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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K filed with the SEC on March 9, 2023, and our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report. The following discussion contains “forward-looking statements” that reflect our future plans, estimates, beliefs and expected performance. We caution that assumptions, expectations, projections, intentions or beliefs about future events may, and often do, vary from actual results and the differences can be material. See “Cautionary Note Regarding Forward-Looking Statements.” Also, see the risk factors and other cautionary statements described under the heading “Item 1A: Risk Factors” included in the Annual Report on Form 10-K and in Item 1A of this Quarterly Report. We do not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law.

This discussion and analysis of our financial condition and results of operation includes the following sections:

• Table containing selected financial data and ratios for the periods;
• Overview – a general description of our business and financial highlights;
• Critical Accounting Policies – a discussion of accounting policies that require critical estimates and assumptions;
• Results of Operations – an analysis of our operating results, including disclosures about the sustainability of our earnings;
• Financial Condition – an analysis of our financial position;
• Liquidity and Capital Resources – an analysis of our cash flows and capital position; and
• Non-GAAP Financial Measures – a reconciliation of non-GAAP measures.

(Dollars in thousands, except per share data)

* The value noted is considered a Non-GAAP financial measure. For a reconciliation of Non-GAAP financial measures see “Non-GAAP Financial Measures” in this Item 2.

Overview

We are a financial holding company headquartered in Wichita, Kansas. Our wholly-owned banking subsidiary, Equity Bank, provides a broad range of financial services primarily to businesses and business owners as well as individuals through our network of 65 full-service banking sites located in Arkansas, Kansas, Missouri, and Oklahoma. As of September 30, 2023, we had consolidated total assets of $4.95 billion, total loans held for investment, net of allowance, of $3.24 billion, total deposits of $4.08 billion, and total stockholders’ equity of $418.1 million. During the three and nine month periods ended September 30, 2023, the Company had net income of $12.3 million and $36.1 million. The Company had net income of $15.2 million and $46.1 million for the three and nine month periods ended September 30, 2022.

Critical Accounting Policies

Our significant accounting policies are integral to understanding the results reported. Our accounting policies are described in detail in Note 1 to the December 31, 2022, audited financial statements included in our Annual Report on Form 10-K filed with the SEC on March 9, 2023. The preparation of our financial statements in accordance with GAAP requires management to make a number of judgments and assumptions that affect our reported results and disclosures. Several of our accounting policies are inherently subject to valuation assumptions and other subjective assessments and are more critical than others in terms of their importance to results. Changes in any of the estimates and assumptions underlying critical accounting policies could have a material effect on our financial statements. Our accounting policies are described in “NOTE 1 – NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” in the Notes to Interim Consolidated Financial Statements.

The accounting policies that management believes are the most critical to an understanding of our financial condition and results of operations and require complex management judgment are described below.

Allowance for Credit Losses: The allowance for credit losses for loans represents management’s estimate of all expected credit losses over the expected contractual life of our loan portfolio. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management’s evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay a loan (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications, and other pertinent factors, including regulatory recommendations. The level of the allowance for credit losses maintained by management is believed adequate to absorb all expected future losses inherent in the loan portfolio at the balance sheet date; however, determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. The actual realized facts and circumstances may be different than those currently estimated by management and may result in significant changes in the allowance for credit losses in future periods. The allowance for credit losses for loans, as reported in our consolidated balance sheets, is adjusted by provision for credit losses, which is recognized in earnings and is reduced by the charge-off of loan amounts, net of recoveries.

The allowance represents management’s best estimate, but significant changes in circumstances relating to loan quality and economic conditions could result in significantly different results than what is reflected in the consolidated balance sheet as of September 30, 2023. Likewise, an improvement in loan quality or economic conditions may allow for a further reduction in the required allowance. Changing credit conditions would be expected to impact realized losses, driving variability in specifically assessed allowances, as well as calculated quantitative and more subjectively analyzed qualitative factors. Depending on the volatility in these conditions, material impacts could be realized within the Company’s operations. Significant changes in economic conditions, both positive and negative, could result in unexpected realization of provision or reversal of allowance for credit losses due to its impact on the quantitative and qualitative inputs to the Company’s calculation. Under the CECL methodology, the impact of these conditions has the potential to further exacerbate periodic differences due to its life of loan perspective. The life of loans calculated under the methodology is based in contractual duration and modified for prepayment expectations, making significant variation in periodic results possible due to changing contractual or adjusted duration of the assets within the calculation.

Goodwill: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized and expensed in the period identified. Goodwill will be assessed more frequently if a triggering event occurs which indicates that the carrying value of the asset might be impaired. We have selected December 31 as the date to perform our annual goodwill impairment test. Goodwill is the only intangible asset with an indefinite useful life. For the quarter ended September 30, 2023, management conducted the quarterly qualitative assessment and has determined there was no evidence of a triggering event as of or during the period then ended. Based on this qualitative analysis and conclusion, it was determined that a more robust quantitative assessment was not necessary at our measurement date.

When performing quantitative goodwill impairment assessments, management is required to estimate the fair value of the Company’s equity in a change in control transaction. To complete this valuation, management is required to derive assumptions related to industry performance, reporting unit business performance, economic and market conditions, and various other assumptions, many of which require significant management judgment.

Although management believes that the judgments and estimates used are reasonable, actual results could differ and we may be exposed to losses or gains that could be material.

Results of Operations

We generate our revenue from interest income and fees on loans, interest and dividends on investment securities, and non-interest income, such as service charges and fees, debit card income, trust and mortgage banking income. We incur interest expense on deposits and other borrowed funds and non-interest expense, such as salaries and employee benefits and occupancy expenses.

Changes in interest rates earned on interest-earning assets or incurred on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and non-interest-bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic change in net interest income. Fluctuations in interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international circumstances and domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Arkansas, Kansas, Missouri and Oklahoma, as well as developments affecting the consumer, commercial and real estate sectors within these markets.

