First Interstate Bancsystem Inc: Form 10-Q for the period ended Sep 30, 2024

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

When we refer to “we,” “our,” “us,” “First Interstate,” or the “Company” in this report, we mean First Interstate BancSystem, Inc. and our consolidated subsidiaries, including our wholly owned subsidiary, First Interstate Bank, unless the context indicates that we refer only to the parent company, First Interstate BancSystem, Inc. When we refer to the “Bank” or “FIB” in this report, we mean only First Interstate Bank.

The following discussion of our consolidated financial data reflects our historical results of operations and financial condition and should be read in conjunction with our financial statements and accompanying notes presented elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2023, including the audited financial statements and related notes contained therein, as previously filed with the Securities and Exchange Commission, or SEC.

Cautionary Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and Rule 3b-6 promulgated thereunder, that involve inherent risks and uncertainties. Any statements about our plans, objectives, expectations, strategies, beliefs, or future performance or events constitute forward-looking statements. Such statements are identified by words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trends,” “objectives,” “views,” “continues” or similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “may,” or similar expressions. Forward-looking statements involve known and unknown risks, uncertainties, assumptions, estimates and other important factors that could cause actual results to differ materially from any results, performance or events expressed or implied by such forward-looking statements. A detailed discussion of risks that may cause actual results to differ materially from current expectations in the forward-looking statements is included below in this report under the caption “Risk Factors” and in our Annual Report on Form 10-K for the year ended December 31, 2023, under the captions “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors”. These factors and the other risk factors described in our periodic and current reports filed with the SEC from time to time, however, are not necessarily all of the important factors that could cause our actual results, performance, or achievements to differ materially from those expressed in or implied by any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results.

All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above. Interested parties are urged to read in their entirety the referenced risk factors prior to making any investment decision with respect to the Company. Forward-looking statements speak only as of the date they are made and we do not undertake or assume any obligation to update publicly any of these statements to reflect actual results, new information or future events, changes in assumptions or changes in other factors affecting forward-looking statements, except to the extent required by applicable law. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

Non-GAAP Financial Measures

In addition to financial measures presented in accordance with generally accepted accounting principles (“GAAP”) in the United States, this document contains non-GAAP financial measures where management believes it would be helpful to understand our results of operations or financial position. The Company’s management believes that the non-GAAP financial measures provide additional intelligence about ongoing operations and enhance comparability of results of operations with prior periods by presenting financial results without the impact of items or events that may obscure trends in the Company’s underlying performance. This information should be considered as supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. Where non-GAAP financial measures are used, the comparable GAAP financial measure, as well as the reconciliation to the comparable GAAP financial measure, can be found herein.

Fully-Taxable Equivalent Basis. The Company adjusts its net interest income to include its interest income on a fully-taxable equivalent (FTE) basis and further adjusts to exclude purchase accounting interest accretion on acquired loans. Interest income, yields, and ratios on an FTE basis are considered non-GAAP financial measures. Net interest margin (FTE) is calculated as annualized net interest income on an FTE basis divided by average earning assets. Management believes net interest income on an FTE basis provides an insightful picture of the interest margin for comparison purposes. The FTE basis also allows management to assess the comparability of revenue arising from both taxable and tax-exempt sources. The FTE basis assumes a federal statutory tax rate of 21 percent. These measures are considered standard measures of comparison within the banking industry. We encourage readers to consider the Unaudited Consolidated Financial Statements and other financial information contained in this Form 10-Q in their entirety, and not to rely on any single financial measure. See Non-GAAP Financial Measures included herein for a reconciliation to the most directly comparable GAAP financial measures.

Limitations associated with non-GAAP financial measures include the risks that persons might disagree as to the appropriateness of items included in these measures and that other companies might calculate these measures differently. These non-GAAP disclosures should not be considered an alternative to the Company’s GAAP results.

Executive Overview

We are a financial and bank holding company focused on community banking. Since our incorporation in Montana in 1971, we have grown both organically and through strategic acquisitions. We operate 299 banking offices, including branches and detached drive-up facilities, in communities across fourteen states—Arizona, Colorado, Idaho, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, North Dakota, Oregon, South Dakota, Washington, and Wyoming. Through our bank subsidiary, First Interstate Bank, we deliver a comprehensive range of banking products and services—including online and mobile banking—to individuals, businesses, government entities, and others throughout our market areas. We are proud to provide lending opportunities to clients that participate in a wide variety of industries, including:

Our principal business activity is lending to, accepting deposits from, and conducting financial transactions with or for individuals, businesses, governmental units, and other entities located in the communities we serve. We derive our income principally from interest charged on loans and, to a lesser extent, from interest and dividends earned on fixed income investments.

We also derive income from non-interest sources such as: (i) fees received in connection with various lending and deposit services; (ii) wealth management services, such as trust, employee benefit, investment, and insurance services; (iii) mortgage loan originations, sales, and servicing; (iv) merchant and electronic banking services; and (v) from time-to-time, gains on sales of assets and securities.

Our principal expenses include: (i) interest expense on deposit accounts and other borrowings; (ii) salaries and employee benefits; (iii) data processing and communication costs primarily associated with maintaining loan and deposit functions; (iv) furniture, equipment, and occupancy expenses for maintaining our facilities; (v) professional fees, including FDIC insurance assessments; (vi) income tax expense; (vii) provisions for credit losses; (viii) intangible amortization; (ix) other real estate owned expenses; and (x) other ancillary expenses including legal expenses, credit card rewards expense, fees associated with originating and closing loans, insurance, and other expenses necessary to support our employees and service our clients. From time to time, we also incur acquisition costs related to our strategic acquisitions.

