# Southside Bancshares Inc: Form 10-Q for the period ended Sep 30, 2023

- Company: [Southside Bancshares Inc](/companies/sbsi.md) (CIK 705432)
- Form: 10-Q
- Filed: 2023-10-27
- Accepted by EDGAR: Oct 27, 2023, 13:59 ET
- Period: 2023-09-30
- Accession: 0000705432-23-000184
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/705432/000070543223000184/sbsi-20230930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/705432/000070543223000184/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2023-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2023-07-01 to 2023-09-30 | $39.8m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2023-01-01 to 2023-09-30 | $100.3m | us-gaap:InterestExpense |
| Income tax | 3 months, 2023-07-01 to 2023-09-30 | $3.1m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2023-01-01 to 2023-09-30 | $12.2m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2023-07-01 to 2023-09-30 | $18.4m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2023-01-01 to 2023-09-30 | $69.4m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2023-07-01 to 2023-09-30 | $0.60 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2023-01-01 to 2023-09-30 | $2.24 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2023-07-01 to 2023-09-30 | $0.60 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2023-01-01 to 2023-09-30 | $2.25 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2023-07-01 to 2023-09-30 | 30,543,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2023-01-01 to 2023-09-30 | 30,916,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2023-01-01 to 2023-09-30 | $136.5m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2023-01-01 to 2023-09-30 | $5.1m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months, 2023-01-01 to 2023-09-30 | $32.4m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 9 months, 2023-01-01 to 2023-09-30 | $40.1m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2023-09-30 | $325.8m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2023-09-30 | $7.97bn | us-gaap:Assets |
| Total liabilities | at 2023-09-30 | $7.24bn | us-gaap:Liabilities |
| Long-term debt | at 2023-09-30 | $154.1m | us-gaap:LongTermDebt |
| Shareholders' equity | at 2023-09-30 | $728.6m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 88,739 characters.

The following is a discussion of our consolidated financial condition, changes in our financial condition and results of our operations, and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this Quarterly Report on Form 10-Q, our First Quarter and Second Quarter Reports on Form 10-Q and in our 2022 Form 10-K. Certain risks, uncertainties and other factors, including those set forth under “Risk Factors” in Part I, Item 1A. of the 2022 Form 10-K, “Risk Factors” in Part II, Item 1A. of the First Quarter Form 10-Q and elsewhere in this Quarterly Report on Form 10-Q, may cause actual results to differ materially from the results discussed in the forward-looking statements appearing in this discussion and analysis.

#### Forward-Looking Statements

Certain statements of other than historical fact that are contained in this report may be considered to be “forward-looking statements” within the meaning of and subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. These statements may include words such as “expect,” “estimate,” “project,” “anticipate,” “appear,” “believe,” “could,” “should,” “may,” “might,” “will,” “would,” “seek,” “intend,” “probability,” “risk,” “goal,” “target,” “objective,” “plans,” “potential,” and similar expressions. Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions, estimates, intentions and future performance and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements. For example, discussions of the effect of our expansion, benefits of the Share Repurchase Plan, trends in asset quality, capital, liquidity, our ability to sell nonperforming assets, expense reductions, planned operational efficiencies and earnings from growth and certain market risk disclosures, including the impact of interest rates, tax reform, inflation, the impacts related to or resulting from other economic factors are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. Accordingly, our results could materially differ from those that have been estimated. The most significant factor that could cause future results to differ materially from those anticipated by our forward-looking statements include the ongoing impact of higher inflation levels, higher interest rates and general economic and recessionary concerns, all of which could impact economic growth and could cause a reduction in financial transactions and business activities, including decreased deposits and reduced loan originations, our ability to manage liquidity in a rapidly changing and unpredictable market, supply chain disruptions, labor shortages and additional interest rate increases by the Federal Reserve. Other factors that could cause actual results to differ materially from those indicated by forward-looking statements include, but are not limited to, the following:

- general (i) political conditions, including, without limitation, governmental action and uncertainty resulting from U.S. and global political trends and (ii) economic conditions, either globally, nationally, in the State of Texas, or in the specific markets in which we operate, including, without limitation, the deterioration of the commercial real estate, residential real estate, construction and development, energy, oil and gas, credit or liquidity markets, which could cause an adverse change in our net interest margin, or a decline in the value of our assets, which could result in realized losses, as well as the risk of an economic slowdown or recession;
- current or future legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we or our customers or our borrowers are engaged, including the impact of the Dodd-Frank Act, the Federal Reserve’s actions to increase interest rates, the capital requirements promulgated by the Basel Committee, the CARES Act, the Economic Aid Act and other regulatory responses to economic conditions;
- economic or other disruptions caused by acts of terrorism, war or other conflicts, including the Russia-Ukraine conflict, natural disasters, such as hurricanes, freezes, flooding and other man-made disasters, such as oil spills or power outages, health emergencies, epidemics or pandemics, climate changes or other catastrophic events;
- potential impacts of the recent adverse developments in the banking industry highlighted by high-profile bank failures, including impacts on customer confidence, deposit outflows, liquidity and the regulatory response thereto;
- technological changes, including potential cyber-security incidents and other disruptions, or innovations to the financial services industry, including as a result of the increased telework environment;
- our ability to identify and address cyber-security risks such as data security breaches, malware, “denial of service” attacks, “hacking” and identity theft, which could disrupt our business and result in the disclosure of and/or misuse or misappropriation of confidential or proprietary information, disruption or damage of our systems, increased costs, significant losses, or adverse effects to our reputation;
- changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact net interest margins and may impact prepayments on our MBS portfolio;
- the risk that our enterprise risk management framework, compliance program or our corporate governance and supervisory oversight functions may not identify or address risks adequately, which may result in unexpected losses;
- the effect of compliance with legislation or regulatory changes;
- credit risks of borrowers, including any increase in those risks due to changing economic conditions;
- increases in our nonperforming assets;
- risks related to environmental liability as a result of certain lending activity;
- our ability to maintain adequate liquidity to fund operations and growth;
- our ability to monitor interest rate risk;
- any applicable regulatory limits or other restrictions on the Bank and its ability to pay dividends to us;
- the failure of our assumptions underlying our allowance for credit losses and other estimates;
- the failure to maintain an effective system of controls and procedures, including internal control over financial reporting;
- the effectiveness of our derivative financial instruments and hedging activities to manage risk;
- unexpected outcomes of, and the costs associated with, existing or new litigation involving us;
- potential claims, damages, penalties, fines and reputational damage resulting from pending or future litigation, regulatory proceedings and enforcement actions;
- changes impacting our balance sheet and leverage strategy;
- risks related to actual mortgage prepayments diverging from projections;
- risks related to fluctuations in the price per barrel of crude oil;
- significant increases in competition in the banking and financial services industry;
- changes in consumer spending, borrowing and saving habits, including as a result of rising inflation and recessionary concerns;
- execution of future acquisitions, reorganization or disposition transactions, including the risk that the anticipated benefits of such transactions are not realized;
- our ability to increase market share and control expenses;
- our ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by our customers;
- the effect of changes in federal or state tax laws;
- the effect of changes in accounting policies and practices;
- adverse changes in the status or financial condition of the GSEs which impact the GSEs’ guarantees or ability to pay or issue debt;
- adverse changes in the credit portfolios of other U.S. financial institutions relative to the performance of certain of our investment securities;
- risks related to actual U.S. agency MBS prepayments exceeding projected prepayment levels;
- risks related to U.S. agency MBS prepayments increasing due to U.S. government programs designed to assist homeowners to refinance their mortgage that might not otherwise have qualified;
- risks related to loans secured by real estate, including the risk that the value and marketability of collateral could decline;
- risks associated with our common stock and our other securities, including fluctuations in our stock price and general volatility in the stock market; and
- other risks and uncertainties discussed in “Part I – Item 1A. Risk Factors” in the 2022 Form 10-K and “Part II -Item 1A. Risk Factors” in the First Quarter Form 10-Q.

All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice. We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments, unless otherwise required by law.

#### Critical Accounting Estimates

Our accounting and reporting estimates conform with U.S. GAAP and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We consider accounting estimates that can (1) be replaced by other reasonable estimates and/or (2) changes to an estimate from period to period that have a material impact on the presentation of our financial condition, changes in financial condition or results of operations as well as (3) those estimates that require significant and complex assumptions about matters that are highly uncertain to be critical accounting estimates. We consider our critical accounting policies to include allowance for credit losses on loans and off-balance-sheet credit exposure.

Critical accounting estimates include a high degree of uncertainty in the underlying assumptions. Management bases its estimates on historical experience, current information and other factors deemed relevant. The development, selection and disclosure of our critical accounting estimates are reviewed with the Audit Committee of the Company’s Board of Directors. Actual results could differ from these estimates. For additional information regarding critical accounting policies, refer to “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Estimates,” “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Allowance for Credit Losses – Loans and Allowance for Credit Losses – Off-Balance-Sheet Credit Exposures,” “Note 1 – Summary of Significant Accounting and Reporting Policies,” “Note 5 – Loans and Allowance for Loan Losses” and “Note 17 – Off-Balance-Sheet Arrangements, Commitments and Contingencies” in the 2022 Form 10-K. As of September 30, 2023, there have been no significant changes to our critical accounting estimates.

#### Non-GAAP Financial Measures

Certain non-GAAP measures are used by management to supplement the evaluation of our performance. These include the following fully taxable-equivalent measures: Net interest income (FTE), net interest margin (FTE) and net interest spread (FTE), which include the effects of taxable-equivalent adjustments using a federal income tax rate of 21% to increase tax-exempt interest income to a tax-equivalent basis. Interest income earned on certain assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments.

*Net interest income (FTE), net interest margin (FTE) and net interest spread (FTE).* Net interest income (FTE) is a non-GAAP measure that adjusts for the tax-favored status of net interest income from certain loans and investments and is not permitted under GAAP in the consolidated statements of income. We believe this measure to be the preferred industry measurement of net interest income, and that it enhances comparability of net interest income arising from taxable and tax-exempt sources. The most directly comparable financial measure calculated in accordance with GAAP is our net interest income. Net interest margin (FTE) is the ratio of net interest income (FTE) to average earning assets. The most directly comparable financial measure calculated in accordance with GAAP is our net interest margin. Net interest spread (FTE) is the difference in the average yield on average earning assets on a tax-equivalent basis and the average rate paid on average interest bearing liabilities. The most directly comparable financial measure calculated in accordance with GAAP is our net interest spread.