Net Income

Three months ended September 30, 2023, compared with three months September 30, 2022: Net income allocable to common stockholders for the three months ended September 30, 2023, was $12.3 million, or $0.80 diluted earnings per share as compared to $15.2 million, or $0.93 diluted earnings per share for the three months ended September 30, 2022, a decrease of $2.9 million. The decrease was largely due to a decrease in net interest income of $1.0 million, an increase in the provision for loan losses of $1.4 million and an increase in non-interest expense of $2.0 million, offset by a decrease in the provision for Income taxes of $1.7 million.

Nine months ended September 30, 2023, compared with nine months ended September 30, 2022: Net income allocable to common stockholders for the nine months ended September 30, 2023, was $36.1 million, or $2.30 diluted earnings per share as compared to $46.1 million, or $2.79 diluted earnings per share for the nine months ended September 30, 2022, a decrease of $10.0 million. The decrease was largely due to a decrease in net interest income of $1.2 million, a decrease in other income of $3.3 million, an increase in non-interest expense of $7.5 million, offset by a decrease in the provision for income taxes of $3.0 million.

Net Interest Income and Net Interest Margin Analysis

Net interest income is the difference between interest income on interest-earning assets, including loans and securities, and interest expense incurred on interest-bearing liabilities, including deposits and other borrowed funds. To evaluate net interest income, management measures and monitors (1) yields on loans and other interest-earning assets, (2) the costs of deposits and other funding sources, (3) the net interest spread, and (4) net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as net interest income divided by average interest-earning assets. Because non-interest-bearing sources of funds, such as non-interest-bearing deposits and stockholders’ equity also fund interest-earning assets, net interest margin includes the benefit of these non-interest-bearing sources of funds. Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a “volume change,” and is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a “yield/rate change.”

Three months ended September 30, 2023, compared with three months ended September 30, 2022: The following table shows the average balance of each principal category of assets, liabilities, and stockholders’ equity and the average yields on interest-earning assets and average rates on interest-bearing liabilities for the three months ended September 30, 2023, and 2022. The yields and rates are calculated by dividing annualized income or annualized expense by the average daily balances of the associated assets or liabilities.

Average Balance Sheets and Net Interest Analysis

(Dollars in thousands)

(1) Average loan balances include nonaccrual loans.

(2) Net interest margin is calculated by dividing annualized net interest income by average interest-earnings assets for the period.

(3) Tax exempt income is not included in the above table on a tax equivalent basis.

(4) Actual unrounded values are used to calculate the reported yield or rate disclosed. Accordingly, recalculations using the amounts in thousands as disclosed in this report may not produce the same amounts.

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest yields/rates. The following table analyzes the change in volume variances and yield/rate variances for the three month periods ended September 30, 2023, and 2022.

Analysis of Changes in Net Interest Income

For the Three Months Ended September 30, 2023, and 2022

(Dollars in thousands)

(1) The effect of changes in volume is determined by multiplying the change in volume by the previous year’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the prior year’s volume. The changes attributable to both volume and rate, which cannot be segregated, have been allocated to the volume variance and the rate variance in proportion to the relationship of the absolute dollar amount of the change in each.

Interest income increased $16.5 million for the quarter ended September 30, 2023, as compared to the quarter ended September 30, 2022. Of this increase, $12.7 million is attributable to increases in loan rate/yield. Yield on loans increased by 158 basis points for the quarter ended September 30, 2023, as compared quarter ended to September 30, 2022. The increase in interest income on loans is primarily due to higher yields on the entire loan portfolio, offset by decrease due to volume on commercial and industrial, commercial real estate, residential real estate and agricultural. Overall, the increase in interest income on interest earning assets is due to the increase in market interest rates.

Increase in interest expense of $17.4 million was due to a general increase in market interest rates and to a lesser extent an increase in volume on borrowing, primarily from the Federal Reserve Bank. The increase in the cost of interest-bearing deposits, from 0.57% for the quarter ended September 30, 2022 to 2.40% for the quarter ended September 30, 2023, was primarily the result the Federal Reserve raising the federal funds target rate in response to inflationary concerns.

During the quarter ended September 30, 2023, when compared to the quarter ended September 30, 2022, net interest margin decreased 11 basis points and net interest spread decreased by 47 basis points to 2.92% from 3.39%. The decrease in net interest margin is primarily due to the increase in yield earned on interest-earning asset, which was outpaced by increases in the cost of interest-bearing liabilities. The decrease in interest spread is primarily due to the increase in volume of interest bearing liabilities at current market rates.

Nine months ended September 30, 2023, compared with nine months ended September 30, 2022: The following table shows the average balance of each principal category of assets, liabilities, and stockholders’ equity and the average yields on interest-earning assets and average rates on interest-bearing liabilities for the nine months ended September 30, 2023, and 2022. The yields and rates are calculated by dividing annualized income or annualized expense by the average daily balances of the associated assets or liabilities.

Average Balance Sheets and Net Interest Analysis

(Dollars in thousands)

(1) Average loan balances include nonaccrual loans.

(2) Net interest margin is calculated by dividing annualized net interest income by average interest-earnings assets for the period.

(3) Tax exempt income is not included in the above table on a tax equivalent basis.

(4) Actual unrounded values are used to calculate the reported yield or rate disclosed. Accordingly, recalculations using the amounts in thousands as disclosed in this report may not produce the same amounts.

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest yields/rates. The following table analyzes the change in volume variances and yield/rate variances for the nine month periods ended September 30, 2023, and 2022.

Analysis of Changes in Net Interest Income

For the Nine Months Ended September 30, 2023, and 2022

(Dollars in thousands)

(1) The effect of changes in volume is determined by multiplying the change in volume by the previous year’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the prior year’s volume. The changes attributable to both volume and rate, which cannot be segregated, have been allocated to the volume variance and the rate variance in proportion to the relationship of the absolute dollar amount of the change in each.

Interest income on interest-earning assets increased $47.6 million for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. Of this increase, $37.7 million is attributable to increases in loan yields by 155 basis points for the nine months ended September 30, 2023, as compared to the nine months September 30, 2022. The increase in yields on interest-earning assets is due to the overall increase in market interest rates which is driven by the monetary policy of the Federal Reserve.

The increase in interest expense on total interest-bearing deposits of $42.1 million was due to a general increase in market interest rates. The increase in the cost of interest-bearing deposits increased from 0.36% for the nine months ended September 30, 2022 to 2.09% for the nine months ended September 30, 2023, was primarily the result the Federal Reserve raising federal funds target rate in response to inflationary concerns.