Recent Trends and Developments

Our community banking footprint spans across the Rocky Mountain, Pacific Northwest, Midwest, and Southwest regions, in large part due to our acquisition activity. As part of our normal course of business, we continue to evaluate bank acquisitions and other strategic opportunities on an on-going basis.

The Company has ample liquidity, and the capital ratios exceed all regulatory requirements to be deemed “well-capitalized” as of September 30, 2024. Our deposit base is diversified, including by depositor, which includes individuals, businesses across multiple industries, governmental units, and other entities, as well as geographically, across the communities we serve.

As of September 30, 2024, our FDIC insured deposits consisted of 65.0% of total deposits, including accounts eligible for pass-through insurance. As of October 28, 2024, the Bank had available borrowing capacity of $4.7 billion with the FHLB and $0.9 billion with the Federal Reserve Bank (“FRB”) based on pledged investment securities and loan collateral.

U.S. inflation data hit a multi-decade high in June 2022, climbing to 9.1%, as reported by the Bureau of Labor Statistics. However, we have now seen a meaningful decrease to 2.4% as of September 2024. While our operating expenses are affected by general inflation, the asset and liability structure of the Company largely consists of monetary items. Monetary items, such as cash, investments, loans, deposits and other borrowings, are assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates have a more significant impact on the Company’s performance than does general inflation. However, despite the more recent declines, inflationary pressures from the last two years may still have negative impacts on the Company’s clients and their customers, impacting their ability or willingness to repay loans or maintain deposits.

The Federal Reserve stated its current objective is to return the rate of inflation to 2.0% and it is closely monitoring the progress that has been made to achieve this goal. The Federal Reserve increased short-term interest rates 525 basis points between March 16, 2022 and July 29, 2023. With general inflationary pressures easing, since July 2023, the Federal Reserve had paused any further changes to short-term interest rates only to decrease them by 50 basis points in September 2024. While many financial industry experts have speculated that rates will decline further in the near-term, the Federal Reserve has not yet provided definitive guidance on any further changes to short-term interest rates.

The Company’s quarterly yield on interest earning assets increased to 4.83% as of September 30, 2024 from 4.80% as of June 30, 2024, and 4.63% as of September 30, 2023.

The sustained elevation of short-term interest rates have also impacted the Company’s cost of funds, primarily resulting from the shift of non-interest-bearing deposits into higher-cost, interest-bearing, and time deposit balances as well as variable rate debt. The Company’s cost of funds was stable at 1.86% during the three months ended September 30, 2024 and June 30, 2024, and increased from 1.59% during the three months ended September 30, 2023. During the third quarter of 2024, the change in the mix and yield on earning assets offset the changes in the mix and cost of funds, resulting in an increase of the Company’s net interest margin during the three months ended September 30, 2024 to 3.01% from 2.97% during the three months ended June 30, 2024. The change in mix and cost of funds more than offset the change in the mix and yield on earning assets as the net interest margin declined from 3.05% for the three months ended September 30, 2023. The Company’s FTE net interest margin increased to 3.04% during the three months ended September 30, 2024, from 3.00% during the three months ended June 30, 2024, and decreased from 3.07% during the three months ended September 30, 2023.

A slowdown, downturn, or recession in the U.S. economy could impact the Company by impacting the level of deposits held by our clients, whether through a higher volume of withdrawals or through a lower volume of deposits. Client deposits are one of the Company’s primary lending sources. The credit quality of the Company’s loans may also be impacted if clients must weather adverse economic conditions which could result in an increase in credit losses or other related expenses.

Primary Factors Used in Evaluating Our Business

As a banking institution, we monitor and evaluate our financial condition and our results of operations by examining the levels and trends of the line items included in our balance sheet and statements of income, as well as the various financial ratios that are commonly used in our industry and monitored by our regulators. We analyze these ratios and financial trends against both our own historical levels as well as the financial condition and performance of comparable banking institutions in our region and nationally.

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2023, our financial performance is impacted by a number of external factors outside our control, as well as our ability to execute on the key components of our strategy for continued success and future growth. See Part II – Other Information, “Item 1A – Risk Factors” for an update of the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023.

Critical Accounting Estimates and Significant Accounting Policies

Our consolidated financial statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant accounting policies we follow are summarized in Note 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2023, and are also referenced in Note 1 to the unaudited financial statements in this quarterly report. There have been no material changes during the third quarter of 2024 in our critical accounting estimates and policies from the critical accounting estimates and policies as described in our Annual Report on Form 10-K for the year ended December 31, 2023.

The preparation of financial statements in conformity with GAAP requires management to measure the Company’s financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. We manage our interest rate risk in several ways. Refer to “Note – Derivatives and Hedging Activities” in the accompanying “Notes to Unaudited Consolidated Financial Statements” for further discussion on how we manage interest rate risk. There can be no assurance that we will not be materially adversely affected by future changes in interest rates, as interest rates are highly sensitive to many factors that are beyond our control.

Results of Operations

The following discussion and analysis is intended to provide detail about the results of our operations and financial condition. More information regarding the results as of December 31, 2023 can be found in our Annual Report on Form 10-K for the year ended December 31, 2023.