These non-GAAP financial measures should not be considered alternatives to GAAP-basis financial statements and other bank holding companies may define or calculate these non-GAAP measures or similar measures differently. Whenever we present a non-GAAP financial measure in an SEC filing, we are also required to present the most directly comparable financial measure calculated and presented in accordance with GAAP and reconcile the differences between the non-GAAP financial measure and such comparable GAAP measure.

In the following table we present the reconciliation of net interest income to net interest income adjusted to a fully taxable-equivalent basis assuming a 21% marginal tax rate for interest earned on tax-exempt assets such as municipal loans and investment securities (dollars in thousands), along with the calculation of net interest margin (FTE) and net interest spread (FTE).

| Non-GAAP Reconciliations | Three Months Ended September 30, 2023 | 2022 | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: | ---: | ---: |
| Net interest income (GAAP) | $53,273 | $55,515 | $160,542 | $155,499 |
| Tax equivalent adjustments: |  |  |  |  |
| Loans | 674 | 742 | 2,044 | 2,249 |
| Tax-exempt investment securities | 2,474 | 2,973 | 7,486 | 8,431 |
| Net interest income (FTE) (1) | $56,421 | $59,230 | $170,072 | $166,179 |
| Average earning assets | $7,418,157 | $6,999,525 | $7,269,326 | $6,742,985 |
| Net interest margin | 2.85% | 3.15% | 2.95% | 3.08% |
| Net interest margin (FTE) (1) | 3.02% | 3.36% | 3.13% | 3.29% |
| Net interest spread | 2.14% | 2.87% | 2.31% | 2.90% |
| Net interest spread (FTE) (1) | 2.31% | 3.08% | 2.48% | 3.11% |

(1) These amounts are presented on a fully taxable-equivalent basis and are non-GAAP measures.

Management believes adjusting net interest income, net interest margin and net interest spread to a fully taxable-equivalent basis is a standard practice in the banking industry as these measures provide useful information to make peer comparisons. Tax-equivalent adjustments are reported in the respective earning asset categories as listed in the “Average Balances with Average Yields and Rates” tables under Results of Operations.

OVERVIEW

#### ECONOMIC CONDITIONS

The economic conditions and growth prospects for our markets, even against the headwinds of inflation and potential recessionary concerns, continue to reflect a solid and positive overall outlook. Worker shortages, supply chain disruptions, higher interest rates and inflationary conditions have had some impact on the level of economic growth in our market areas. Ongoing higher inflation and interest rates could have a negative impact on both our consumer and commercial borrowers. Currently, the Texas markets we serve continue to remain healthy due to both job and population growth.

#### DEPOSITS

Our deposits increased $151.6 million, or 2.4%, to $6.35 billion at September 30, 2023 from $6.20 billion at December 31, 2022. At September 30, 2023, we had 181,094 total deposit accounts with an average balance of $31,000. Our estimated uninsured deposits was 36.2% as of September 30, 2023. When excluding affiliate deposits (Southside-owned deposits) and public fund deposits (all collateralized), our total estimated deposits without insurance or collateral was 19.4% as of September 30, 2023.

We continued to increase interest rates paid on deposits during the quarter in order to retain deposits. Our noninterest bearing deposits represent approximately 23% of total deposits. During the three months ended September 30, 2023, our cost of interest bearing deposits increased 188 basis points from 0.70% for the three months ended September 30, 2022 to 2.58%. Our cost of total deposits for the third quarter of 2023 increased 147 basis points from 0.51% for the three months ended September 30, 2022 to 1.98%.

Our cost of interest bearing deposits increased 169 basis points, from 0.47% for the nine months ended September 30, 2022, to 2.16% for the nine months ended September 30, 2023. Our cost of total deposits increased 128 basis points, from 0.34% for the nine months ended September 30, 2022, to 1.62% for the nine months ended September 30, 2023.

#### CAPITAL RESOURCES AND LIQUIDITY

Our capital ratios and contingent liquidity sources remain solid. We utilized the Federal Reserve’s Bank Term Funding Program to reduce our overall funding costs and to enhance our interest rate risk position. As of September 30, 2023, our BTFP borrowings of $291.3 million were at a cost of 4.46%.

The table below shows our total lines of credit, current borrowings as of September 30, 2023, total amounts available for future borrowings, and swapped value (in thousands):

|  | September 30, 2023 Line of Credit | Borrowings | Total Available for Future Liquidity | Swapped |
| --- | ---: | ---: | ---: | ---: |
| FHLB advances | $1,924,617 | $212,829 | $1,711,788 | $210,000 |
| Federal Reserve discount window | 636,863 | — | 636,863 | — |
| Correspondent bank lines of credit | 62,500 | — | 62,500 | — |
| Federal Reserve Bank Term Funding Program | 291,273 | 291,267 | 6 | — |
| Total liquidity lines | $2,915,253 | $504,096 | $2,411,157 | $210,000 |

### Southside Bancshares, Inc. \|44

#### Operating Results

Net income decreased $8.5 million, or 31.5%, for the three months ended September 30, 2023, to $18.4 million compared to the same period in 2022. The decrease in net income was primarily a result of the $5.5 million increase in the provision for credit losses, the $2.2 million decrease in net interest income and the $2.1 million increase in noninterest expense, partially offset by the $755,000 decrease in income tax expense and the $567,000 increase in noninterest income. Earnings per diluted common share decreased $0.24, or 28.6%, to $0.60 for the three months ended September 30, 2023, compared to $0.84 for the three months ended September 30, 2022.

During the nine months ended September 30, 2023, our net income decreased $8.0 million, or 10.3%, to $69.4 million compared to $77.4 million for the same period in 2022. The decrease in net income was primarily a result of the $8.6 million increase in noninterest expense, the $5.7 million increase in the provision for credit losses and the $1.9 million increase in income tax expense, partially offset by the $5.0 million increase in net interest income and the $3.2 million increase in noninterest income. Earnings per diluted common share decreased $0.15, or 6.3%, to $2.24 for the nine months ended September 30, 2023, compared to $2.39 for the same period in 2022.

#### Financial Condition

Our total assets increased $413.8 million, or 5.5%, to $7.97 billion at September 30, 2023 from $7.56 billion at December 31, 2022. Our securities portfolio increased by $17.7 million, or 0.7%, to $2.64 billion, compared to $2.63 billion at December 31, 2022. The increase in the securities portfolio was due to purchases of three-month U.S. Treasury Bills and to a lesser extent, MBS, partially offset by a decrease in municipal bonds during the nine months ended September 30, 2023. Our FHLB stock increased $3.6 million, or 39.0%, to $12.8 million from $9.2 million at December 31, 2022, due to the increase in our FHLB borrowings during the nine months ended September 30, 2023, increasing the amount of FHLB stock we are required to hold.

Loans at September 30, 2023 were $4.42 billion, an increase of $272.9 million, or 6.6%, compared December 31, 2022, due to increases of $160.8 million in construction loans, $129.6 million in commercial real estate loans and $26.0 million in 1-4 family residential loans. The increases were partially offset by decreases of $26.2 million in commercial loans, $8.7 million in loans to individuals and $8.6 million in municipal loans. Loans held for sale increased $0.7 million, or 107.2%, to $1.4 million at September 30, 2023 from $667,000 at December 31, 2022.

Our nonperforming assets at September 30, 2023 decreased $6.5 million, or 59.7%, to $4.4 million and represented 0.05% of total assets, compared to $10.9 million, or 0.14% of total assets, at December 31, 2022. Nonaccruing loans increased $1.5 million, or 51.7%, to $4.3 million, and the ratio of nonaccruing loans to total loans was 0.10% and 0.07% for September 30, 2023 and December 31, 2022, respectively. There was a $15,000 restructured loan at September 30, 2023, compared to $7.8 million at December 31, 2022. The decrease in restructured loans was due to the adoption of ASU 2022-22 on January 1, 2023, which allowed for the prospective exclusion of loan modifications that are performing, but would have previously required disclosure as troubled debt restructures in nonperforming assets. There were no repossessed assets at September 30, 2023 and $74,000 at December 31, 2022. There was $50,000 and $93,000 of OREO at September 30, 2023 and December 31, 2022, respectively.

Our deposits increased $151.6 million, or 2.4%, to $6.35 billion at September 30, 2023 from $6.20 billion at December 31, 2022, which consisted of an increase of $391.8 million in interest bearing deposits, partially offset by a decrease of $240.3 million in noninterest bearing deposits. The increase in interest bearing deposits included an increase in our brokered deposits of $130.4 million, or 19.8%, as the funding of our cash flow hedge swaps partially transitioned from FHLB advances to brokered deposits to obtain lower cost funding. Additionally, our public fund deposits increased $160.3 million, or 17.7%, to $1.07 billion at September 30, 2023 from $907.7 million at December 31, 2022.

Total FHLB borrowings increased $59.5 million, or 38.8%, to $212.8 million at September 30, 2023 from $153.4 million at December 31, 2022.

Our total shareholders’ equity at September 30, 2023 decreased 2.3%, or $17.4 million, to $728.6 million, or 9.1% of total assets, compared to $746.0 million, or 9.9% of total assets, at December 31, 2022. The decrease in shareholders’ equity was the result of the repurchase of $40.9 million of our common stock, cash dividends paid of $32.4 million and other comprehensive loss of $17.5 million, partially offset by net income of $69.4 million, stock compensation expense of $2.7 million, common stock issued under our dividend reinvestment plan of $908,000 and net issuance of common stock under employee stock plans of $424,000.

Key financial indicators management follows include, but are not limited to, numerous interest rate sensitivity and interest rate risk indicators, credit risk, operations risk, liquidity risk, capital risk, regulatory risk, inflation risk, competition risk, yield curve risk, U.S. agency MBS prepayment risk and economic risk indicators.