When compared to the nine months ended September 30, 2022, net interest margin decreased 2 basis points during the nine months ended September 30, 2023. Comparing the same periods, net interest spread decreased by 41 basis points to 2.89% from 3.30%. The decrease in both net interest margin and net interest spread can be attributed to the increase in yield on interest-earning assets being out paced by increases in the cost of interest-bearing liabilities.

Provision for Credit Losses

We maintain an allowance for credit losses for estimated losses in our loan portfolio. The allowance for credit losses is increased by a provision for credit losses, which is a charge to earnings, and subsequent recoveries of amounts previously charged-off, but is decreased by charge-offs when the collectability of a loan balance is unlikely. Management estimates the allowance balance required using past loan loss experience within the Company’s portfolio. This historical loss calculation is then modified to reflect quantitative economic circumstances based on evidenced economic conditions and regression formulas, which incorporate lag factors in identifying a sufficiently predictive adjusted-R square, as well as qualitative factors not inherently reflected in our historical loss or quantitative economic inputs. Included in our qualitative assessment is the consideration of prospective economic conditions over the next 12 months, considered the Company’s reasonable and supportable forecast period. As these factors change, the amount of the credit loss provision changes.

Three months ended September 30, 2023, compared with three months ended September 30, 2022: During the three months ended September 30, 2023, there was a provision for credit losses of $1.2 million compared to a reversal of provision for credit losses of $136 thousand during the three months ended September 30, 2022. The provision for the quarter is the result of extended duration within the portfolio as well as realized charge-offs; however, overall we continue to experience positive credit trends The Company continues to estimate the allowance for credit losses with assumptions that anticipate slowing prepayment rates and continued market disruption caused by elevated inflation, supply chain issues and the impact of monetary policy on consumers and businesses. Net charge-offs for both the three months ended September 30, 2023, and 2022, were $1.6 million. For the three months ended September 30, 2023, gross charge-offs were $1.7 million, offset by gross recoveries of $65 thousand. In comparison, gross charge-offs were $1.7 million for the three months ended September 30, 2022, offset by gross recoveries of $76 thousand.

Nine months ended September 30, 2023, compared with nine months ended September 30, 2022: During the nine months ended September 30, 2023, there was a provision for credit losses of $1.2 million compared to a provision of $276 thousand during the nine months ended September 30, 2022. The increase in the provision for the nine months ended September 30, 2023, is the result of an increase in realized charge-offs and extension of duration in the portfolio. Net charge-offs for the nine months ended September 30, 2023, were $2.8 million compared to net charge-offs of $2.1 million for the nine months ended September 30, 2022. For the nine months ended September 30, 2023, gross charge-offs were $3.4 million, offset by gross recoveries of $536 thousand. In comparison, gross charge-offs were $2.6 million for the nine months ended September 30, 2022, offset by gross recoveries of $453 thousand.

Non-Interest Income

The primary sources of non-interest income are service charges and fees, debit card income, mortgage banking income, and increases in the value of bank-owned life insurance. Non-interest income does not include loan origination or other loan fees, which are recognized as an adjustment to yield using the interest method.

Three months ended September 30, 2023, compared with three months ended September 30, 2022: The following table provides a comparison of the major components of non-interest income for the three months ended September 30, 2023, and 2022.

Non-Interest Income

For the Three Months Ended September 30,

(Dollars in thousands)

Total non-interest income decreased $234 thousand during the three months ended September 30, 2023, as compared to the same period in 2022. The decrease is largely attributable to decreases in recovery on zero-basis purchased loans of $127 thousand, service charges and fees of $98 thousand, debit card income of $91 thousand and mortgage banking income of $84 thousand. The decrease in mortgage banking income is due to decreased activity in held for sale mortgage portfolio primarily due to increases in mortgage interest rates. The increase in other non-interest income was primarily due to increases in loan repurchase obligation reversal which was partially offset by decreased gains from economic derivatives.

Nine months ended September 30, 2023, compared with nine months ended September 30, 2022: The following table provides a comparison of the major components of non-interest income for the nine months ended September 30, 2023, and 2022.

Non-Interest Income

For the Nine Months Ended September 30,

(Dollars in thousands)

Total non-interest income decreased $3.3 million during the nine months ended September 30, 2023, as compared to the same period in 2022. The decrease is largely attributable to $1.3 million net loss on the sale of available-for-sale securities, a $1.2 million decrease in other income and a $540 thousand gain on branch sale in 2022. The investment securities sold were lower yielding AFS securities and the proceeds from the sale were reinvested in higher yielding interest-earning assets and to paydown higher cost interest-bearing liabilities to enhance future earnings. The calculated earn-back is expected to be less than 12 months. The decrease in mortgage banking income is due to decreased activity in held for sale mortgage portfolio. The decrease in other non-interest income was primarily due to decreases in loan repurchase obligation reversal and reduced gains on economic derivatives.

Non-Interest Expense

Three months ended September 30, 2023, compared with three months ended September 30, 2022: For the three months ended September 30, 2023, non-interest expense totaled $34.2 million, an increase of $2.0 million, when compared to the three months ended September 30, 2022. Changes in the various components of non-interest expense for the three months ended September 30, 2023, and 2022, are discussed in more detail in the following table.

Non-Interest Expense

For the Three Months Ended September 30,

(Dollars in thousands)

Salaries and employee benefits: There was an increase in salaries and employee benefits of $415 thousand for the period ended September 30, 2023, as compared to the same period in 2022. The increase is primarily due to increases in employee salaries and employee insurance cost, off-set by decreases in share-based compensation expense. The decrease in share-based compensation is due to the reversal of share-based compensation expense associated with the departure of senior management team members.

Data processing: There was an increase in data processing costs of $415 thousand for the period ended September 30, 2023, as compared to the same period in 2022. The increase is primarily due to inflationary effects on data processing vendor contracts.

FDIC insurance: FDIC insurance costs increased $320 thousand for the period ended September 30, 2023, as compared to the same period in 2022. The increase was primarily due to an increase in FDIC assessment rates.