Net Income

Net income decreased $17.2 million to $55.5 million, or $0.54 per share, during the three months ended September 30, 2024, as compared to net income of $72.7 million, or $0.70 per share, for the same period in 2023, and is primarily attributable to a higher provision for credit losses and lower net interest income. Lower net interest income resulted from higher interest expense on interest-bearing liabilities during the 2024 period. This decrease in net interest income was partially offset by higher non-interest income, lower tax expense, and lower non-interest expenses.

Net income decreased $22.1 million to $173.9 million, or $1.69 per share during the nine months ended September 30, 2024, as compared to net income of $196.0 million, or $1.89 per share for the same period in 2023. The decrease during the nine months ended September 30, 2024 when compared to the same period in 2023 was primarily attributable to lower net interest income, which has resulted from higher interest expense on interest-bearing liabilities and higher provision expense. This decrease was partially offset by an increase in non-interest income resulting from a $23.4 million loss on the disposition of available-for-sale investment securities during the 2023 period as well as from lower non-interest expenses during the 2024 period.

Net Interest Income

Our operating results depend primarily on our net interest income, which is the difference between the interest the Company earns on its interest-earning assets, such as loans and investment securities, and the expense the Company pays on interest-bearing liabilities, such as deposits and borrowings. Net interest income depends on both the volume of our interest-earning assets and interest-bearing liabilities and the interest rates the Company earns or pays on them.

Changes in interest rate spread, which is the difference between interest earned on assets and interest paid on liabilities, has the most significant impact on net interest income. Other factors like volume of loans, investment securities, and other interest-earning assets compared to the volume of interest-bearing deposits and indebtedness also cause changes in our net interest income between periods. Non-interest-bearing sources of funds, such as demand deposits and stockholders’ equity, help to support earning assets.

For the periods indicated, the following table presents average balance sheet information, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities.

(Dollars in millions)

Net interest income decreased $8.2 million during the three months ended September 30, 2024, as compared to the same period in 2023, primarily due to an increase in interest expense resulting from higher costs of interest-bearing deposits, partially offset by an increase in interests income on loans.

Net interest income included interest accretion related to the fair valuation of acquired loans of $4.4 million during the three months ended September 30, 2024, compared to interest accretion of $5.2 million during the three months ended September 30, 2023.

Our net interest margin ratio decreased 4 basis points to 3.01% for the three months ended September 30, 2024, as compared to 3.05% for the same period in 2023 and our net FTE interest margin ratio, a non-GAAP financial measure, decreased 3 basis points for the three months ended September 30, 2024, as compared to the same period in 2023. Exclusive of the impact of interest accretion on acquired loans, the net FTE interest margin ratio, decreased 3 basis points to 2.97% during the three months ended September 30, 2024, as compared to 3.00% for the same period in 2023. The decreases in net interest margin ratio were primarily a result of higher interest bearing deposit costs and higher FHLB and BTFP borrowings, which were partially offset by increases in interest earned on our loans and a modestly favorable change in the mix of earning assets.

(Dollars in millions)

49

Net interest income decreased $63.7 million during the nine months ended September 30, 2024, as compared to the same period in 2023, primarily due to an increase in interest expense resulting from higher costs of interest-bearing deposits, partially offset by an increase in interest income on loans.

Net interest income included interest accretion related to the fair valuation of acquired loans of $16.0 million during the nine months ended September 30, 2024, compared to interest accretion of $15.0 million for the same period in 2023.

Our net FTE interest margin ratio, a non-GAAP measure, decreased 19 basis points for the nine months ended September 30, 2024, as compared to the same period in 2023. Exclusive of the impact of interest accretion on acquired loans, the net FTE interest margin ratio, decreased 20 basis points to 2.91% during the nine months ended September 30, 2024, as compared to 3.11% for the same period in 2023.

The table below sets forth a summary of the changes in interest income and interest expense resulting from estimated changes in average asset and liability balances (volume) and estimated changes in average interest rates (referred to as “rate”) for the three and the nine months ended September 30, 2024 and 2023. Changes which are not due solely to volume or rate have been allocated to these categories based on the respective percent changes in average volume and average rate as they compare to each other.

(Dollars in millions)

(1) Interest income and average rates for tax exempt loans and securities are presented on a FTE basis.

(2) Dividends on FHLB and FRB stock is used to determine the rate.

Non-GAAP Reconciliations

The table below provides a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measure.

(In millions, except % and per share data)

Provision for Credit Losses

The Company had a $19.8 million provision for credit losses, which included a provision for credit losses of $20.0 million on loans held for investment and a reduction of credit losses for unfunded commitments of $0.2 million during the three months ended September 30, 2024, as compared to an $0.1 million reduction of credit losses during same period in 2023. The provision incorporated the impact of credit movement during the quarter, changes in loan balances, the attributes of the current portfolio, asset quality metrics, a review of the current economic outlook, and net charge-offs of $27.4 million, or an annualized 0.60% of average loans outstanding during the three months ended September 30, 2024, as compared to net charge-offs of $1.1 million, or an annualized 0.02% of average loans outstanding during the same period in 2023. Net loan charge-offs in the third quarter of 2024 were composed of charge-offs of $29.1 million, primarily consisting of a $15.9 million commercial real estate loan and a $6.2 million construction real estate loan. These charge-offs were offset by recoveries of $1.7 million.