#### Balance Sheet Strategy

Determining the appropriate size of the balance sheet is one of the critical decisions any bank makes. Our balance sheet is not merely the result of a series of micro-decisions, but rather the size is controlled based on the economics of assets compared to the economics of funding and funding sources. Changing interest rate environments and economic conditions require that we monitor the interest rate sensitivity of the assets, the funding driving our growth and closely align ALCO objectives accordingly.

Due to disruptions in the banking industry during the first quarter of 2023, we increased the balance of securities pledged as collateral at the FRDW in preparation for potential liquidity needs and utilized the BTFP as a source of wholesale funding to reduce interest cost and interest rate risk. We ended the third quarter of 2023 with approximately $636.9 million in available liquidity between the FRDW and the BTFP in addition to the approximately $1.71 billion credit line available from FHLB due primarily to the blanket lien on our loan portfolio and to a lesser extent, securities available as collateral. At September 30, 2023, the estimated deposits, without insurance or collateral, to total deposits, excluding affiliate deposits (Southside-owned deposits) was 19.4%, or $1.23 billion.

During the nine months ended September 30, 2023, we entered into $350 million of additional cash flow hedge swaps, $100 million of which were terminated in the second quarter. We also replaced $60 million of brokered deposits with FHLB advances as the funding source for cash flow hedge swaps, bringing this funding source to $210 million. At September 30, 2023, brokered deposits funded $550 million of our $760 million remaining cash flow hedge swaps. As of September 30, 2023, a pre-tax unrealized gain of $39.4 million was recognized in other comprehensive income, and there was no ineffective portion of these hedges. We continue to evaluate the lowest cost funding sources for our cash flow swaps and will utilize either brokered deposits, FHLB advances or FRDW borrowings, or a combination of the three funding sources. At September 30, 2023, the majority of the securities portfolio was funded by non-maturity deposits with wholesale funding accounting for approximately 47% of the funding source, of which approximately 59% is swapped at a fixed rate, providing protection from rising interest rates.

We utilize wholesale funding and securities to enhance overall profitability to determine the appropriate leverage of our capital, determining acceptable levels of credit, interest rate and liquidity risk consistent with prudent capital management. This balance sheet strategy currently consists of borrowing funds from the brokered market, FHLB and the Federal Reserve through the FRDW and BTFP. These funds are invested primarily in U.S. agency MBS and long-term municipal securities and to a lesser extent, U.S. Treasury Bills and corporate securities. Although U.S. agency MBS often carry lower yields than loans we make, these securities generally (i) increase the overall quality of our assets because of either the implicit or explicit guarantees of the U.S. Government, (ii) are more liquid than individual loans and (iii) may be used to collateralize our borrowings or other obligations.

Risks associated with this asset structure include a potentially lower net interest rate spread and margin when compared to our peers, changes in the slope of the yield curve, increased interest rate risk, the length of interest rate cycles, changes in volatility or spreads associated with the MBS, municipal and corporate securities, the unpredictable nature of MBS prepayments and credit risks associated with the municipal and corporate securities. See “Part I - Item 1A. Risk Factors – Risks Related to Our Business” in the 2022 Form 10-K for a discussion of risks related to interest rates. An additional risk is significant increases in interest rates, especially long-term interest rates, which could adversely impact the fair value of the AFS securities portfolio and could also impact our equity capital. Due to the unpredictable nature of MBS prepayments, the length of interest rate cycles and the slope of the interest rate yield curve, net interest income could fluctuate more than simulated under the scenarios modeled by our ALCO and described under “Item 3. Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.

Our securities portfolio increased slightly from $2.63 billion at December 31, 2022 to $2.64 billion at September 30, 2023. The increase in the securities portfolio was due to securities purchased during the nine months ended September 30, 2023, which more than offset sales of securities and principal payments.

During the nine months ended September 30, 2023, the composition of the securities portfolio continued to change as U.S. Treasury Bills and MBS increased while the remaining categories in the portfolio decreased. The increase in MBS was attributable to purchases of U.S. Agency MBS, partially offset by MBS sales and principal payments. During the nine months ended September 30, 2023, we purchased $888.5 million in short-term U.S. Treasury Bills, $268.3 million in MBS and $5.8 million in investment grade subordinated corporate debt. Sales during the nine months ended September 30, 2023, included $372.7 million in U.S. Treasury Bills, $205.7 million in municipal securities and $174.7 million in MBS to align the investment portfolio with the current balance sheet strategy. Sales of AFS securities for the three and nine months ended September 30, 2023, resulted in a net realized gain of $11,000 and a net realized loss of $5.6 million, respectively, which was partially offset by the sale of equity securities that resulted in a net gain of $5.1 million for the nine months ended September 30, 2023.

At September 30, 2023, securities as a percentage of assets totaled 33.2%, compared to 34.7% at December 31, 2022, due primarily to a $413.8 million, or 5.5%, increase in the total assets. Our balance sheet management strategy is dynamic and is continually evaluated as market conditions warrant.

During the year ended 2022, we entered into partial term fair value hedges for certain of our fixed rate callable AFS municipal securities. The instruments are designated as fair value hedges as the changes in the fair value of the interest rate swap are expected to offset changes in the fair value of the hedged item attributable to changes in the SOFR swap rate, the designated benchmark interest rate. As of September 30, 2023, hedged securities with a carrying amount of $609.1 million are included in our AFS securities portfolio in our consolidated balance sheets representing approximately 46% and 86% of the AFS securities portfolio and the AFS municipal portfolio, respectively. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for us making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. As of September 30, 2023, a pre-tax unrealized gain of $42.2 million was recognized in other comprehensive income, and there was no ineffective portion of these hedges.

With respect to funding sources, we primarily utilize deposits and to a lesser extent wholesale funding to achieve our strategy of minimizing cost while achieving overall interest rate risk objectives as well as the liability management objectives of the ALCO. Our primary wholesale funding sources are brokered deposits, FHLB and borrowings from the Federal Reserve through the FRDW and BTFP. Our FHLB borrowings increased 38.8%, or $59.5 million, to $212.8 million at September 30, 2023 from $153.4 million at December 31, 2022.

As of September 30, 2023, our total wholesale funding as a percentage of deposits, not including brokered deposits, increased to 23.3%, from 18.1% at December 31, 2022, and 19.2% at September 30, 2022.

Our brokered deposits consist of CDs and non-maturity deposits. Our brokered CDs decreased $109.3 million, or 49.5%, from $220.9 million at December 31, 2022 to $111.5 million at September 30, 2023. At September 30, 2023, our brokered CDs had a weighted average cost of 525 basis points and remaining maturities of approximately 3 months or less. Our brokered non-maturity deposits increased to $678.1 million at September 30, 2023, of which $550.0 million are related to our cash flow hedges, from $438.4 million at December 31, 2022, with a weighted average cost of 301 basis points and 126 basis points, respectively. Our wholesale funding policy currently allows for maximum brokered deposits of $1.41 billion, with an additional $100 million of flexibility for deposits maturing within 30 days. Potential higher interest expense and lack of customer loyalty are risks associated with the use of brokered deposits.

In connection with $760.0 million of our wholesale funds, the Bank has entered into various variable rate agreements and fixed or variable rate short-term pay agreements with an interest rate tied to overnight SOFR. In connection with $760.0 million and $575.0 million of the agreements outstanding at September 30, 2023 and December 31, 2022, respectively, the Bank also entered into various interest rate swap contracts that are treated as cash flow hedges under ASC Topic 815, “Derivatives and Hedging” that are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the underlying SOFR interest rate. The interest rate swap contracts had an average interest rate of 2.13% with a remaining average weighted maturity of 2.4 years at September 30, 2023. Refer to “Note 11 – Derivative Financial Instruments and Hedging Activities” in our consolidated financial statements included in this report for a detailed description of our hedging policy and methodology related to derivative instruments.

#### Results of Operations

Our results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on assets (loans and investments) and interest expense due on our funding sources (deposits and borrowings) during a particular period. Results of operations are also affected by our noninterest income, provision for credit losses, noninterest expenses and income tax expense. General economic and competitive conditions, particularly changes in interest rates, changes in interest rate yield curves, prepayment rates of MBS and loans, repricing of loan relationships, government policies and actions of regulatory authorities also significantly affect our results of operations. Future changes in applicable law, regulations or government policies may also have a material impact on us.

The following table presents net interest income for the periods presented (in thousands):

| Interest income: | Three Months Ended September 30, 2023 | 2022 | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: | ---: | ---: |
| Loans | $64,110 | $45,257 | $177,570 | $118,489 |
| Taxable investment securities | 8,731 | 4,896 | 23,216 | 14,136 |
| Tax-exempt investment securities | 13,758 | 11,482 | 41,394 | 32,306 |
| MBS | 4,426 | 4,770 | 12,585 | 12,025 |
| FHLB stock and equity investments | 265 | 101 | 889 | 291 |
| Other interest earning assets | 1,788 | 374 | 5,148 | 606 |
| Total interest income | 93,078 | 66,880 | 260,802 | 177,853 |
| Interest expense: |  |  |  |  |
| Deposits | 30,951 | 7,887 | 72,536 | 15,388 |
| FHLB borrowings | 1,174 | 1,078 | 5,347 | 1,668 |
| Subordinated notes | 962 | 1,004 | 2,955 | 3,002 |
| Trust preferred subordinated debentures | 1,178 | 669 | 3,309 | 1,496 |
| Repurchase agreements | 1,048 | 54 | 2,423 | 82 |
| Other borrowings | 4,492 | 673 | 13,690 | 718 |
| Total interest expense | 39,805 | 11,365 | 100,260 | 22,354 |
| Net interest income | $53,273 | $55,515 | $160,542 | $155,499 |

#### Net Interest Income

Net interest income is one of the principal sources of a financial institution’s earnings stream and represents the difference or spread between interest and fee income generated from interest earning assets and the interest expense paid on interest bearing liabilities. Fluctuations in interest rates or interest rate yield curves, as well as repricing characteristics and volume and changes in the mix of interest earning assets and interest bearing liabilities, materially impact net interest income. During the nine months ended September 30, 2023, the Federal Reserve increased the target federal funds rate by 100 basis points to 550 basis points and has indicated it anticipates interest rates will remain higher for longer. The increase in the federal funds rate has increased our net interest income. However, as the federal funds rate increases further and the yield curve remains inverted, it may be less beneficial to our net interest income.