Advertising and business development: There was an increase in advertising and business development costs of $228 thousand for the period ended September 30, 2023, as compared to the same period in 2022. The increase was primarily driven by additional expense to attract new deposit customers.

Other: Other non-interest expenses consists of subscriptions, memberships and dues, employee expenses, including travel, meals, entertainment and education, supplies, printing, insurance, account related losses, correspondent bank fees, customer program expenses, losses net of gains on the sale of fixed assets, losses net of gains on the sale of repossessed assets other than real estate, other operating expenses, such as settlement of claims, losses from limited partnerships entered into for tax credits and provision for unfunded commitments. The increase in the other expense category includes a loss of $335 thousand on the disposal of other assets, an increase of $266 thousand of recruiting expenses, and an increase in travel related expenses of $130 thousand.

Nine months ended September 30, 2023, compared with nine months ended September 30, 2022: For the nine months ended September 30, 2023, non-interest expense totaled $100.6 million, an increase of $7.5 million, when compared to the nine months ended September 30, 2022. Changes in the various components of non-interest expense for the nine months ended September 30, 2023, and 2022, are discussed in more detail in the following table.

Non-Interest Expense

For the Nine Months Ended September 30,

(Dollars in thousands)

Salaries and employee benefits: There was a $1.9 million increase in salaries and employee benefits for the nine month period ended September 30, 2023, as compared to the same period in 2022. Salaries increased $2.1 million from September 30, 2022 and share-based compensation expense decreased by $505 thousand for the same period. The decrease in share-based compensation is due to the reversal of share-based compensation expense associated with the departure of senior management team members.

Data processing: There was an increase in data processing costs of $1.4 million for the nine month period ended September 30, 2023, as compared to the same period in 2022. The increase was primarily due to increases in data processing fees of $794 thousand, software license expenses of $259 thousand, credit card processing fees of $205 thousand, and debit card expenses of $200 thousand.

Professional fees: Costs of professional fees increased $794 thousand for the nine month period ended September 30, 2023, as compared to the same period in 2022. The increase was primarily due to increases in consulting fees of $636 thousand and attorney fees of $168 thousand.

FDIC insurance: FDIC insurance costs increased $755 thousand for the nine month period ended September 30, 2023, as compared to the same period in 2022. The increase was primarily due to an increase in FDIC assessment rates.

Advertising and business development: There was an increase in advertising and business development costs of $688 thousand for the nine month period ended September 30, 2023, as compared to the same period in 2022. The increase was primarily driven by additional expense to attract new deposit customers.

Other: Other non-interest expenses consists of subscriptions, memberships and dues, employee expenses, including travel, meals, entertainment and education, supplies, printing, insurance, account related losses, correspondent bank fees, customer program expenses, losses net of gains on the sale of fixed assets, losses net of gains on the sale of repossessed assets other than real estate, other operating expenses, such as settlement of claims, losses from limited partnerships entered into for tax credits and provision for unfunded commitments. In the other expense category, there was a net $3.0 million increase, or 29.8%, between the nine months ending September 30, 2023, and 2022. The increase was primarily due to additional amortization of solar tax credits of $1.0 million, $825 thousand increase in the estimated credit loss on unfunded commitments and an increase in travel related expenses $704 thousand.

Efficiency Ratio

The efficiency ratio is a supplemental financial measure utilized in the internal evaluation of performance and is not defined under GAAP. For a reconciliation of non-GAAP financial measures see “Non-GAAP Financial Measures” in this Item 2. Our efficiency ratio is computed by dividing non-interest expense, excluding merger expenses, by the sum of net interest income and non-interest income, excluding net gain or loss from securities transactions. Generally, an increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease would indicate a more efficient allocation of resources.

The efficiency ratio was 68.8% for the three months ended September 30, 2023, compared with 63.1% for the three months ended September 30, 2022. The increase was primarily due to an increase in non-interest expense as well as a decrease in net interest income.

The efficiency ratio was 69.3% for the nine months ended September 30, 2023, compared with 62.6% for the nine months ended September 30, 2022. The increase was primarily due to an increase in non-interest expense as well as a decrease in net interest income.

Income Taxes

In general, the Company records income tax expense each quarter based on its estimate as to the full year’s effective tax rate which includes, in addition to statutory rates, estimated amounts for tax-exempt interest income, non-taxable life insurance income, non-deductible executive compensation, valuation allowance on deferred assets, other non-deductible expense, and federal and state income tax credits anticipated to be available in proportion to anticipated annual income before income taxes. Certain items, however, are given discrete period treatment and the tax effects for such items are therefore reported in the quarter that an event arises. Events or items that may give rise to discrete recognition include excess tax benefits or shortfalls with respect to share-based compensation, changes in tax law, and non-deductible merger expense.

Three months ended September 30, 2023, compared with three months ended September 30, 2022: The effective income tax rate for the three month period ended September 30, 2023, was 13.5% as compared to 19.4% for the three month period ended September 30, 2022. Income tax expense for the three month period ended September 30, 2023, includes $4 thousand of tax benefit attributable to the settlement in stock of restricted stock units and the exercise of options and $476 thousand of benefit related to the recognition of federal tax credits net of related proportional amortization adjustments consistent with ASU 2023-02.

Nine months ended September 30, 2023, compared with nine months ended September 30, 2022: The effective income tax rate for the nine month period ended September 30, 2023, was 14.1% as compared to 16.2% for the nine month period ended September 30, 2022. Income tax expense for the nine month period ended September 30, 2023, includes $79 thousand of tax benefit attributable to the settlement in stock of restricted stock units and the exercise of options and $1.9 million of benefit related to the recognition of federal tax credits net of related proportional amortization adjustments consistent with ASU 2023-02.

Financial Condition

Total assets decreased $36.4 million from December 31, 2022, to $4.95 billion at September 30, 2023. This variance was primarily due to a decrease of available-for-sale securities of $127.4 and loans held for investment of $29.4 million, partially offset by an increase in cash and cash equivalents of $94.6 million. Total liabilities decreased $44.5 million to $4.53 billion at September 30, 2023. The change in total liabilities is mostly due to a decrease in total deposits of $159.6 million, partially offset by an increase in Federal Reserve Bank borrowings of $140.0 million. Total stockholders’ equity increased $8.0 million from $410.1 million at December 31, 2022, to $418.1 million at September 30, 2023, principally due to net income for the nine months ended September 30, 2023, offset by the increase in treasury stock and unrealized losses on available for sale securities, net of tax.