The provision during the nine months ended September 30, 2024 of $34.1 million included a provision for credit losses on loans held for investment of $47.0 million, a reduction of credit losses on unfunded commitments of $12.8 million, and a reduction of credit losses on investment securities of $0.1 million. This compares to a provision for credit losses of $26.8 million during the same period in 2023. The allowance for credit losses is updated quarterly based on the attributes of the current loan and investment securities portfolios, asset quality metrics, and a review of the current economic outlook.

For information regarding our non-performing loans, see “Financial Condition – Non-Performing Assets” included herein. For more information on our allowance for credit losses, see “Financial Condition – Allowance for Credit Losses” included herein.

Non-Interest Income

Non-interest income also contributes to our operating results with fee-based revenues such as payment services, mortgage banking and wealth management revenues, service charges on deposit accounts, and other service charges, commissions and fees being our principal source of non-interest income. The following table presents the composition of our non-interest income as of the periods indicated:

(Dollars in millions)

Total non-interest income increased $4.4 million for the three months ended September 30, 2024, as compared to the same period in 2023 and increased $28.6 million for the nine months ended September 30, 2024, as compared to the same period in 2023. The increase for the three months ended September 30, 2024 reflects a $2.6 million gain on the sale of a branch. The increase for the nine months ended September 30, 2024 was primarily the result of the realized loss of $23.4 million on the disposition of available-for-sale investment securities and a $1.9 million loss related to the fair value of loans held for sale recognized through other income during the nine months ended September 30, 2023, and a gain on the sale of a branch during the nine months ended September 30, 2024.

Non-Interest Expense

Non-interest expense decreased $1.7 million during the three months ended September 30, 2024 compared to the same period in 2023 driven by lower other expenses and professional fees, which were partially offset by higher salaries and wages, that included $3.8 million in CEO transition related expenses. Non-interest expense decreased $14.3 million during the nine months ended September 30, 2024 as compared to the same period in 2023. The decreases were driven by lower employee benefits, software costs, and other expenses. These decreases were partially offset by increases in salaries and wages that included $3.8 million in CEO transition expenses, expenses related to OREO, and FDIC insurance premiums, driven by $1.5 million in FDIC special assessment accruals in the first quarter of 2024.

The following table presents the composition of our non-interest expense as of the periods indicated:

(Dollars in millions)

52

Salaries and wages expense increased $5.5 million during the three months ended September 30, 2024 and increased $3.3 million during the nine months ended September 30, 2024, as compared to the same periods in 2023. The increases during the three and the nine months ended September 30, 2024 are primarily due to the accrual of $3.8 million for transition expenses related to the CEO’s pending retirement, lower deferred loan costs, and higher short-term incentive accruals over the prior year, which were offset by lower salaries and wages and net severance costs as a result of staffing reductions.

Employee benefits expense was stable during the three months ended September 30, 2024 and decreased $5.9 million during the nine months ended September 30, 2024, as compared to the same periods in 2023. The decrease was primarily due to lower health insurance costs and lower payroll taxes, partially offset by higher long-term incentive accruals.

Outsourced technology services expense increased $0.1 million during the three months ended September 30, 2024, as compared to the same period in 2023 and decreased $2.3 million during the nine months ended September 30, 2024, as compared to the same periods in 2023. The decrease was primarily due to lower software maintenance costs.

FDIC insurance premiums increased $0.2 million during the three months ended September 30, 2024 and increased $3.8 million during the nine months ended September 30, 2024, compared to the same periods in 2023, primarily resulting from a $1.5 million special assessment accrual recorded during the nine months ended September 30, 2024.

Other expenses primarily include advertising and public relations costs; office supply, postage, freight, telephone, and travel expenses; donations expense; debit and credit card expenses; board of director fees; legal expenses; and other losses. Other expenses decreased $5.8 million during the three months ended September 30, 2024 and decreased $14.8 million during the nine months ended September 30, 2024, compared to the same periods in 2023, primarily resulting from decreases in donation expense, credit card reward accruals, reclassifications of new market tax credit amortization expenses, which moved to income tax expenses, as a result of the adoption of ASU 2023-02, fraud losses, travel costs, and continued focus on our cost saving initiatives.

Income Tax Expense

Our effective tax rate was 23.7% for the three months ended September 30, 2024 compared to 23.2% for the three months ended September 30, 2023 and 23.7% for the nine months ended September 30, 2024 compared to 23.4% for the same period in 2023. Differences between the Company's effective tax rate and applicable federal and state blended statutory rate of approximately 24.9% are due to the proportion of non-taxable revenues, non-deductible expenses, and net benefits from tax credits as compared to the levels of pre-tax earnings. Additionally, in connection with the Company’s adoption of ASU 2023-02 on January 1, 2024, the Company began recording proportional amortization of New Market Tax Credits as a component of income tax expense instead of other expenses.

Financial Condition

Total Assets

Total assets decreased $1,075.7 million, or 3.5%, to $29,595.5 million as of September 30, 2024, from $30,671.2 million as of December 31, 2023, primarily due to decreases in investment securities and loans held for investment which supported declines in deposits and securities sold under repurchase agreements, which was partially offset by an increase in cash and cash equivalents. Significant fluctuations in balance sheet accounts are discussed below. More information regarding the results as of December 31, 2023 can be found in our Annual Report on Form 10-K for the year ended December 31, 2023.