Net interest income for the three months ended September 30, 2023 decreased $2.2 million, or 4.0%, compared to the same period in 2022. The decrease in net interest income for the three months ended September 30, 2023 was due to the increase in interest expense on our interest bearing liabilities exceeding the increase in interest income on our interest earning assets. The increase in interest expense was due to higher interest rates and an increase in the average balance of our interest bearing liabilities, partially offset by the increase in interest income, a result of the increase in the average yield and the average balance of interest earning assets. Total interest income increased $26.2 million, or 39.2%, to $93.1 million for the three months ended September 30, 2023, compared to $66.9 million during the same period in 2022. Total interest expense increased $28.4 million, or 250.2%, to $39.8 million for the three months ended September 30, 2023, compared to $11.4 million for the same period in 2022. Our net interest margin and net interest margin (FTE), a non-GAAP measure, decreased to 2.85% and 3.02%, respectively, for the three months ended September 30, 2023, compared to 3.15% and 3.36%, respectively, for the same period in 2022, and our net interest spread and net interest spread (FTE), also a non-GAAP measure, decreased to 2.14% and 2.31%, respectively, compared to 2.87% and 3.08%, respectively, for the same period in 2022.

Net interest income was $160.5 million for the nine months ended September 30, 2023, compared to $155.5 million for the same period in 2022, an increase of $5.0 million, or 3.2%. The increase in net interest income for the nine months ended September 30, 2023 was due to the increase in the average yield as well as the average balance of interest earning assets, partially offset by the increase in interest expense on our interest bearing liabilities due to the increase in interest rates and an increase in the average balance of our interest bearing liabilities. Total interest income increased $82.9 million, or 46.6%, to $260.8 million for the nine months ended September 30, 2023, compared to $177.9 million for the same period in 2022. Total interest expense increased $77.9 million, or 348.5%, to $100.3 million for the nine months ended September 30, 2023, compared to $22.4 million for the same period in 2022. Our net interest margin and net interest margin (FTE), a non-GAAP measure, decreased to 2.95% and 3.13%, respectively, for the nine months ended September 30, 2023, compared to 3.08% and 3.29%, respectively, for the same period in 2022, and our net interest spread and net interest spread (FTE), also a non-GAAP measure, decreased to 2.31% and 2.48%, respectively, compared to 2.90% and 3.11%, respectively, for the same period in 2022. See “Non-GAAP Financial Measures” for more information and for a reconciliation to GAAP.

#### Quarterly Analysis of Changes in Interest Income and Interest Expense

The following table presents on a fully taxable-equivalent basis, a non-GAAP measure, the net change in net interest income and sets forth the dollar amount of increase (decrease) in the average volume of interest earning assets and interest bearing liabilities and from changes in yields/rates. Volume/Yield/Rate variances (change in volume times change in yield/rate) have been allocated to amounts attributable to changes in volumes and to changes in yields/rates in proportion to the amounts directly attributable to those changes (in thousands):

| Fully Taxable-Equivalent Basis: Interest income on: | Three Months Ended September 30, 2023 Compared to 2022 Change Attributable to Average Volume | Average Yield/Rate | Total Change |
| --- | ---: | ---: | ---: |
| Loans (1) | $4,712 | $14,054 | $18,766 |
| Loans held for sale | 15 | 4 | 19 |
| Taxable investment securities | 2,578 | 1,257 | 3,835 |
| Tax-exempt investment securities (1) | (2,177) | 3,954 | 1,777 |
| Mortgage-backed and related securities | (751) | 407 | (344) |
| FHLB stock, at cost, and equity investments | (7) | 171 | 164 |
| Interest earning deposits | 174 | 256 | 430 |
| Federal funds sold | 444 | 540 | 984 |
| Total earning assets | 4,988 | 20,643 | 25,631 |
| Interest expense on: |  |  |  |
| Savings accounts | (49) | 1,026 | 977 |
| CDs | 1,349 | 6,642 | 7,991 |
| Interest bearing demand accounts | 46 | 14,050 | 14,096 |
| FHLB borrowings | 309 | (213) | 96 |
| Subordinated notes, net of unamortized debt issuance costs | (49) | 7 | (42) |
| Trust preferred subordinated debentures, net of unamortized debt issuance costs | — | 509 | 509 |
| Repurchase agreements | 337 | 657 | 994 |
| Other borrowings | 2,591 | 1,228 | 3,819 |
| Total interest bearing liabilities | 4,534 | 23,906 | 28,440 |
| Net change | $454 | $(3,263) | $(2,809) |

(1) Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a fully taxable-equivalent basis. See “Non-GAAP Financial Measures” for more information and for a reconciliation to GAAP.

The increase in total interest income was primarily attributable to an increase in the average yield on interest earning assets to 5.15% from 4.00% for the same period in 2022, as well as an increase in the average balance of interest earning assets of $418.6 million, or 6.0%, for the three months ended September 30, 2023, compared to the same period in 2022. The increase in total interest expense for the three months ended September 30, 2023, was primarily attributable to the increase in interest rates on our interest bearing liabilities to 2.84% from 0.92% for the same period in 2022, and an increase in the average balance of our interest bearing liabilities of $666.9 million, or 13.6%, for the three months ended September 30, 2023, compared to the same period in 2022.

The “Average Balances with Average Yields and Rates” table that follows shows average earning assets and interest bearing liabilities together with the average yield on the earning assets and the average rate of the interest bearing liabilities (dollars in thousands) for the three months ended September 30, 2023 and 2022. The interest and related yields presented are on a fully taxable-equivalent basis and are therefore non-GAAP measures. See “Non-GAAP Financial Measures” for more information, and for a reconciliation to GAAP.

*(unaudited)*

| ASSETS | Average Balances with Average Yields and Rates (Annualized) Three Months Ended September 30, 2023 Average Balance | Interest | Average Yield/Rate | September 30, 2022 Average Balance | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans (1) | $4,396,184 | $64,758 | 5.84% | $4,012,547 | $45,992 | 4.55% |
| Loans held for sale | 1,537 | 26 | 6.71% | 606 | 7 | 4.58% |
| Securities: |  |  |  |  |  |  |
| Taxable investment securities (2) | 912,789 | 8,731 | 3.79% | 626,136 | 4,896 | 3.10% |
| Tax-exempt investment securities (2) | 1,510,044 | 16,232 | 4.26% | 1,750,952 | 14,455 | 3.28% |
| Mortgage-backed and related securities (2) | 442,908 | 4,426 | 3.96% | 520,501 | 4,770 | 3.64% |
| Total securities | 2,865,741 | 29,389 | 4.07% | 2,897,589 | 24,121 | 3.30% |
| FHLB stock, at cost, and equity investments | 22,363 | 265 | 4.70% | 24,013 | 101 | 1.67% |
| Interest earning deposits | 37,891 | 535 | 5.60% | 18,664 | 105 | 2.23% |
| Federal funds sold | 94,441 | 1,253 | 5.26% | 46,106 | 269 | 2.31% |
| Total earning assets | 7,418,157 | 96,226 | 5.15% | 6,999,525 | 70,595 | 4.00% |
| Cash and due from banks | 106,348 |  |  | 102,840 |  |  |
| Accrued interest and other assets | 400,850 |  |  | 433,532 |  |  |
| Less: Allowance for loan losses | (36,493) |  |  | (35,706) |  |  |
| Total assets | $7,888,862 |  |  | $7,500,191 |  |  |
| LIABILITIES AND SHAREHOLDERS’ EQUITY |  |  |  |  |  |  |
| Savings accounts | $622,246 | 1,458 | 0.93% | $685,947 | 481 | 0.28% |
| CDs | 949,894 | 9,443 | 3.94% | 588,212 | 1,452 | 0.98% |
| Interest bearing demand accounts | 3,189,048 | 20,050 | 2.49% | 3,164,961 | 5,954 | 0.75% |
| Total interest bearing deposits | 4,761,188 | 30,951 | 2.58% | 4,439,120 | 7,887 | 0.70% |
| FHLB borrowings | 230,184 | 1,174 | 2.02% | 173,838 | 1,078 | 2.46% |
| Subordinated notes, net of unamortized debt issuance costs | 93,817 | 962 | 4.07% | 98,621 | 1,004 | 4.04% |
| Trust preferred subordinated debentures, net of unamortized debt issuance costs | 60,268 | 1,178 | 7.75% | 60,263 | 669 | 4.40% |
| Repurchase agreements | 104,070 | 1,048 | 4.00% | 30,530 | 54 | 0.70% |
| Other borrowings | 317,913 | 4,492 | 5.61% | 98,174 | 673 | 2.72% |
| Total interest bearing liabilities | 5,567,440 | 39,805 | 2.84% | 4,900,546 | 11,365 | 0.92% |
| Noninterest bearing deposits | 1,441,738 |  |  | 1,746,245 |  |  |
| Accrued expenses and other liabilities | 109,490 |  |  | 101,881 |  |  |
| Total liabilities | 7,118,668 |  |  | 6,748,672 |  |  |
| Shareholders’ equity | 770,194 |  |  | 751,519 |  |  |
| Total liabilities and shareholders’ equity | $7,888,862 |  |  | $7,500,191 |  |  |
| Net interest income (FTE) |  | $56,421 |  |  | $59,230 |  |
| Net interest margin (FTE) |  |  | 3.02% |  |  | 3.36% |
| Net interest spread (FTE) |  |  | 2.31% |  |  | 3.08% |

(1) Interest on loans includes net fees on loans that are not material in amount.

(2) For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.

