is primarily due to increases in savings and interest-bearing checking, reciprocal and time deposits that were partially off set by a decrease in non-interest bearing deposits as well as scheduled maturities of brokered time deposits. Reciprocal deposits totaled $995.5 million and $832.0 million at September 30, 2024 and December 31, 2023, respectively. These deposits represent demand, money market and time deposits from our customers that have been placed through IntraFi Network. This service allows our customers to access multi-million dollar FDIC deposit insurance on deposit balances greater than the standard FDIC insurance maximum.

We cannot be sure that we will be able to maintain our current level of core deposits. In particular, those deposits that are uninsured may be susceptible to outflow. Data relating to our deposit portfolios (excluding brokered time) follows:

(Dollars in thousands)

(1) These amounts exclude intercompany related deposits of $51.8 million and $51.2 million respectively. Uninsured deposits reported in our Call Report at September 30, 2024 and December 31, 2023 totaled $1,108.6 million and $1,013.2 million, respectively.

We have also implemented strategies that incorporate using federal funds purchased, other borrowings and Brokered CDs to fund a portion of our interest-earning assets. The use of such alternate sources of funds supplements our core deposits and is also an integral part of our asset/liability management efforts.

Other borrowings, historically comprising primarily of FRB and FHLB borrowings, totaled zero and $50.0 million at September 30, 2024, and December 31, 2023, respectively.

As described above, we have utilized wholesale funding, including federal funds purchased, FHLB and FRB borrowings and Brokered CDs to augment our core deposits and fund a portion of our assets. At September 30, 2024, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $1.04 billion, or 22.4% of total funding (deposits and all borrowings, excluding subordinated debt and debentures). Because wholesale funding sources are affected by general market conditions, the availability of such funding may be dependent on the confidence these sources have in our financial condition and operations. The continued availability to us of these funding sources is not certain, and Brokered CDs may be difficult for us to retain or replace at attractive rates as they mature. Our liquidity may be constrained if we are unable to renew our wholesale funding sources or if adequate financing is not available in the future at acceptable rates of interest or at all. Our financial performance could also be affected if we are unable to maintain our access to funding sources or if we are required to rely more heavily on more expensive funding sources. In such case, our net interest income and results of operations could be adversely affected.

We historically employed derivative financial instruments to manage our exposure to changes in interest rates. During the first nine months of 2024 and 2023, we entered into $136.0 million and $92.9 million (aggregate notional amounts), respectively, of interest rate swaps with commercial loan customers, which were offset with interest rate swaps that the Bank entered into with a broker-dealer. We recorded $1.52 million and $1.46 million of fee income related to these transactions during the first nine months of 2024 and 2023, respectively. See note #6 to the Condensed Consolidated Financial Statements included within this report for more information on our derivative financial instruments.

Liquidity and capital resources. Liquidity risk is the risk of being unable to timely meet obligations as they come due at a reasonable funding cost or without incurring unacceptable losses. Our liquidity management involves the measurement and monitoring of a variety of sources and uses of funds. Our Condensed Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus our liquidity management on maintaining adequate levels of liquid assets (primarily funds on deposit with the FRB and certain securities AFS) as well as developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for purchasing securities or originating Portfolio Loans as well as to be able to respond to unforeseen liquidity needs.

Our primary sources of funds include our deposit base, secured advances from the FHLB and FRB, federal funds purchased, borrowing facilities with other banks, and access to the capital markets (for Brokered CDs). At September 30, 2024, in addition to liquidity available from our normal operating, funding and investing activities we had unused credit lines with the FHLB and FRB of approximately $1.111 billion and $471.7 million, respectively. We also had approximately $771.3 million in fair value of unpledged securities AFS and HTM at September 30, 2024, which could be pledged for an estimated additional borrowing capacity at the FHLB and FRB of approximately $718.0 million.

At September 30, 2024, we had $698.5 million of time deposits that mature in the next 12 months. Historically, a majority of these maturing time deposits are renewed by our customers. Additionally, $3.85 billion of our deposits at September 30, 2024, were in account types from which the customer could withdraw the funds on demand. Changes in the balances of deposits that can be withdrawn upon demand are usually predictable and the total balances of these accounts have generally grown or have been stable over time as a result of our marketing and promotional activities. However, there can be no assurance that historical patterns of renewing time deposits or overall growth or stability in deposits will continue in the future.