Loan Portfolio

The following table summarizes our loan portfolio by type of loan as of the dates indicated.

Composition of Loan Portfolio

(Dollars in thousands)

Our commercial loan portfolio consists of various types of loans, most of which are generally made to borrowers located in the Wichita, Kansas City, and Tulsa Metropolitan Statistical Areas (“MSAs”), as well as various community markets throughout Arkansas, Kansas, Missouri, and Oklahoma. The majority of our portfolio consists of commercial and industrial and commercial real estate loans, and a substantial portion of our borrowers’ ability to honor their obligations is dependent on local economies in which they operate.

At September 30, 2023, gross total loans, including loans held for sale, were 80.4% of deposits and 66.4% of total assets. At December 31, 2022, gross total loans, including loans held for sale, were 78.1% of deposits and 66.5% of total assets.

We provide commercial lines of credit, working capital loans, commercial real estate loans (including loans secured by owner-occupied commercial properties), term loans, equipment financing, aircraft financing, real property acquisition and development loans, borrowing base loans, real estate construction loans, homebuilder loans, SBA loans, agricultural and agricultural real estate loans, letters of credit and other loan products to national and regional companies, real estate developers, mortgage lenders, manufacturing and industrial companies and other businesses. The types of loans we make to consumers include residential real estate loans, home equity loans, home equity lines of credit, installment loans, unsecured and secured personal lines of credit, overdraft protection, and letters of credit.

Commercial and industrial: Commercial and industrial loans include loans used to purchase fixed assets, to provide working capital or meet other financing needs of the business.

Commercial real estate: Commercial real estate loans include all loans secured by nonfarm nonresidential properties and multifamily residential properties, as well as 1-4 family investment-purpose real estate loans.

Residential real estate: Residential real estate loans include loans secured by primary or secondary personal residences. Pools of mortgages are occasionally purchased to expand our loan portfolio and provide additional loan income.

Agricultural real estate, Agricultural, Consumer and other: Agricultural real estate loans are loans related to farmland. Agricultural loans are primarily operating lines subject to annual farming revenues including productivity/yield of the agricultural commodities produced. Consumer loans are generally secured by consumer assets but may be unsecured.

The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with predetermined interest rates and floating rates in each maturity range as of September 30, 2023, are summarized in the following table.

Loan Maturity and Sensitivity to Changes in Interest Rates

(Dollars in thousands)

The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with predetermined interest rates and floating rates in each maturity range as of December 31, 2022, are summarized in the following table.

Loan Maturity and Sensitivity to Changes in Interest Rates

(Dollars in thousands)

62

Credit Quality Indicators

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information, current economic trends, and other factors. Loans are analyzed individually and classified based on credit risk. Consumer loans are considered pass credits unless downgraded due to payment status or reviewed as part of a larger credit relationship.

For additional information, see “NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES” in the Condensed Notes to Interim Consolidated Financial Statements.

Nonperforming Assets

The following table presents information regarding nonperforming assets at the dates indicated.

Nonperforming Assets

(Dollars in thousands)

Generally, loans are designated as nonaccrual when either principal or interest payments are 90 days or more past due based on contractual terms, unless the loan is well secured and in the process of collection. Consumer loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual, or charged off, at an earlier date if collection of principal or interest is considered doubtful. When a loan is placed on nonaccrual status, unpaid interest credited to income earned in the current year is reversed against income and unpaid interest earned in prior years is charged off. Future interest income may be recorded on a cash basis after recovery of principal is reasonably assured. Nonaccrual loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The nonperforming loans at September 30, 2023, consisted of 219 separate credits and 188 separate borrowers. We had 4 non-performing loan relationships, totaling $7.5 million, with an outstanding balance in excess of $1.0 million as of September 30, 2023.

There are several procedures in place to assist us in maintaining the overall quality of our loan portfolio. We have established underwriting guidelines to be followed by lenders and we also monitor delinquency levels for any negative or adverse trends. In accordance with applicable regulation, appraisals or evaluations are required to independently value real estate and are an important element to consider when underwriting loans secured in part or in whole by real estate. The value of real estate collateral provides additional support to the borrower’s credit capacity. There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general economic conditions.

Potential Problem Loans

Potential problem loans consist of loans that are performing in accordance with contractual terms, but for which management has concerns about the borrower’s ability to comply with repayment terms because of the borrower’s potential financial difficulties. Potential problem loans are assigned a grade of special mention or substandard. At September 30, 2023, the Company had $14.5 million in potential problem loans which were not included in either non-accrual or 90 days past due categories, compared to $37.6 million at December 31, 2022.

With respect to potential problem loans, all monitored and under-performing loans are reviewed and evaluated to determine if they are impaired. If we determine that a loan is impaired, then we evaluate the borrower’s overall financial condition to determine the need, if any, for possible write downs or appropriate additions to the allowance for credit losses based on the unlikelihood of full repayment of principal and interest in accordance with the contractual terms or the net realizable value of the pledged collateral.

Allowance for Credit Losses

Please see “Critical Accounting Policies – Allowance for Credit Losses” for additional discussion of our allowance policy.

In connection with our review of the loan portfolio, risk elements attributable to particular loan types or categories are considered when assessing the quality of individual loans. Some of the risk elements include the following items.

• Commercial and industrial loans are dependent on the strength of the industries of the related borrowers and the success of their businesses. Commercial and industrial loans are advanced for equipment purchases, to provide working capital, or to meet other financing needs of the business. These loans may be secured by accounts receivable, inventory, equipment, or other business assets. Financial information is obtained from the borrower to evaluate the debt service coverage and ability to repay the loans.
• Commercial real estate loans are dependent on the industries tied to these loans as well as the local commercial real estate market. The loans are secured by the real estate, and appraisals are obtained to support the loan amount. An evaluation of the project’s cash flows is performed to evaluate the borrower’s ability to repay the loan at the time of origination and is periodically updated during the life of the loan.
• Residential real estate loans are affected by the local residential real estate market, the local economy, and movement in interest rates. We evaluate the borrower’s repayment ability through a review of credit reports and debt to income ratios. Appraisals are obtained to support the loan amount.
• Agricultural real estate loans are real estate loans related to farmland and are affected by the value of farmland. We evaluate the borrower’s ability to repay based on cash flows from farming operations.
• Agricultural loans are primarily operating lines subject to annual farming revenues including productivity/yield of the agricultural commodities produced and market pricing at the time of sale.
• Consumer loans are dependent on the local economy. Consumer loans are generally secured by consumer assets but may be unsecured. We evaluate the borrower’s repayment ability through a review of credit scores and an evaluation of debt to income ratios.