*Note: As of September 30, 2023 and 2022, loans totaling $4.3 million and $3.0 million, respectively were on nonaccrual status. Our policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.*

#### Year-to-Date Analysis of Changes in Interest Income and Interest Expense

The following table presents on a fully taxable-equivalent basis, a non-GAAP measure, the net change in net interest income and sets forth the dollar amount of increase (decrease) in the average volume of interest earning assets and interest bearing liabilities and from changes in yields/rates. Volume/Yield/Rate variances (change in volume times change in yield/rate) have been allocated to amounts attributable to changes in volumes and to changes in yields/rates in proportion to the amounts directly attributable to those changes (in thousands):

| Fully Taxable-Equivalent Basis: Interest income on: | Nine Months Ended September 30, 2023 Compared to 2022 Change Attributable to Average Volume | Average Yield/Rate | Total Change |
| --- | ---: | ---: | ---: |
| Loans (1) | $13,019 | $45,821 | $58,840 |
| Loans held for sale | 19 | 17 | 36 |
| Taxable investment securities | 5,469 | 3,611 | 9,080 |
| Tax-exempt investment securities (1) | (1,758) | 9,901 | 8,143 |
| Mortgage-backed and related securities | (1,766) | 2,326 | 560 |
| Federal Home Loan Bank stock, at cost, and equity investments | 71 | 527 | 598 |
| Interest earning deposits | 94 | 1,962 | 2,056 |
| Federal funds sold | 962 | 1,524 | 2,486 |
| Total earning assets | 16,110 | 65,689 | 81,799 |
| Interest expense on: |  |  |  |
| Savings accounts | (40) | 3,161 | 3,121 |
| CDs | 1,994 | 16,597 | 18,591 |
| Interest bearing demand accounts | (546) | 35,982 | 35,436 |
| FHLB borrowings | 2,953 | 726 | 3,679 |
| Subordinated notes, net of unamortized debt issuance costs | (56) | 9 | (47) |
| Trust preferred subordinated debentures, net of unamortized debt issuance costs | — | 1,813 | 1,813 |
| Repurchase agreements | 512 | 1,829 | 2,341 |
| Other borrowings | 11,865 | 1,107 | 12,972 |
| Total interest bearing liabilities | 16,682 | 61,224 | 77,906 |
| Net change | $(572) | $4,465 | $3,893 |

(1) Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a fully taxable-equivalent basis. See “Non-GAAP Financial Measures” for more information and for a reconciliation to GAAP.

The increase in total interest income was attributable to the increase in the average yield on earning assets to 4.97% from 3.74% for the same period in 2022 as well as an increase in average earning assets of $526.3 million, or 7.8%, for the nine months ended September 30, 2023, compared to the same period in 2022. The increase in total interest expense for the nine months ended September 30, 2023 was primarily attributable to the increase in interest rates on our interest bearing liabilities to 2.49% from 0.63% for the same period in 2022 and an increase in the average balance of our interest bearing liabilities of $674.9 million, or 14.3%, when compared to the same period in 2022.

The “Average Balances with Average Yields and Rates” table that follows shows average earning assets and interest bearing liabilities together with the average yield on the earning assets and the average rate of the interest bearing liabilities (dollars in thousands) for the nine months ended September 30, 2023 and 2022. The interest and related yields presented are on a fully taxable-equivalent basis and are therefore non-GAAP measures. See “Non-GAAP Financial Measures” for more information, and for a reconciliation to GAAP.

*(unaudited)*

| ASSETS | Average Balances with Average Yields and Rates (Annualized) Nine Months Ended September 30, 2023 Average Balance | Interest | Average Yield/Rate | September 30, 2022 Average Balance | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans (1) | $4,241,676 | $179,545 | 5.66% | $3,855,844 | $120,705 | 4.19% |
| Loans held for sale | 1,620 | 69 | 5.69% | 1,102 | 33 | 4.00% |
| Securities: |  |  |  |  |  |  |
| Taxable investment securities (2) | 843,846 | 23,216 | 3.68% | 629,413 | 14,136 | 3.00% |
| Tax-exempt investment securities (2) | 1,587,656 | 48,880 | 4.12% | 1,656,691 | 40,737 | 3.29% |
| Mortgage-backed and related securities (2) | 433,335 | 12,585 | 3.88% | 501,330 | 12,025 | 3.21% |
| Total securities | 2,864,837 | 84,681 | 3.95% | 2,787,434 | 66,898 | 3.21% |
| FHLB stock, at cost, and equity investments | 25,071 | 889 | 4.74% | 20,796 | 291 | 1.87% |
| Interest earning deposits | 60,623 | 2,310 | 5.09% | 46,972 | 254 | 0.72% |
| Federal funds sold | 75,499 | 2,838 | 5.03% | 30,837 | 352 | 1.53% |
| Total earning assets | 7,269,326 | 270,332 | 4.97% | 6,742,985 | 188,533 | 3.74% |
| Cash and due from banks | 105,885 |  |  | 103,390 |  |  |
| Accrued interest and other assets | 406,160 |  |  | 492,173 |  |  |
| Less: Allowance for loan losses | (36,564) |  |  | (35,746) |  |  |
| Total assets | $7,744,807 |  |  | $7,302,802 |  |  |
| LIABILITIES AND SHAREHOLDERS’ EQUITY |  |  |  |  |  |  |
| Savings accounts | $645,415 | 4,201 | 0.87% | $669,632 | 1,080 | 0.22% |
| CDs | 845,851 | 21,215 | 3.35% | 556,728 | 2,624 | 0.63% |
| Interest bearing demand accounts | 3,005,449 | 47,120 | 2.10% | 3,146,350 | 11,684 | 0.50% |
| Total interest bearing deposits | 4,496,715 | 72,536 | 2.16% | 4,372,710 | 15,388 | 0.47% |
| FHLB borrowings | 281,260 | 5,347 | 2.54% | 117,724 | 1,668 | 1.89% |
| Subordinated notes, net of unamortized debt issuance costs | 96,753 | 2,955 | 4.08% | 98,587 | 3,002 | 4.07% |
| Trust preferred subordinated debentures, net of unamortized debt issuance costs | 60,266 | 3,309 | 7.34% | 60,262 | 1,496 | 3.32% |
| Repurchase agreements | 89,282 | 2,423 | 3.63% | 27,393 | 82 | 0.40% |
| Other borrowings | 362,684 | 13,690 | 5.05% | 35,421 | 718 | 2.71% |
| Total interest bearing liabilities | 5,386,960 | 100,260 | 2.49% | 4,712,097 | 22,354 | 0.63% |
| Noninterest bearing deposits | 1,506,431 |  |  | 1,697,779 |  |  |
| Accrued expenses and other liabilities | 91,784 |  |  | 92,161 |  |  |
| Total liabilities | 6,985,175 |  |  | 6,502,037 |  |  |
| Shareholders’ equity | 759,632 |  |  | 800,765 |  |  |
| Total liabilities and shareholders’ equity | $7,744,807 |  |  | $7,302,802 |  |  |
| Net interest income (FTE) |  | $170,072 |  |  | $166,179 |  |
| Net interest margin (FTE) |  |  | 3.13% |  |  | 3.29% |
| Net interest spread (FTE) |  |  | 2.48% |  |  | 3.11% |

(1) Interest on loans includes net fees on loans that are not material in amount.

(2) For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.

*Note: As of September 30, 2023 and 2022, loans totaling $4.3 million and $3.0 million, respectively, were on nonaccrual status. Our policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.*

#### Noninterest Income

Noninterest income consists of revenue generated from a broad range of financial services and activities and other fee generating services that we either provide or in which we participate.

The following table details the categories included in noninterest income (dollars in thousands):

|  | Three Months Ended September 30, 2023 | Change From 2022 | 2023 2022 |  |
| --- | ---: | ---: | ---: | ---: |
| Deposit services | $6,479 | $6,241 | $238 | 3.8% |
| Net gain (loss) on sale of securities AFS | 11 | (99) | 110 | 111.1% |
| Net gain on sale of equity securities | — | — | — | — |
| Gain on sale of loans | 96 | 109 | (13) | (11.9)% |
| Trust fees | 1,522 | 1,407 | 115 | 8.2% |
| BOLI | 790 | 720 | 70 | 9.7% |
| Brokerage services | 760 | 701 | 59 | 8.4% |
| Other noninterest income | 1,178 | 1,190 | (12) | (1.0)% |
| Total noninterest income | $10,836 | $10,269 | $567 | 5.5% |

|  | Nine Months Ended September 30, 2023 | Change From 2022 | 2023 2022 |  |
| --- | ---: | ---: | ---: | ---: |
| Deposit services | $19,192 | $19,365 | $(173) | (0.9)% |
| Net gain (loss) on sale of securities AFS | (5,590) | (3,819) | (1,771) | (46.4)% |
| Net gain on sale of equity securities | 5,058 | — | 5,058 | 100.0% |
| Gain on sale of loans | 385 | 495 | (110) | (22.2)% |
| Trust fees | 4,479 | 4,421 | 58 | 1.3% |
| BOLI | 3,221 | 2,131 | 1,090 | 51.1% |
| Brokerage services | 2,361 | 2,608 | (247) | (9.5)% |
| Other noninterest income | 4,227 | 4,890 | (663) | (13.6)% |
| Total noninterest income | $33,333 | $30,091 | $3,242 | 10.8% |

The 5.5% increase in noninterest income for the three months ended September 30, 2023, when compared to the same period in 2022, was due to increases in deposit services income and trust fees and a net gain on sale of securities AFS. The 10.8% increase in noninterest income for the nine months ended September 30, 2023, when compared to the same period in 2022, was due to a net gain on sale of equity securities and an increase in BOLI income, partially offset by an increase in net loss on sale of securities AFS and a decrease in other noninterest income.

During the three and nine months ended September 30, 2023, we sold MBS and municipal securities that resulted in a net gain on sale of AFS securities of $11,000 and a net loss on sale of AFS securities of $5.6 million, respectively.

During the nine months ended September 30, 2023, we sold equity securities that resulted in a net gain of $5.1 million.

Gain on sale of loans decreased for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, due to a decrease in the volume of loans sold and a decrease in margins on loan sales as interest rates continued to increase in 2023.

Trust fees increased for the three months ended September 30, 2023, when compared to the same period in 2022, due to an increase in accounts under management during the quarter.

The increase in BOLI income for the nine months ended September 30, 2023, when compared to the same period in 2022, was primarily due to a death benefit of $951,000 realized in the first quarter of 2023 for a former covered officer.