Investment Securities

We manage our investment portfolio primarily as a source of liquidity. In doing so, we seek to obtain the highest risk adjusted return within our risk tolerance and liquidity guidelines, while satisfying the pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. Our portfolio is primarily comprised of U.S. Treasury notes, state, county, and municipal, U.S. government agency, U.S. government agency residential and commercial mortgage-backed securities and collateralized mortgage obligations, collateralized loan obligations, private mortgage-backed, and corporate securities. Federal funds sold and interest-bearing deposits in the Bank are additional investments that are classified as cash equivalents rather than as investment securities. Investment securities classified as available-for-sale are recorded at fair value, while investment securities classified as held-to-maturity are recorded at amortized cost. Unrealized gains or losses, net of the deferred tax effect, on available-for-sale securities are reported as increases or decreases in accumulated other comprehensive income or loss, a component of stockholders’ equity.

Investment securities decreased $773.8 million, or 8.6%, to $8,275.6 million, or 28.0% of total assets, as of September 30, 2024, from $9,049.4 million, or 29.5% of total assets, as of December 31, 2023. The decrease was primarily resulting from normal pay-downs and maturities, partially offset by $134.6 million increase in fair market values and $102.2 million of reinvestment into investment securities.

As of September 30, 2024 and December 31, 2023, the estimated duration of our investment portfolio was 3.4 and 3.5 years, respectively.

As of September 30, 2024 and December 31, 2023, we had $6,662.4 million and $8,284.5 million, respectively, of investment securities that had been in a continuous loss position for more than twelve months. At September 30, 2024 and December 31, 2023, the Company had no allowance for credit losses on available-for-sale securities and an allowance for credit losses on held-to maturity securities classified as corporate and municipal securities of $0.7 million and $0.8 million, respectively.

Loans Held for Investment, Net of Deferred Fees and Costs

Loans held for investment, net of deferred fees and costs, decreased $252.5 million as of September 30, 2024 as compared to December 31, 2023.

The following table presents the composition and comparison of loans held for investment for the periods indicated:

Declines in the construction real estate loans are primarily a result of the conversion of loans to permanent commercial real estate financing.

Non-Performing Assets

Non-performing assets include non-performing loans and OREO.

Non-Performing Loans. Non-performing loans include non-accrual loans and loans contractually past due 90 days or more and still accruing interest.

Non-accrual loans. We generally place loans on non-accrual status when they become 90 days past due unless they are well secured and in the process of collection or if the collection of principal and interest is in doubt. When a loan is placed on non-accrual status, any interest previously accrued but not collected is reversed from income. Non-accrual loans increased approximately $66.3 million, or 62.3%, to $172.7 million as of September 30, 2024, from $106.4 million as of December 31, 2023, primarily driven by the categorization of a single $54.4 million commercial and industrial loan relationship to non-accrual in the first quarter of 2024. As of September 30, 2024 there were approximately $60.7 million of non-accrual loans for which there was no related allowance for credit losses, as these loans had sufficient collateral securing the loan for repayment.

Loans contractually past due 90 days or more and still accruing interest. Loans past due 90 days or more accruing interest were $1.8 million as of September 30, 2024, a decrease of $3.1 million, or 63.3%, from $4.9 million as of December 31, 2023.

Other Real Estate Owned (“OREO”). OREO consists of real property acquired through foreclosure on the collateral underlying defaulted loans. We record OREO at fair value less estimated selling costs. Any excess of loan carrying value over the fair value of the real estate at the time it is acquired, is recorded as a charge against the allowance for credit losses. Estimated losses that result from the ongoing periodic valuation of these properties are charged to earnings in the period in which they are identified. OREO decreased $12.1 million, or 73.3%, to $4.4 million as of September 30, 2024, from $16.5 million as of December 31, 2023, primarily resulting from the disposal of a $9.0 million agricultural real estate property and a $3.0 million commercial property.

The following table sets forth information regarding non-performing assets as of the dates indicated:

(Dollars in millions)

The following table sets forth the allocation of our non-performing loans among our various loan categories as of the dates indicated.

(Dollars in millions)

Allowance for Credit Losses

The Company performs a quarterly assessment of the appropriateness of its allowance for credit losses in accordance with GAAP. The allowance for credit losses is established through a provision for credit losses based on our evaluation of quantitative and qualitative risk factors in our loan portfolio at each balance sheet date. In determining the allowance for credit losses, we estimate losses on specific loans, or groups of loans, where the expected loss can be identified and reasonably determined over the life of the loans. The balance of the allowance for credit losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature or tenure of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current environmental and economic factors, and the estimated impact of forecasted economic conditions on historical loan loss rates.

The allowance for credit losses is increased by provisions charged against earnings and net recoveries of charged-off loans and is reduced by negative provisions credited to earnings and net loan charge-offs. The allowance for credit losses consists of three elements:

(1) Specific valuation allowances associated with collateral-dependent and other individually evaluated loans. Specific valuation allowances are determined based on assessment of the fair value of the collateral underlying the loans as determined through independent appraisals, the present value of future cash flows, observable market prices, and any relevant qualitative or environmental factors impacting loans.