The following table presents, as of and for the periods indicated, an analysis of the allowance for credit losses and other related data.

Allowance for Credit Losses

For the Quarters Ended,

(Dollars in thousands)

(1) Excluding loans held for sale.

Management believes that the allowance for credit losses at September 30, 2023, was adequate to cover current expected credit losses in the loan portfolio as of such date. There can be no assurance, however, that we will not sustain losses in future periods, which could be substantial in relation to the size of the allowance at September 30, 2023.

The allowance for credit losses on loans measured on a collective basis totaled $39.8 million, or 1.2% of the $3.26 billion in loans measured on a collective basis at September 30, 2023, compared to an allowance for credit losses of $40.9 million, or 1.2%, of the $3.29 billion in loans measured on a collective basis at December 31, 2022. The total reserve percentage to total loans was 1.3% at September 30, 2023, and 1.4% at December 31, 2022.

Securities

We use our securities portfolio to provide a source of liquidity, to provide an appropriate return on funds invested, to manage interest rate risk, to meet pledging requirements and to meet regulatory capital requirements. At September 30, 2023, securities represented 21.4% of total assets, slightly decreasing from 23.8% at December 31, 2022.

At the date of purchase, debt securities are classified into one of two categories: held-to-maturity or available-for-sale. We do not purchase securities for trading purposes. At each reporting date, the appropriateness of the classification is reassessed. Investments in debt securities that are classified as held-to-maturity are carried at cost, and adjusted for the amortization of premiums and the accretion of discounts, only if management has the positive intent and ability to hold those securities to maturity. Debt securities that are not classified as held-to-maturity are classified as available-for-sale and are measured at fair value in the financial statements with unrealized gains and losses reported, net of tax, as accumulated comprehensive income or loss until realized. Interest earned on securities is included in total interest and dividend income. Also included in total interest and dividend income are dividends received on stock investments in the Federal Reserve Bank of Kansas City and the FHLB of Topeka. These stock investments are stated at cost.

The following table summarizes the amortized cost and fair value by classification of available-for-sale securities as of the dates shown.

Available-For-Sale Securities

(Dollars in thousands)

Held-To-Maturity Securities

(Dollars in thousands)

At September 30, 2023, and December 31, 2022, we did not own securities of any one issuer (other than the U.S. government and its agencies or sponsored entities) for which aggregate par value exceeded 10% of consolidated stockholders’ equity at the reporting dates noted.

The following tables summarize the contractual maturity of debt securities and their weighted average yields as of September 30, 2023, and December 31, 2022. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations, with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Available-for-sale securities are shown at fair value and held-to-maturity securities are shown at cost, adjusted for the amortization of premiums and the accretion of discounts.

(Dollars in thousands)

(1) The calculated yield is not presented on a tax equivalent basis.

(Dollars in thousands)

(1) The calculated yield is not presented on a tax equivalent basis.

Mortgage-backed securities are securities that have been developed by pooling a number of real estate mortgages which are principally issued by federal agencies such as Ginnie Mae, Fannie Mae, and Freddie Mac. Unlike U.S. Treasury and U.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Premiums and discounts on mortgage-backed securities are amortized and accreted over the expected life of the security and may be impacted by prepayments. As such, mortgage-backed securities which are purchased at a premium will generally produce decreasing net yields as interest rates drop because homeowners tend to refinance their mortgages, resulting in prepayments and an acceleration of premium amortization. Securities purchased at a discount will reflect higher net yields in a decreasing interest rate environment, as prepayments result in an acceleration of discount accretion.

The contractual maturity of mortgage-backed securities is not a reliable indicator of their expected lives because borrowers have the right to prepay their obligations at any time. Monthly pay downs on mortgage-backed securities cause the average lives of these securities to be much different than their stated lives. At September 30, 2023, and December 31, 2022, 59.6% and 62.1% of the residential mortgage-backed securities held by us had contractual final maturities of more than ten years, with a weighted average life of 5.2 years and 5.1 years and a modified duration of 4.4 years and 4.3 years.

Goodwill Impairment Assessment

At September 30, 2023, we performed an interim qualitative analysis and concluded there were no indications that goodwill was impaired.

Deposits

Our lending and investing activities are primarily funded by deposits. A variety of deposit accounts are offered with a wide range of interest rates and terms including demand, savings, money market, and time deposits. We rely primarily on competitive pricing policies, convenient locations, comprehensive marketing strategy, and personalized service to attract and retain these deposits.

The following table shows our composition of deposits at September 30, 2023, and December 31, 2022.

Composition of Deposits

(Dollars in thousands)

Total deposits at September 30, 2023, were $4.08 billion, an decrease of $159.6 million, or 3.8%, compared to total deposits of $4.24 billion at December 31, 2022.

Equity Bank participates in the Insured Cash Sweep (“ICS”) service that allows the Bank to break large non-time deposits into smaller amounts and place them in a network of other ICS banks to ensure FDIC insurance coverage on the entire deposit. These deposits are placed through ICS services, but are Equity Bank’s customer relationships that management views as core funding. The Bank also participates in the Certificate of Deposit Account Registry Service (“CDARS”) program. CDARS allows the bank to break large time deposits into smaller amounts and place them in a network of other CDARS banks to ensure FDIC insurance coverage on the entire deposit. Reciprocal deposits are not considered brokered deposits as long as the aggregate balance is less than the lesser of 20% of total liabilities or $5.0 billion and Equity Bank is well capitalized and well rated. All non-reciprocal deposits and reciprocal deposits in excess of regulatory limits are considered brokered deposits.