Other noninterest income decreased for the nine months ended September 30, 2023, when compared to the same period in 2022, primarily due to decreases in investment income and mortgage servicing fee income, partially offset by a gain recognized on the repurchase of $5.0 million of our subordinated notes and an increase in equity investment income.

#### Noninterest Expense

We incur certain types of noninterest expenses associated with the operation of our various business activities. The following table details the categories included in noninterest expense (dollars in thousands):

|  | Three Months Ended September 30, 2023 | Change From 2022 | 2023 2022 |  |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $21,241 | $21,368 | $(127) | (0.6)% |
| Net occupancy | 3,796 | 3,847 | (51) | (1.3)% |
| Advertising, travel & entertainment | 1,062 | 789 | 273 | 34.6% |
| ATM expense | 358 | 317 | 41 | 12.9% |
| Professional fees | 1,472 | 1,412 | 60 | 4.2% |
| Software and data processing | 2,432 | 1,736 | 696 | 40.1% |
| Communications | 359 | 497 | (138) | (27.8)% |
| FDIC insurance | 902 | 485 | 417 | 86.0% |
| Amortization of intangibles | 407 | 550 | (143) | (26.0)% |
| Other noninterest expense | 3,524 | 2,463 | 1,061 | 43.1% |
| Total noninterest expense | $35,553 | $33,464 | $2,089 | 6.2% |

|  | Nine Months Ended September 30, 2023 | Change From 2022 | 2023 2022 |  |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $64,473 | $61,666 | $2,807 | 4.6% |
| Net occupancy | 11,220 | 11,157 | 63 | 0.6% |
| Advertising, travel & entertainment | 2,966 | 2,242 | 724 | 32.3% |
| ATM expense | 1,033 | 954 | 79 | 8.3% |
| Professional fees | 4,036 | 3,486 | 550 | 15.8% |
| Software and data processing | 6,751 | 5,106 | 1,645 | 32.2% |
| Communications | 1,034 | 1,509 | (475) | (31.5)% |
| FDIC insurance | 2,666 | 1,434 | 1,232 | 85.9% |
| Amortization of intangibles | 1,327 | 1,758 | (431) | (24.5)% |
| Other noninterest expense | 9,889 | 7,453 | 2,436 | 32.7% |
| Total noninterest expense | $105,395 | $96,765 | $8,630 | 8.9% |

The increase in noninterest expense for the three months ended September 30, 2023, when compared to the same period in 2022, was due to increases in other noninterest expense, software and data processing expense, FDIC insurance and advertising, travel and entertainment. The increase in noninterest expense for the nine months ended September 30, 2023, when compared to the same period in 2022, was due to increases in salaries and employee benefits, other noninterest expense, software and data processing expense, FDIC insurance, advertising, travel and entertainment, and professional fees.

Salaries and employee benefits increased for the nine months ended September 30, 2023, when compared to the same period in 2022, due to an increase in direct salary expense, partially offset by a decrease in retirement expense.

For the nine months ended September 30, 2023, direct salary expense increased $3.3 million, or 6.1%, when compared to the same period in 2022, primarily due to normal salary increases effective in the first quarter of 2023.

Retirement expense, included in salaries and employee benefits, decreased $448,000, or 17.9%, for the nine months ended September 30, 2023, when compared to the same period in 2022. This decrease was primarily due to decreases in our split dollar expense and deferred compensation expense.

Advertising, travel and entertainment expense increased for the three months ended September 30, 2023, when compared to the same period in 2022, primarily due to increases in media and other advertising expense, travel related expenses and conference registration fees, and increased for the nine months ended September 30, 2023, when compared to the same period in 2022, primarily due to increases in travel related expenses, media and other advertising expense, conference registrations fees and donations.

ATM expense increased for the three months ended September 30, 2023, when compared to the same period in 2022, due primarily to an increase in ATM maintenance expense.

Professional fees increased for the nine months ended September 30, 2023, when compared to the same period in 2022, due to an increase in legal and consulting fees.

Software and data processing expense increased for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, due to new software contracts and increases in existing contract renewal costs.

Communications expense decreased for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, driven by a decrease in phone and internet costs due to a change in vendors.

FDIC insurance increased for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, due to an increase in the rate assessed by the FDIC and an increase in our assessment base resulting from an increase in our total assets.

Amortization of intangibles decreased for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, due primarily to a decrease in core deposit intangible amortization which is recognized on an accelerated method resulting in a decline in expense over the amortization period.

The primary increase in other noninterest expense for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, was in non-service cost retirement expense related to the Retirement Plan. Several additional expenses increased during the three and nine months ended September 30, 2023, including advantage check card losses, other losses and computer supplies expense.

#### Income Taxes

Pre-tax income for the three and nine months ended September 30, 2023 was $21.6 million and $81.6 million, respectively, a decrease of 30.0% and 6.9%, compared to $30.8 million and $87.7 million for the same periods in 2022. We recorded income tax expense of $3.1 million and $12.2 million, for the three and nine months ended September 30, 2023, respectively, compared to income tax expense of $3.9 million and $10.3 million for the same periods in 2022. The ETR as a percentage of pre-tax income was 14.5% and 15.0% for the three and nine months ended September 30, 2023, compared to an ETR as a percentage of pre-tax income of 12.6% and 11.8% for the same periods in 2022. The increase in the income tax expense for the nine months ended September 30, 2023 was primarily a result of a decrease in net tax-exempt income as a percentage of pre-tax income as compared to the same periods in 2022.

The ETR differs from the statutory rate of 21% primarily due to the effect of tax-exempt income from municipal loans and securities, as well as BOLI. The net deferred tax asset totaled $41.2 million at September 30, 2023 as compared to $34.7 million at December 31, 2022. The increase in the net deferred tax asset is primarily the result of an increase in unrealized losses in the AFS securities portfolio.

See “Note 11 – Income Taxes” to our consolidated financial statements included in this report. No valuation allowance was recorded at September 30, 2023 or December 31, 2022, as management believes it is more likely than not that all of the deferred tax asset items will be realized in future years.

#### Composition of Loans

One of our main objectives is to seek attractive lending opportunities in Texas, primarily in the market areas in which we operate. Refer to “Part I – Item 1. Business – Market Area” in the 2022 Form 10-K for a discussion of our primary market area and the geographic concentration of our loan portfolio as of December 31, 2022. There were no substantial changes in these concentrations during the nine months ended September 30, 2023. The majority of our loan originations are made to borrowers who live in and/or conduct business in the market areas of Texas in which we operate or adjoin, with the exception of municipal loans, which are made primarily throughout the state of Texas. Municipal loans are made to municipalities, counties, school districts and colleges.

The following table sets forth loan totals by class as of the dates presented (dollars in thousands):

| Real estate loans: | September 30, 2023 | December 31, 2022 | September 30, 2022 | Compared to December 31, 2022 Change (%) | September 30, 2022 Change (%) |
| --- | ---: | ---: | ---: | ---: | ---: |
| Construction | $720,515 | $559,681 | $554,345 | 28.7% | 30.0% |
| 1-4 family residential | 689,492 | 663,519 | 646,692 | 3.9% | 6.6% |
| Commercial | 2,117,306 | 1,987,707 | 1,901,921 | 6.5% | 11.3% |
| Commercial loans | 385,816 | 412,064 | 433,538 | (6.4)% | (11.0)% |
| Municipal loans | 441,512 | 450,067 | 449,219 | (1.9)% | (1.7)% |
| Loans to individuals | 65,992 | 74,653 | 77,780 | (11.6)% | (15.2)% |
| Total loans | $4,420,633 | $4,147,691 | $4,063,495 | 6.6% | 8.8% |

Our total loan portfolio increased $272.9 million, or 6.6%, and $357.1 million, or 8.8%, at September 30, 2023 compared to December 31, 2022 and September 30, 2022, respectively, with increases in all the real estate loan categories, partially offset by decreases in commercial loans, municipal loans and loans to individuals.

At September 30, 2023, our real estate loans represented 79.8% of our loan portfolio and were comprised of commercial real estate loans of 60.0%, 1-4 family residential loans of 19.6% and construction loans of 20.4%. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. Our 1-4 family residential loans consist primarily of loans secured by first mortgages on owner occupied 1-4 family residences. Our construction loans are collateralized by property located primarily in or near the market areas we serve. A number of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects are financed, but these typically have cash flows from leases with tenants, secondary sources of repayment, and in some cases, additional collateral.

#### PCD Loans

We have purchased certain loans that as of the date of purchase have experienced more-than-insignificant deterioration in credit quality since origination. Management evaluates these loans against a probability threshold to determine if substantially all of the contractually required payments will be received. PCD loans are recorded at the purchase price plus an allowance for credit losses which becomes the PCD loan’s initial amortized cost. The non-credit related discount or premium, the difference between the initial amortized cost and the par value, will be amortized into interest income over the life of the loan. Any further changes to the allowance for credit losses are recorded through provision expense. In accordance with the adoption of ASU 2016-13, management did not reassess whether PCI assets met the criteria of PCD assets and elected to not maintain pools of loans as of the date of adoption. All PCD loans are evaluated based upon product type within the underlying segment.

#### Nonperforming Assets

Nonperforming assets consist of delinquent loans 90 days or more past due, nonaccrual loans, OREO, repossessed assets and restructured loans. Nonaccrual loans are loans 90 days or more delinquent and collection in full of both the principal and interest is not expected. Additionally, some loans that are not delinquent or that are delinquent less than 90 days may be placed on nonaccrual status if it is probable that we will not receive contractual principal and interest payments in accordance with the terms of the respective loan agreements. When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any accrued balance is reversed for financial statement purposes. OREO represents real estate taken in full or partial satisfaction of debts previously contracted. The dollar amount of OREO is based on a current evaluation of the OREO at the time it is recorded on our books, net of estimated selling costs. Updated valuations are obtained as needed and any additional impairments are recognized. Restructured loans represent loans that have been modified due to the borrower experiencing financial difficulty to provide interest rate reductions or below market interest rates, restructuring amortization schedules and other actions intended to minimize potential losses. Categorization of a loan as nonperforming is not in itself a reliable indicator of potential loan loss. Other factors, such as the value of collateral securing the loan and the financial condition of the borrower are considered in judgments as to potential loan loss.