(2) Collective valuation allowances based on loan loss experience and future expectations for similar loans with similar characteristics and trends. The Company applies open pool methodologies for all portfolio segments. The open pool methodology averages quarterly loss rates by modeling segment, calculated as quarter-to-date net charge off balance divided by the end of period balance. Loss rates are recalculated quarterly with recoveries captured in the quarter a loan was charged off, are averaged across a look back period from 2009 to the current period, and are annualized. Macroeconomic-conditioned historical loss rates are applied to loan-level cash flows. Expected future principal and interest cash flows are calculated using contractual repayment terms and prepayment, utilization, interest rate, and probability of default assumptions. Macroeconomic sensitivity models calculate segment-specific multipliers using third party forecast data. The multipliers condition the annual loss rates over the 2-year forecast period, followed by a 1-year straight-line reversion to the unadjusted historical average loss rates. The unadjusted loss rates then apply for the remaining life of the loan. Estimated losses are totaled and aggregated to the segment level.

(3) Qualitative allowance adjustments are determined based on asset quality trends, industry concentrations, environmental risks, changes in portfolio composition, and other qualitative risk factors, both internal and external to the Company. Other qualitative factors, including changes in loan and lending policies, collateral quality, underwriting standards and personnel, credit review quality, and model imprecision, are also considered.

Based on the assessment of the appropriateness of the allowance for credit losses, the Company records provisions for credit losses to maintain the allowance for credit losses at appropriate levels.

Loans acquired in business combinations are initially recorded at fair value as adjusted for credit risk and an allowance for credit losses at the date of acquisition. For loans with no significant evidence of credit deterioration since origination, the difference between the fair value and the unpaid principal balance of the loan at the acquisition date is amortized into interest income using the effective interest method over the remaining period to contractual maturity. An allowance for credit loss is recorded for the expected credit losses over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through provision expense using the same methodology as other loans held for investment.

For loans acquired in business combinations with evidence of deterioration in credit quality since origination, the Company determines the fair value of the loans by estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. An allowance for credit losses is recognized by estimating the expected credit losses of the purchased asset and recording an adjustment to the acquisition date fair value to establish the initial amortized cost basis of the asset. Differences between the established amortized cost basis, and the unpaid principal balance of the asset, is considered to be a non-credit discount/premium and is accreted/amortized into interest income using the level yield interest method. Subsequent changes to the allowance for credit losses are recorded through provision expense using the same methodology as other loans held for investment.

Loans, or portions thereof, are charged-off against the allowance for credit losses when management believes the collectability of the principal is unlikely, or, with respect to consumer installment loans, according to an established delinquency schedule. Generally, loans are charged-off when (1) there has been no material principal reduction within the previous 90 days and there is no pending sale of collateral or other assets, (2) there is no significant or pending event which will result in principal reduction within the upcoming 90 days, (3) it is clear that we will not be able to collect all or a portion of the loan, (4) payments on the loan are sporadic, will result in an excessive amortization, or are not consistent with the collateral held, or (5) foreclosure or repossession actions are pending. Loan charge-offs do not directly correspond with the receipt of independent appraisals or the use of observable market data if the collateral value is determined to be sufficient to repay the principal balance of the loan.

If a collateral-dependent loan is adequately collateralized, a specific valuation allowance for credit losses is not recorded. As such, significant changes in collateral-dependent and non-performing loans do not necessarily correspond proportionally with changes in the specific valuation component of the allowance for credit losses. Additionally, the Company expects the timing of charge-offs will vary between quarters and will not necessarily correspond proportionally to changes in the allowance for credit losses or changes in non-performing or collateral-dependent loans due to timing differences among the initial identification of a collateral-dependent loan, recording of a specific valuation allowance for collateral-dependent loans, and any resulting charge-off of uncollectible principal.

Our allowance for credit losses was $225.4 million, or 1.25% of loans held for investment as of September 30, 2024 compared to $227.7 million, or 1.25% of loans held for investment, as of December 31, 2023. The Company’s allowance for off-balance sheet credit losses was $5.6 million as of September 30, 2024, compared to $18.4 million as of December 31, 2023, due to a decline in off-balance sheet commitments.

Although we have established our allowance for credit losses in accordance with GAAP in the United States and we believe that the allowance for credit losses is appropriate to provide for known and expected losses in the portfolio, future provisions will be subject to on-going evaluations of the risks in the loan portfolio. If the economy declines or asset quality deteriorates, material additional provisions could be required.

The following table sets forth information regarding our allowance for credit losses as of and for the periods indicated:

(Dollars in millions)

Total Liabilities

Total liabilities decreased $1,214.0 million, or 4.4%, to $26,229.7 million as of September 30, 2024, from $27,443.7 million as of December 31, 2023, primarily due to decreases in deposits, securities sold under repurchase agreements, and other borrowed funds. Significant fluctuations in liability accounts are discussed below.

Deposits

Our deposits consist of non-interest-bearing and interest-bearing demand, savings, individual retirement, and time deposit accounts. Total deposits decreased $459.0 million, or 2.0%, to $22,864.1 million as of September 30, 2024, from $23,323.1 million as of December 31, 2023, with decreases in all categories except for savings and time deposits $250 thousand and over. Included in the decline was $185.0 million of high-cost, government entity deposits withdrawn during the first quarter of 2024.

The following table summarizes our deposits as of the dates indicated:

(Dollars in millions)

(1) Included in “Time, other” are IntraFi Network Deposits, or Intrafi, deposits of $6.9 million and $26.6 million as of September 30, 2024 and December 31, 2023, respectively.