The following table lists reciprocal and brokered deposits included in total deposits categorized by type at September 30, 2023, and December 31, 2022.

(Dollars in thousands)

The following table provides information on the maturity distribution of time deposits of $250 thousand or more as of September 30, 2023, and December 31, 2022.

(Dollars in thousands)

Other Borrowed Funds

We utilize borrowings to supplement deposits to fund our lending and investing activities. Short-term borrowings and long-term borrowings include federal funds purchased and retail repurchase agreements, FHLB advances, Federal Reserve Bank borrowings, a bank stock loan, and subordinated debt. For additional information see “NOTE 6 – BORROWINGS” in the Condensed Notes to Interim Consolidated Financial Statement.

Liquidity and Capital Resources

Liquidity

Market and public confidence in our financial strength and financial institutions in general will largely determine access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital reserves.

Liquidity is defined as the ability to meet anticipated customer demands for future funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. We measure our liquidity position by considering both on and off-balance sheet sources of and demands for funds on a daily, weekly, and monthly basis.

Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations in a cost-effective manner and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, we focus on both assets and liabilities, and the way they combine to provide adequate liquidity to meet our needs. Recent issues in the banking sector that stem from the failures of several banks has caused banks to increase available liquidity sources and more closely monitor deposit runoff. Prior to the quarter ending March 31, 2023, Equity Bank pledged additional investments to the Federal Reserve Bank and borrowed $140 million under the Bank Term Funding Program as a precaution; however, the Company did not experience the same level of deposit runoff which, the Company believes, is due to the difference in the types of deposits being offered, deposit concentration and ALM management practices as compared to the recent failed financial institutions.

During the nine months ended September 30, 2023, and 2022, our liquidity needs have primarily been met by core deposits, security and loan maturities, and amortizing investment and loan portfolios. Other funding sources include federal funds purchased, brokered certificates of deposit, borrowings from the FHLB, and the Federal Reserve Bank borrowings.

Our largest sources of funds are deposits, Federal Reserve Bank borrowings and FHLB borrowings and largest uses of funds are loans, securities and debt repayment. Average loans were $3.31 billion for the nine months ended September 30, 2023, an increase of 2.3% over the December 31, 2022, average balance. Excess deposits are primarily invested in our interest-bearing deposit account with the Federal Reserve Bank of Kansas City, investment securities, federal funds sold or other short-term liquid investments until the funds are needed to fund loan growth. Our securities portfolio has a weighted average life of 5.2 years and a modified duration of 4.5 years at September 30, 2023.

Cash and cash equivalents were $199.0 million at September 30, 2023, an increase of $94.6 million from the $104.4 million cash and cash equivalents at December 31, 2022. The increase in cash and cash equivalents is driven by $120.6 million net cash provided by investing activities, $63.6 million net cash provided by operating activities, offset by $89.6 million net cash used in financing activities. The $89.6 million net change in cash provided by financing activities includes increases in FHLB term advances of $1.1 billion and federal reserve bank borrowings of $141.0 million, offset by net outflows of $966.1 million for paydown of FHLB term advances, $159.7 million in outflows for the decrease in deposits, $138.9 million outflow for net borrowings on the FHLB line of credit and $17.6 million outflow for the repurchase of treasury stock. Cash and cash equivalents at January 1, 2023, plus liquidity provided by operating activities, pay downs, sales, and maturities of investment securities, Federal Reserve Bank borrowings and FHLB borrowings during the first nine months of 2023 were used to originate or purchase loans and to purchase investment securities. We believe that our daily funding needs can be met through cash provided by operating activities, payments and maturities on loans and investment securities, the core deposit base and FHLB advances and other borrowing relationships.

Off-Balance-Sheet Items

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. Our exposure to credit loss is represented by the contractual amounts of these commitments. The same credit policies and procedures are used in making these commitments as for on-balance sheet instruments.

Standby and Performance Letters of Credit: For additional information see “NOTE 11 – COMMITMENTS AND CREDIT RISK” in the Condensed Notes to Interim Consolidated Financial Statement.

Commitments to Extend Credit: For additional information see “NOTE 11 – COMMITMENTS AND CREDIT RISK” in the Condensed Notes to Interim Consolidated Financial Statement.

Capital Resources

Capital management consists of providing equity to support our current and future operations. The federal bank regulators view capital levels as important indicators of an institution’s financial soundness. As a general matter, FDIC-insured depository institutions and their holding companies are required to maintain minimum capital relative to the amount and types of assets they hold. As a financial holding company and a state-chartered-Fed-member bank, the Company and Equity Bank are subject to regulatory capital requirements.

Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of September 30, 2023, and December 31, 2022, the Company and Equity Bank meet all capital adequacy requirements to which they are subject.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized; although, these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as are asset growth and acquisitions, and capital restoration plans are required.

Failure to meet capital guidelines could subject the institution to a variety of enforcement remedies by federal bank regulatory agencies, including termination of deposit insurance by the FDIC, restrictions on certain business activities and appointment of the FDIC as conservator or receiver. As of September 30, 2023, the most recent notifications from the federal regulatory agencies categorized Equity Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, Equity Bank must maintain minimum Total capital, Tier 1 capital, Common Equity Tier 1 capital, and Tier 1 leverage ratios. For additional information, see “NOTE 8 – REGULATORY MATTERS” in the Condensed Notes to Interim Consolidated Financial Statements. There are no conditions or events since that notification that management believes have changed Equity Bank’s category.

Non-GAAP Financial Measures

We identify certain financial measures discussed in this Quarterly Report as being “non-GAAP financial measures.” In accordance with SEC’s rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP in our statements of income, balance sheet or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios, or statistical measures calculated using exclusively either financial measures calculated in accordance with GAAP, operating measures or other measures that are not non-GAAP financial measures or both.

The non-GAAP financial measures that we discuss in this Quarterly Report should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the way we calculate the non-GAAP financial measures that we discuss in this Quarterly Report may differ from that of other companies reporting measures with similar names. You should understand how such other banking organizations calculate their financial measures similar to, or with names like, the non-GAAP financial measures we have discussed in this Quarterly Report when comparing such non-GAAP financial measures.