The following table sets forth nonperforming assets for the periods presented (dollars in thousands):

|  | September 30, 2023 | December 31, 2022 | September 30, 2022 | Compared to December 31, 2022 Change (%) | September 30, 2022 Change (%) |
| --- | ---: | ---: | ---: | ---: | ---: |
| Nonaccrual loans | $4,316 | $2,846 | $3,039 | 51.7% | 42.0% |
| Accruing loans past due more than 90 days | — | — | — | — | — |
| Restructured loans (1) | 15 | 7,849 | 8,481 | (99.8)% | (99.8)% |
| OREO | 50 | 93 | 162 | (46.2)% | (69.1)% |
| Repossessed assets | — | 74 | 35 | (100.0)% | (100.0)% |
| Total nonperforming assets | $4,381 | $10,862 | $11,717 | (59.7)% | (62.6)% |
| Total loans | $4,420,633 | $4,147,691 | $4,063,495 |  |  |
| Allowance for loan losses at end of period | 41,760 | 36,515 | 36,506 |  |  |

| Ratio of nonaccruing loans to: |  |  |  |
| --- | ---: | ---: | ---: |
| Total loans | 0.10% | 0.07% | 0.07% |
| Ratio of nonperforming assets to: |  |  |  |
| Total assets | 0.05% | 0.14% | 0.16% |
| Total loans | 0.10% | 0.26% | 0.29% |
| Total loans and OREO | 0.10% | 0.26% | 0.29% |
| Ratio of allowance for loan losses to: |  |  |  |
| Nonaccruing loans | 967.56% | 1,283.03% | 1,201.25% |
| Nonperforming assets | 953.21% | 336.17% | 311.56% |
| Total loans | 0.94% | 0.88% | 0.90% |
| Net charge-offs to average loans outstanding | 0.05% | 0.02% | 0.01% |

(1) Pursuant to our adoption of ASU 2022-02, effective January 1, 2023, we prospectively discontinued the recognition and measurement guidance previously required on troubled debt restructures. As a result, “restructured” loans as of September 30, 2023 exclude any loan modifications that are performing but would have previously required disclosure as troubled debt restructures.

We actively market all OREO properties and do not hold them for investment purposes.

#### Allowance for Credit Losses – Loans

In accordance with ASC 326, the allowance for credit losses on loans is estimated and recognized upon origination of the loan based on expected credit losses. The CECL model uses historical experience and current conditions for homogeneous pools of loans, and reasonable and supportable forecasts about future events. The impact of varying economic conditions and portfolio stress factors are a component of the credit loss models applied to each portfolio. Reserve factors are specific to the loan segments that share similar risk characteristics based on the probability of default assumptions and loss given default assumptions, over the contractual term. The forecasted periods gradually mean-revert the economic inputs to their long-run historical trends. Management evaluates the economic data points used in the Moody’s forecasting scenarios on a quarterly basis to determine the most appropriate impact to the various portfolio characteristics based on management’s view and applies weighting to various forecasting scenarios as deemed appropriate based on known and expected economic activities. Management also considers and may apply relevant qualitative factors, not previously considered, to determine the appropriate allowance level. The use of the CECL model includes significant judgment by management and may differ from those of our peers due to different historical loss patterns, economic forecasts, and the length of time of the reasonable and supportable forecast period and reversion period.

We utilize Moody’s Analytics economic forecast scenarios and assign probability weighting to those scenarios which best reflect management’s views on the economic forecast. The probability weighting and scenarios utilized for the estimate of the allowance were generally reflective of continued economic uncertainty related to prolonged inflation, higher interest rates and recessionary concerns, as based on known and knowable information as of September 30, 2023.

When determining the appropriate allowance for credit losses on our loan portfolio, our commercial construction and real estate loans, commercial loans and municipal loans utilize the probability of default/loss given default discounted cash flow approach. Reserves on these loans are based upon risk factors including the loan type and structure, collateral type, leverage ratio, refinancing risk and origination quality, among others. Our consumer construction real estate loans, 1-4 family residential loans and our loans to individuals use a loss rate based upon risk factors including loan types, origination year and credit scores.

Loans evaluated collectively in a pool are monitored to ensure they continue to exhibit similar risk characteristics with other loans in the pool. If a loan does not share similar risk characteristics with other loans, expected credit losses for that loan are evaluated individually.

As of September 30, 2023, our review of the loan portfolio indicated that an allowance for loan losses of $41.8 million was appropriate to cover expected losses in the portfolio. Changes in economic and other conditions, including the application of the CECL model, rising interest rates and heightened inflation, may require future adjustments to the allowance for loan losses.

During the nine months ended September 30, 2023, the allowance for loan losses increased $5.3 million, or 14.4%, to $41.8 million, or 0.94% of total loans, when compared to $36.5 million, or 0.88% of total loans at December 31, 2022.

For the three and nine months ended September 30, 2023, loan charge-offs were $1.3 million and $2.6 million, respectively, and recoveries were $378,000 and $1.2 million, respectively. For the three and nine months ended September 30, 2022, loan charge-offs were $686,000 and $1.7 million, respectively, and recoveries were $449,000 and $1.5 million, respectively. For the three and nine months ended September 30, 2023, we recorded a provision for credit losses for loans of $6.3 million and $6.7 million, respectively. For the three and nine months ended September 30, 2022, we recorded a provision for credit losses for loans of $1.3 million and $1.4 million, respectively.

#### Allowance for Credit Losses – Off-Balance-Sheet Credit Exposures

Allowance for off-balance-sheet credit exposures were as follows (in thousands):

|  | Three Months Ended September 30, 2023 | 2022 | Nine Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: | ---: | ---: |
| Balance at beginning of period | $3,207 | $1,891 | $3,687 | $2,384 |
| Provision for (reversal of) off-balance-sheet credit exposures | 646 | 200 | 166 | (293) |
| Balance at end of period | $3,853 | $2,091 | $3,853 | $2,091 |

Our off-balance-sheet credit exposures include contractual commitments to extend credit and standby letters of credit. For these credit exposures we evaluate the expected credit losses using usage given defaults and credit conversion factors depending on the type of commitment and based upon historical usage rates. These assumptions are reevaluated on an annual basis and adjusted if necessary. For additional information regarding our methodology used to estimate the allowance for credit losses on off-balance-sheet credit exposures, see “Note 12 – Off-Balance-Sheet Arrangements, Commitments and Contingencies” to our consolidated financial statements included in this report.

#### Capital Resources and Liquidity

Our total shareholders’ equity at September 30, 2023 decreased 2.3%, or $17.4 million, to $728.6 million, or 9.1% of total assets, compared to $746.0 million, or 9.9% of total assets, at December 31, 2022. The decrease in shareholders’ equity was the result of the repurchase of $40.9 million of our common stock, cash dividends paid of $32.4 million and other comprehensive loss of $17.5 million, partially offset by net income of $69.4 million, stock compensation expense of $2.7 million, common stock issued under our dividend reinvestment plan of $908,000 and net issuance of common stock under employee stock plans of $424,000.

The Company’s Common Equity Tier 1 capital includes common stock and related paid-in capital, net of treasury stock, and retained earnings. The Bank’s Common Equity Tier 1 capital includes common stock and related paid-in capital, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include accumulated other comprehensive income in Common Equity Tier 1. We also elected, for a five-year transitional period, the effects of credit loss accounting under CECL from Common Equity Tier 1, as further discussed below. Common Equity Tier 1 for both the Company and the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities.

Tier 1 capital includes Common Equity Tier 1 capital and additional Tier 1 capital. For the Company, additional Tier 1 capital at September 30, 2023 included $58.5 million of trust preferred securities. For bank holding companies that had assets of less than $15 billion as of December 31, 2009, trust preferred securities issued prior to May 19, 2010 can be treated as Tier 1 capital to the extent that they do not exceed 25% of Tier 1 capital after the application of capital deductions and adjustments. The Bank did not have any additional Tier 1 capital beyond Common Equity Tier 1 at September 30, 2023.

Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital for both the Company and the Bank includes a permissible portion of the allowance for credit losses on loans and off-balance sheet exposures. Tier 2 capital for the Company also includes $93.8 million of qualified subordinated debt as of September 30, 2023. The permissible portion of qualified subordinated notes decreases 20% per year during the final five years of the term of the notes.

In April 2020, the FDIC, Federal Reserve, and the Office of the Comptroller of the Currency issued supplemental instructions allowing banking organizations that implement CECL before the end of 2020, the option to delay for two years an estimate of the CECL methodologies’ effect on regulatory capital, relative to the incurred loss methodologies effect on capital, followed by a three-year transition period. We elected to adopt the five-year transition option. In accordance with CECL guidance, a CECL transitional amount totaling $4.1 million has been added back to CET1 as of September 30, 2023, representing 50% of the $8.2 million transitional amount at December 31, 2022.

Management believes that, as of September 30, 2023, we met all capital adequacy requirements to which we were subject. It is management’s intention to maintain our capital at a level acceptable to all regulatory authorities and future dividend payments will be determined accordingly. Regulatory authorities require that any dividend payments made by either us or the Bank not exceed earnings for that year. Accordingly, shareholders should not anticipate a continuation of the cash dividend payments simply because of the existence of a dividend reinvestment program. The payment of dividends will depend upon future earnings, our financial condition and other related factors including the discretion of the board of directors.