Deposit Insurance

The deposits of the Bank are insured up to the applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC, generally up to $250,000 per insured depositor. The Bank pays deposit insurance premiums based on assessment rates established by the FDIC. The estimated amount of deposits in excess of the FDIC insurance limit at September 30, 2024 was $8.0 billion, or 35.0% of total deposits. Estimates of uninsured deposits are based on the methodologies and assumptions used in the Bank’s call reports and do not necessarily reflect an evaluation of all scenarios that potentially would determine the availability of deposit insurance to customer accounts based on FDIC regulations.

Securities Sold Under Repurchase Agreements

In addition to deposits, repurchase agreements with commercial depositors, which include municipalities, provide an additional source of funds. Under repurchase agreements, deposit balances are invested in short-term U.S. government agency securities overnight and are then repurchased the following day. All outstanding repurchase agreements are due in one day and balances fluctuate in the normal course of our client’s business. Securities sold under repurchase agreement balances decreased $225.5 million, or 28.8%, to $557.2 million as of September 30, 2024, from $782.7 million as of December 31, 2023.

Other Borrowed Funds

Other borrowed funds is comprised of FHLB and BTFP overnight and fixed-rate borrowings with remaining contractual tenors of up to one year. Other borrowed funds decreased $523.0 million, or 20.1%, to $2,080.0 million as of September 30, 2024 from $2,603.0 million as of December 31, 2023.

Capital Resources and Liquidity Management

Capital Resources. Stockholders’ equity is influenced primarily by earnings, dividends, sales and redemptions of common stock, and changes in the unrealized holding gains or losses, net of taxes, on available-for-sale investment securities. Stockholders’ equity increased $138.3 million, or 4.3%, to $3,365.8 million as of September 30, 2024, from $3,227.5 million as of December 31, 2023, due to a decrease to the unrealized losses on available-for-sale securities through other comprehensive income and the retention of retained earnings, partially offset by cash dividends paid and stock repurchases of vested restricted shares tendered in lieu of cash for payment of income tax withholding amounts by participants.

On October 23, 2024, the Company’s board of directors declared a dividend of $0.47 per common share, payable on November 14, 2024, to common stockholders of record as of November 4, 2024. The dividend equates to a 6.3% annual yield based on the $29.85 average closing pricing of the Company’s common stock during the third quarter of 2024.

As a bank holding company, the Company must comply with the capital requirements established by the Federal Reserve, and our subsidiary Bank must comply with the capital requirements established by the FDIC. The current risk-based guidelines applicable to us and our Bank are based on the Basel III framework, as implemented by the federal bank regulators. As of September 30, 2024 and December 31, 2023, the Company had capital levels that, in all cases, exceeded the guidelines to be deemed “well-capitalized.” For additional information regarding our capital levels, see “Note – Regulatory Capital” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.

Liquidity. Liquidity measures our ability to meet current and future cash flow needs on a timely basis and at a reasonable cost. We manage our liquidity position to meet the daily cash flow needs of clients, while maintaining an appropriate balance between assets and liabilities to meet the return-on-investment objectives of our shareholders. Our liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest-bearing deposits in banks, federal funds sold, available-for-sale investment securities, and maturing or prepaying balances in our held-to-maturity investment and loan portfolios. Liquid liabilities include core deposits, federal funds purchased, securities sold under repurchase agreements, and borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market funds through non-core deposits, the issuance of additional collateralized borrowings such as FHLB and BTFP advances, the issuance of debt securities, additional borrowings through the Federal Reserve’s discount window, and the issuance of preferred or common securities. Our short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures, and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of prepaying and maturing balances in our loan and investment portfolios, the issuance of securities, borrowings and other debt financing, and increases in client deposits.

For the nine months ended September 30, 2024, net cash provided by operating activities was $259.8 million, net cash provided by investing activities was $1,200.0 million and net cash used in financing activities was $1,339.2 million. Major uses of cash were $459.0 million in outflows of deposits and $773.0 million in repayment of other borrowed funds. Major sources of cash included $266.5 million of advances in long-term debt and $1,009.4 million in investment security maturities and paydowns. Total cash and cash equivalents were $698.6 million as of September 30, 2024, compared to $578.0 million as of December 31, 2023. For additional information regarding our operating, investing, and financing cash flows, see the unaudited “Consolidated Statements of Cash Flows,” included in Part I – Financial Information, “Item 1 – Financial Statements.” For additional information regarding our deposits, see “Financial Condition – Deposits,” included in Part I – Financial Information, “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

As a holding company, we are a corporation separate and apart from our subsidiary Bank and, therefore, we provide for our own liquidity. Our primary sources of funding include management fees and dividends declared and paid by the Bank and access to capital markets. There are statutory, regulatory, and debt covenant limitations that affect the ability of our Bank to pay dividends to us. Management believes that such limitations will not impact our ability to meet our ongoing short-term cash obligations.

The Company continuously monitors our liquidity position and adjustments are made to the balance between sources and uses of funds as deemed appropriate. We are not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources, or operations. In addition, we are not aware of any regulatory recommendations regarding liquidity, which if implemented, would have a material adverse effect on us. The Bank satisfies incremental liquidity needs with either liquid assets or external funding sources. Available liquidity includes cash, FHLB advances and FRB borrowings through the discount window. The Bank has pledged its investment securities portfolio to access wholesale funding as needed and does not intend to sell or restructure securities at this time.