We have developed contingency funding plans that stress test our liquidity needs that may arise from certain events such as an adverse change in our financial metrics (for example, credit quality or regulatory capital ratios). Our liquidity management also includes periodic monitoring that measures quick assets (defined generally as highly liquid or short-term assets) to total assets, short-term liability dependence and basic surplus (defined as quick assets less volatile liabilities to total assets). Policy limits have been established for our various liquidity measurements and are monitored on a quarterly basis. In addition, we also prepare cash flow forecasts that include a variety of different scenarios.

We believe that we currently have adequate liquidity at our Bank because of our cash and cash equivalents, our portfolio of securities AFS, our access to secured advances from the FHLB and FRB and our ability to issue Brokered CDs.

We also believe that the available cash on hand at the parent company (including time deposits) of approximately $47.0 million as of September 30, 2024, provides sufficient liquidity resources at the parent company to meet operating expenses, to make interest payments on the subordinated debt and debentures, and, along with dividends from the Bank, to pay projected cash dividends on our common stock.

Effective management of capital resources is critical to our mission to create value for our shareholders. In addition to common stock, our capital structure also currently includes subordinated debt and cumulative trust preferred securities.

Capitalization

(In thousands)

80

In May 2020, we issued $40.0 million of fixed to floating subordinated notes with a ten year maturity and a five year call option. The initial coupon rate is 5.95% fixed for five years and then floats at the Secured Overnight Financing Rate (“SOFR”) plus 5.825%. These notes are presented in the Condensed Consolidated Statement of Financial Condition under the caption “Subordinated debt” and the September 30, 2024, balance of $39.6 million is net of remaining unamortized deferred issuance costs of approximately $0.4 million that are being amortized through the maturity date into interest expense on other borrowings and subordinated debt and debentures in our Condensed Consolidated Statements of Operations.

We currently have four special purpose entities with $39.8 million of outstanding cumulative trust preferred securities as of September 30, 2024. These special purpose entities issued common securities and provided cash to our parent company that in turn issued subordinated debentures to these special purpose entities equal to the trust preferred securities and common securities. The subordinated debentures represent the sole asset of the special purpose entities. The common securities and subordinated debentures are included in our Condensed Consolidated Statements of Financial Condition.

The FRB has issued rules regarding trust preferred securities as a component of the Tier 1 capital of bank holding companies. The aggregate amount of trust preferred securities (and certain other capital elements) are limited to 25 percent of Tier 1 capital elements, net of goodwill (net of any associated deferred tax liability). The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital, subject to restrictions. At the parent company, all of these securities qualified as Tier 1 capital at September 30, 2024, and December 31, 2023.

Common shareholders’ equity increased to $452.4 million at September 30, 2024, from $404.4 million at December 31, 2023. The increase is primarily due to earnings retention and a decrease in accumulated other comprehensive loss. Our tangible common equity (“TCE”) totaled $422.5 million and $374.1 million, respectively, at those same dates. Our ratio of TCE to tangible assets was 8.08% and 7.15% at September 30, 2024, and December 31, 2023, respectively. TCE and the ratio of TCE to tangible assets are non-GAAP measures. TCE represents total common equity less goodwill and other intangible assets.

In December 2023, our Board of Directors authorized a 2024 share repurchase plan. Under the terms of the 2024 share repurchase plan, we are authorized to buy back up to 1,100,000, or approximately 5% of our outstanding common stock. There were no shares repurchased during the first nine months of 2024. During the first nine months of 2023, we repurchased 288,401 shares of common stock, for an aggregate purchase price of $5.0 million.

We currently pay a quarterly cash dividend on our common stock. These dividends totaled $0.72 per share and $0.69 per share in the first nine months of 2024 and 2023, respectively. We generally favor a dividend payout ratio between 30% and 50% of net income.

As of September 30, 2024 and December 31, 2023, our Bank (and holding company) continued to meet the requirements to be considered “well-capitalized” under federal regulatory standards (also see note #10 to the Condensed Consolidated Financial Statements included within this report).

Asset/liability management. Interest-rate risk is created by differences in the cash flow characteristics of our assets and liabilities. Options embedded in certain financial instruments, including caps on adjustable-rate loans as well as borrowers’ rights to prepay fixed-rate loans, also create interest-rate risk.

Our asset/liability management efforts identify and evaluate opportunities to structure our assets and liabilities in a manner that is consistent with our mission to maintain profitable financial leverage within established risk parameters. We evaluate various opportunities and alternate asset/liability management strategies carefully and consider the likely impact on our risk profile as well as the anticipated contribution to earnings. The marginal cost of funds is a principal consideration in the implementation of our asset/liability management strategies, but such evaluations further consider interest-rate and liquidity risk as well as other pertinent factors. We have established parameters for interest-rate risk. We regularly monitor our interest-rate risk and report at least quarterly to our board of directors.