To be categorized as well capitalized we must maintain minimum Common Equity Tier 1 risk-based, Tier 1 risk-based, Total capital risk-based and Tier 1 leverage ratios as set forth in the following table (dollars in thousands):

| September 30, 2023 Common Equity Tier 1 (to Risk-Weighted Assets) | Actual Amount | Ratio | For Capital Adequacy Purposes Amount | Ratio | To Be Well Capitalized Under Prompt Corrective Actions Provisions Amount | Amount |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Consolidated | $686,806 | 12.27% | $251,949 | 4.50% | N/A | N/A |
| Bank Only | $825,559 | 14.75% | $251,932 | 4.50% | $363,901 | 6.50% |
| Tier 1 Capital (to Risk-Weighted Assets) |  |  |  |  |  |  |
| Consolidated | $745,264 | 13.31% | $335,932 | 6.00% | N/A | N/A |
| Bank Only | $825,559 | 14.75% | $335,909 | 6.00% | $447,879 | 8.00% |
| Total Capital (to Risk-Weighted Assets) |  |  |  |  |  |  |
| Consolidated | $879,571 | 15.71% | $447,909 | 8.00% | N/A | N/A |
| Bank Only | $866,028 | 15.47% | $447,879 | 8.00% | $559,848 | 10.00% |
| Tier 1 Capital (to Average Assets) (1) |  |  |  |  |  |  |
| Consolidated | $745,264 | 9.61% | $310,319 | 4.00% | N/A | N/A |
| Bank Only | $825,559 | 10.64% | $310,227 | 4.00% | $387,784 | 5.00% |

| December 31, 2022 Common Equity Tier 1 (to Risk-Weighted Assets) | Actual Amount | Ratio | For Capital Adequacy Purposes Amount | Ratio | To Be Well Capitalized Under Prompt Corrective Actions Provisions Amount | Ratio |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Consolidated | $687,686 | 12.63% | $245,107 | 4.50% | N/A | N/A |
| Bank Only | $823,323 | 15.12% | $245,085 | 4.50% | $354,012 | 6.50% |
| Tier 1 Capital (to Risk-Weighted Assets) |  |  |  |  |  |  |
| Consolidated | $746,140 | 13.70% | $326,809 | 6.00% | N/A | N/A |
| Bank Only | $823,323 | 15.12% | $326,780 | 6.00% | $435,707 | 8.00% |
| Total Capital (to Risk-Weighted Assets) |  |  |  |  |  |  |
| Consolidated | $877,281 | 16.11% | $435,746 | 8.00% | N/A | N/A |
| Bank Only | $855,790 | 15.71% | $435,707 | 8.00% | $544,633 | 10.00% |
| Tier 1 Capital (to Average Assets) (1) |  |  |  |  |  |  |
| Consolidated | $746,140 | 9.96% | $299,511 | 4.00% | N/A | N/A |
| Bank Only | $823,323 | 11.00% | $299,410 | 4.00% | $374,263 | 5.00% |

(1) Refers to quarterly average assets as calculated in accordance with policies established by bank regulatory agencies.

As of September 30, 2023, Southside Bancshares and Southside Bank met all capital adequacy requirements under the Basel III Capital Rules that became fully phased-in as of January 1, 2019. Refer to the Supervision and Regulation section in the 2022 Form 10-K for further discussion of our capital requirements.

The table below summarizes our key equity ratios for the periods presented:

|  | Three Months Ended September 30, 2023 | 2022 |
| --- | ---: | ---: |
| Return on average assets | 0.93% | 1.43% |
| Return on average shareholders’ equity | 9.50% | 14.23% |
| Dividend payout ratio – Basic | 58.33% | 40.48% |
| Dividend payout ratio – Diluted | 58.33% | 40.48% |
| Average shareholders’ equity to average total assets | 9.76% | 10.02% |
|  | Nine Months Ended September 30, |  |
|  | 2023 | 2022 |
| Return on average assets | 1.20% | 1.42% |
| Return on average shareholders’ equity | 12.21% | 12.92% |
| Dividend payout ratio – Basic | 46.67% | 42.50% |
| Dividend payout ratio – Diluted | 46.88% | 42.68% |
| Average shareholders’ equity to average total assets | 9.81% | 10.97% |

#### Management of Liquidity

Liquidity management involves our ability to convert assets to cash with minimum risk of loss while enabling us to meet our current and future obligations to our customers at any time. This means addressing (1) the immediate cash withdrawal requirements of depositors and other fund providers; (2) the funding requirements of lines and letters of credit; and (3) the short-term credit needs of customers. Liquidity is provided by cash, interest earning deposits and short-term investments that can be readily liquidated with a minimum risk of loss. At September 30, 2023, these investments were 6.3% of total assets, as compared with 2.4% for December 31, 2022 and 2.6% for September 30, 2022. The increase to 6.3% at September 30, 2023 as compared to December 31, 2022 and September 30, 2022, is reflective of increases in the short-term investment portfolio and interest earning deposits, partially offset by the increase in total assets. Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities. The Bank has three unsecured lines of credit for the purchase of overnight federal funds at prevailing rates with Frost Bank, TIB – The Independent Bankers Bank and Comerica Bank for $40.0 million, $15.0 million and $7.5 million, respectively. There were no federal funds purchased at September 30, 2023 or December 31, 2022. To provide more liquidity in response to economic conditions in recent years, the Federal Reserve has encouraged broader use of the discount window. At September 30, 2023, the amount of additional funding the Bank could obtain from the FRDW, collateralized by securities, was approximately $636.9 million. There were no borrowings from the FRDW at September 30, 2023, and $188.0 million at December 31, 2022. To provide more stability and to assure that banks have the ability to meet the needs of all of their depositors, the Federal Reserve created the BTFP in the first quarter of 2023. At September 30, 2023, the amount of additional funding the Bank could obtain from the BTFP, collateralized by securities, was approximately $6,000. There were $291.3 million in borrowings from the BTFP at September 30, 2023. At September 30, 2023, the amount of additional funding the Bank could obtain from FHLB, collateralized by securities, FHLB stock and nonspecified loans and securities, was approximately $1.71 billion, net of FHLB stock purchases required. The Bank has a $5.0 million line of credit with Frost Bank to be used to issue letters of credit, and at September 30, 2023, the line had one outstanding letter of credit for $155,000. The Bank currently has no outstanding letters of credit from FHLB held as collateral for its public fund deposits.

Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The ALCO closely monitors various liquidity ratios and interest rate spreads and margins. The ALCO utilizes a simulation model to perform interest rate simulation tests that apply various interest rate scenarios including immediate shocks and MVPE to assist in determining our overall interest rate risk and the adequacy of our liquidity position. In addition, the ALCO utilizes this simulation model to determine the impact on net interest income of various interest rate scenarios. By utilizing this technology, we can determine changes that need to be made to the asset and liability mix to minimize the change in net interest income under these various interest rate scenarios.

Management continually evaluates our liquidity position and currently believes the Company has adequate funding to meet our financial needs.

#### Recent Accounting Pronouncements

See “Note 1 – Summary of Significant Accounting and Reporting Policies” in our consolidated financial statements included in this Quarterly Report on Form 10-Q.

#### Subsequent Events

Subsequent to September 30, 2023, and through October 24, 2023, we purchased 141,480 shares of common stock at an average price of $28.56 pursuant to the Stock Repurchase Plan.

## Market risk

As filed, 5,156 characters.

The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Statements” included in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report and other cautionary statements set forth elsewhere in this Quarterly Report on Form 10-Q.

Refer to the discussion of market risks included in “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in the 2022 Form 10-K.

In the banking industry, a major risk exposure is changing interest rates. The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates. Federal Reserve monetary control efforts, the effects of deregulation, economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.

In an attempt to manage our exposure to changes in interest rates, management closely monitors our exposure to interest rate risk through our ALCO. Our ALCO meets regularly and reviews our interest rate risk position and makes recommendations to our board for adjusting this position. In addition, our board regularly reviews our asset/liability position. We primarily use two methods for measuring and analyzing interest rate risk: net income simulation analysis and MVPE modeling. We utilize the net income simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. This model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months. The model is used to measure the impact on net interest income relative to a base case scenario of rates immediately increasing 100 and 200 basis points or decreasing 50, 100 and 200 basis points over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. The impact of interest rate-related risks such as prepayment, basis and option risk are also considered. The model has interest rate floors and no interest rates are assumed to go negative. We continue to monitor interest rates and anticipate additional rate increases during the remainder of 2023.

The following table reflects the noted increases and decreases in interest rates under the model simulations and the anticipated impact on net interest income relative to the base case over the next 12 months for the periods presented.

| Rate projections: Increase: | Anticipated impact over the next 12 months September 30, 2023 | 2022 |
| --- | ---: | ---: |
| 100 basis points | 3.14% | 4.26% |
| 200 basis points | 6.53% | 7.19% |
| Decrease: |  |  |
| 50 basis points | (2.22)% | (2.13)% |
| 100 basis points | (4.71)% | (4.54)% |
| 200 basis points | (9.60)% | (10.28)% |

As part of the overall assumptions, certain assets and liabilities are given reasonable floors. This type of simulation analysis requires numerous assumptions including but not limited to changes in balance sheet mix, prepayment rates on mortgage-related assets and fixed rate loans, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity. Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rates.

Economic conditions and growth prospects are currently impacted by record inflation and potential recessionary concerns. Furthermore, worker shortages, supply chain disruptions and inflationary conditions, have had some impact on the level of economic growth in our market areas. Ongoing higher inflation levels and higher interest rates could have a negative impact on the financial condition of both our consumer and commercial borrowers.

The ALCO monitors various liquidity ratios to ensure a satisfactory liquidity position for us. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in the general level of interest rates. Regulatory authorities also monitor our gap position along with other liquidity ratios. In addition, as described above, we utilize a simulation model to determine the impact of net interest income under several different interest rate scenarios. By utilizing this model, we can determine changes that need to be made to the asset and liability mixes to mitigate the change in net interest income under these various interest rate scenarios.

## Controls and procedures

As filed, 1,260 characters.

#### Evaluation of Disclosure Controls and Procedures

Management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), undertook an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report, and, based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, in recording, processing, summarizing and reporting in a timely manner the information that the Company is required to disclose in its reports under the Exchange Act and in accumulating and communicating to the Company’s management, including the Company’s CEO and CFO, such information as appropriate to allow timely decisions regarding required disclosure.

#### Changes in Internal Control Over Financial Reporting

No changes were made to our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 131 characters.

There have been no material changes in the risk factors previously disclosed in the First Quarter Form 10-Q and the 2022 Form 10-K.

Filed Oct 27, 2023.
Source: SEC EDGAR, the filing index for accession 0000705432-23-000184. Last ingested by Listed: Nov 6, 2026, 13:09 ET. No prices; not investment advice.