(Dollars in billions)

Through the Bank’s relationship with the FHLB, the Bank owns $59.3 million of FHLB stock and has access to additional liquidity and funding sources through FHLB advances. The Bank’s borrowing capacity is dependent upon the amount of collateral the Bank places at the FHLB. As of September 30, 2024, the Bank had FHLB borrowings of $1,080.0 million with remaining tenors of one-year or less and $3.9 million with original tenors of greater than one-year. The Bank’s remaining borrowing capacity with the FHLB was $4,885.2 million as of September 30, 2024.

The Bank had a $1.0 billion advance through the BTFP as of September 30, 2024. As of September 30, 2024, the Bank’s borrowing capacity at the Federal Reserve Discount Window was $0.9 billion.

Recent Accounting Pronouncements

See “Note – Recent Authoritative Accounting Guidance” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report for details of recently issued accounting pronouncements and their expected impact on our financial statements.

QUANTITATIVE AND QUALITATIVE DISCLOSURES

ABOUT MARKET RISK

This analysis should be read in conjunction with text under the caption “Quantitative and Qualitative Disclosures About Market Risk” in our Form 10-K, which text is incorporated herein by reference. Our analysis of market risk and market-sensitive financial information contains forward-looking statements and is subject to the disclosure at the beginning of “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding such forward-looking information.

Asset Liability Management

The goal of asset liability management is the prudent control of market risk, liquidity, and capital. Asset liability management is governed by policies, goals, and objectives adopted and reviewed by the Bank’s board of directors. Development of asset liability management strategies and monitoring of interest rate risk are the responsibility of the Asset Liability Committee, or ALCO, which is composed of members of senior management.

Interest Rate Risk

Interest rate risk is the risk of loss of future earnings or long-term value due to changes in interest rates. Our primary source of earnings is net interest income, which is affected by the level of interest rates, changes in interest rates, the speed of changes in interest rates, the relationship between rates on interest-bearing assets and liabilities, the impact of interest rate fluctuations on asset prepayments, and the mix of interest-bearing assets and liabilities.

The ability to optimize net interest income is largely dependent upon the achievement of an interest rate spread that can be managed during periods of fluctuating interest rates. Interest sensitivity is a measure of the extent to which net interest income will be affected by market interest rates over a period.

Net Interest Income Sensitivity

We believe net interest income sensitivity provides the best perspective of how day-to-day decisions affect our interest rate risk profile. We monitor net interest income sensitivity by utilizing an income simulation model to subject 12- and 24- month net interest income to various rate movements. Simulations modeled quarterly include scenarios where market rates change instantaneously up or down in a parallel or non-parallel manner. Estimates produced by our income simulation model are based on numerous assumptions including, but not limited to: (1) the timing of changes in interest rates, (2) shifts or rotations in the yield curve, (3) repricing characteristics for market rate sensitive instruments, (4) differing sensitivities of financial instruments due to differing underlying rate indices, (5) varying loan prepayment speeds for different interest rate scenarios, (6) the effect of interest rate limitations in our assets, such as caps and floors, and (7) overall growth and repayment rates and product mix of assets and liabilities. Because of limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on our results, but rather to provide insight into our current interest rate exposure and execute appropriate asset/liability management strategies accordingly.

The following table presents the net interest income simulation model’s projected change in net interest income over a one-year horizon due to a change in interest rates. The net interest income simulation assumes parallel shifts in the yield curve and a static balance sheet. The net interest income simulation also uses a “deposit beta” modeling assumption which is an estimate of the change in interest-bearing deposit pricing for a given change in market interest rates. In up-rate scenarios, the deposit beta assumption is 30% with the pricing change occurring in the first month of the net interest income simulation horizon. In down-rate scenarios, the deposit beta assumption is 50% with the pricing change occurring in the first month of the net interest income simulation horizon. Actual changes to deposit pricing may vary significantly from this assumption due to management actions, customer behavior, and market forces, which may have significant impacts to our net interest income. The net interest income simulations at September 30, 2024 project that interest-bearing liabilities reprice faster than our interest earning assets.

The preceding interest rate sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results.

The Company uses financial derivative instruments for management of interest rate sensitivity. In August 2022, the Company entered into two interest rate collars related to variable-rate loans that were designated as cash flow hedges with a total notional amount of $300.0 million. The collars designated as cash flow hedges synthetically fix the interest income received by the Company when the interest index falls below a floor rate on a rate reset and when the interest index exceeds the cap rate on a rate reset. In October 2022, the Company entered into four forward starting receive-fixed hedges related to pools of variable-rate loans and securities that were designated as cash flow hedges with a total notional amount of $850.0 million. The swaps designated as cash flow hedges synthetically fix the interest income received by the Company. During the third quarter of 2024, the Company voluntarily terminated three swaps, which were designated as cash flow hedges, two of which were related to variable-rate loans and one related to variable-rate securities with a total notional amount of $550.0 million. The termination of the cash flow hedges resulted in a net unrealized loss totaling $0.2 million. The two interest rate collars and one remaining swap designated as cash flow hedges were effective with a total notional amount of $600.0 million. For more information regarding these financial derivative instruments, see “Note - Derivatives and Hedging Activities” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, under the supervision and with the participation of the Chief Executive Officer (who is our principal executive officer) and Chief Financial Officer (who is our principal financial officer), evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of September 30, 2024. The term "disclosure controls and procedures" means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2024, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods required by the SEC’s rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

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

Limitations on the Effectiveness of Controls and Procedures

The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of disclosure controls and procedures or internal control over financial reporting may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.

PART II.

OTHER INFORMATION

There have been no material changes in risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2023 during the period covered by this quarterly report.