We employ simulation analyses to monitor our interest-rate risk profile and evaluate potential changes in our net interest income and market value of portfolio equity that result from changes in interest rates. The purpose of these simulations is to identify sources of interest-rate risk. The simulations do not anticipate any actions that we might initiate in response to changes in interest rates and, accordingly, the simulations do not provide a reliable forecast of anticipated results. The simulations are predicated on immediate, permanent and parallel shifts in interest rates and generally assume that current loan and deposit pricing relationships remain constant. The simulations further incorporate assumptions relating to changes in customer behavior, including changes in prepayment rates on certain assets and liabilities. At September 30, 2024, our interest rate risk profile as measured by our longer term interest rate risk measure based on changes in economic value indicates exposure to rising rates. This measure has decreased modestly from December 31, 2023 due to a decline in asset duration, an increase in liability duration and a higher base value. Asset duration declined given a shift in the asset mix to shorter duration loans. The increase in liability duration is due to modestly lower betas on some non-maturity deposit accounts and a favorable shift in deposit mix with a decline in low duration brokered time deposits combined with growth in higher duration deposits. In addition, at September 30, 2024 our simulation base-rate scenario for market value of portfolio equity increased from December 31, 2023 due primarily to an increase in the Bank’s tangible equity and an improvement in asset values given a decline in interest rates. We are carefully monitoring the change in our funding mix as well as the composition of our earning assets and the impact of potential future changes in interest rates on our changes in market value of portfolio equity and changes in net interest income. As a result, we may add some longer-term borrowings, may utilize derivatives (interest rate swaps, interest rate caps and interest rate floors) and may continue to sell some fixed rate jumbo and other portfolio mortgage loans in the future.

CHANGES IN MARKET VALUE OF PORTFOLIO EQUITY, NET INTEREST INCOME AND NET INTEREST MARGIN

(Dollars in thousands)

(1) Simulation analyses calculate the change in the net present value of our assets and liabilities, including debt and related financial derivative instruments, under parallel shifts in interest rates by discounting the estimated future cash flows using a market-based discount rate. Cash flow estimates incorporate anticipated changes in prepayment speeds and other embedded options.

(2) Simulation analyses calculate the change in net interest income under immediate parallel shifts in interest rates over the next twelve months, based upon a static statement of financial condition, which includes debt and related financial derivative instruments, and do not consider loan fees or loan origination costs.

(3) Simulation analyses calculate the change in tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”) under immediate parallel shifts in interest rates over the next twelve months, based upon a static statement of financial condition, which includes debt and related financial derivative instruments, and do not consider loan fees or loan origination costs.

LITIGATION MATTERS

The aggregate amount we have accrued for losses we consider probable as a result of litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is insignificant. However, because of a number of factors, including the fact that certain of these litigation matters are still in their early stages, this maximum amount may change in the future.

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote.

Accounting standards update. See note #2 to the Condensed Consolidated Financial Statements included elsewhere in this report for details on recently issued accounting pronouncements and their impact on our interim condensed consolidated financial statements.

Fair valuation of financial instruments. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820 - “Fair Value Measurements and Disclosures” (“FASB ASC Topic 820”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

We utilize fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. FASB ASC Topic 820 differentiates between those assets and liabilities required to be carried at fair value at every reporting period (“recurring”) and those assets and liabilities that are only required to be adjusted to fair value under certain circumstances (“nonrecurring”). Equity securities at fair value, securities AFS, loans held for sale, carried at fair value, derivatives and capitalized mortgage loan servicing rights are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or fair value accounting or write-downs of individual assets. See note #11 to the Condensed Consolidated Financial Statements included within this report for a complete discussion on our use of fair valuation of financial instruments and the related measurement techniques.

CRITICAL ACCOUNTING POLICIES

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Accounting and reporting policies for the ACL and capitalized mortgage loan servicing rights are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those that we have used could result in material changes in our consolidated financial position or results of operations. There have been no material changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See applicable disclosures set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 under the caption “Asset/liability management.”

CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures.

With the participation of management, our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(e) and 15d – 15(e)) for the period ended September 30, 2024, have concluded that, as of such date, our disclosure controls and procedures were effective.

(b) Changes in Internal Controls.

During the quarter ended September 30, 2024, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2023.