Tangible Book Value Per Common Share and Tangible Book Value Per Diluted Common Share: Tangible book value is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate: (a) tangible common equity as total stockholders’ equity less preferred stock, goodwill, core deposit intangibles (net of accumulated amortization), and other intangible assets (net of accumulated amortization); (b) tangible book value per common share as tangible common equity (as described in clause (a)) divided by shares of common stock outstanding; and (c) tangible book value per diluted common share as tangible common equity (as described in clause (a)) divided by diluted shares of common stock outstanding. For tangible book value, the most directly comparable financial measure calculated in accordance with GAAP is book value.

Management believes that these measures are important to many investors who are interested in changes from period to period in book value per common share exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing total book value while not increasing our tangible book value.

The following table reconciles, as of the dates set forth below, total stockholders’ equity to tangible common equity, tangible book value per common share, and tangible book value per diluted common share and compares these values with book value per common share.

(Dollars in thousands, except per share data)

Tangible Common Equity to Tangible Assets: Tangible common equity to tangible assets is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate (a) tangible common equity as total stockholders’ equity less preferred stock, goodwill, core deposit intangibles (net of accumulated amortization), and other intangible assets (net of accumulated amortization); (b) tangible assets as total assets less goodwill, core deposit intangibles (net of accumulated amortization), and other intangible assets (net of accumulated amortization); and (c) tangible common equity to tangible assets as tangible common equity (as described in clause (a)) divided by tangible assets (as described in clause (b)). For tangible common equity to tangible assets, the most directly comparable financial measure calculated in accordance with GAAP is total stockholders’ equity to total assets.

Management believes that this measure is important to many investors in the marketplace who are interested in the relative changes from period to period in common equity and total assets, each exclusive of changes in intangible assets. Goodwill and other intangible assets have the effect of increasing both total stockholders’ equity and total assets while not increasing tangible common equity or tangible assets.

The following table reconciles, as of the dates set forth below, total stockholders’ equity to tangible common equity and total assets to tangible assets.

(Dollars in thousands)

Return on Average Tangible Common Equity: Return on average tangible common equity is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate (a) average tangible common equity as total average stockholders’ equity less average goodwill, core deposit intangibles (net of accumulated amortization), and other intangible assets (net of accumulated amortization); (b) adjusted net income allocable to common stockholders as net income allocable to common stockholders plus intangible asset amortization (net of taxes); and (c) return on average tangible common equity as annualized adjusted net income allocable to common stockholders (as described in clause (b)) divided by average tangible common equity (as described in clause (a)). For return on average tangible common equity, the most directly comparable financial measure calculated in accordance with GAAP is return on average equity.

Management believes that this measure is important to many investors in the marketplace who are interested in earnings quality on tangible common equity. Goodwill and other intangible assets have the effect of increasing total stockholders’ equity while not increasing tangible common equity.

The following table reconciles, as of the dates set forth below, return on average stockholders’ equity and return on average tangible common equity.

(Dollars in thousands)

Efficiency Ratio: The efficiency ratio is a non-GAAP measure generally used by financial analysts and investment bankers to evaluate financial institutions. We calculate the efficiency ratio by dividing non-interest expense, excluding merger expenses, by the sum of net interest income and non-interest income, excluding net gain on acquisition and branch sales, and net gain (loss) from securities transactions. The GAAP-based efficiency ratio is non-interest expense divided by net interest income plus non-interest income.

In management’s judgment, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess operating expenses in relation to operating revenue by removing merger expenses, net gain (loss) from securities transactions, and net gain in acquisition and branch sales.

The following table reconciles, as of the dates set forth below, the efficiency ratio to the GAAP-based efficiency ratio.

(Dollars in thousands)

Our asset-liability policy provides guidelines for effective funds management and management has established a measurement system for monitoring net interest rate sensitivity position within established guidelines.

As a financial institution, the primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short-term maturity. Interest rate risk is the potential of economic gains or losses due to future interest rate changes. These changes can be reflected in future net interest income and/or fair market values. The objective is to measure the effect on net interest income (“NII”) and economic value of equity (“EVE”) and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.

We manage interest rate exposure by structuring the balance sheet in the ordinary course of business. We have the ability to enter into instruments such as leveraged derivatives, interest rate swaps, financial options, financial futures contracts or forward delivery contracts for the purpose of reducing interest rate risk. Currently, we do not have a material exposure to these instruments. We also have the ability to enter into interest rate swaps as an accommodation to our customers in connection with an interest rate swap program. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.

Our exposure to interest rate risk is managed by the Asset Liability Committee (“ALCO”), which is composed of certain members of senior management, in accordance with policies approved by the Board of Directors. ALCO formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, ALCO considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. ALCO meets monthly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, securities purchased and sale activities, commitments to originate loans and the maturities of investment securities and borrowings. Additionally, the ALCO reviews liquidity, projected cash flows, maturities of deposits and consumer and commercial deposit activity.

ALCO uses a simulation analysis to monitor and manage the pricing and maturity of assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on net interest income. The simulation tests the sensitivity of NII and EVE. Contractual maturities and repricing opportunities of loans are incorporated in the simulation model as are prepayment assumptions, maturity data and call options within the investment securities portfolio. Assumptions based on past experience are incorporated into the model for non-maturity deposit accounts. All assumptions are as of the base period without consideration of preceding market rate changes and any lag in impact to NII. The depicted expectations are management's estimate exclusive of any non-contractual lagging impacts that have not yet been realized in income from preceding changes to interest rates. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure the future NII and EVE. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.

The change in the impact of net interest income from the base case for September 30, 2023, and December 31, 2022, was primarily driven by the rate and mix of variable and fixed rate financial instruments, the underlying duration of the financial instruments and the level of response to changes in the interest rate environment.

The increase in the level of positive impact to net interest income in the up interest rate shock scenarios is due to the level of adjustable rate loans receivable that will reprice to higher interest rates, non-term deposits that will adjust to higher rates but at a slower pace, the use of derivatives to hedge borrowing costs, reduced levels of fixed rate investments, reduced duration of asset based cash flow hedges, and elevated levels of cash on the balance sheet compared to December 31, 2022. These factors result in the positive impacts to net interest income in the up interest rate shock scenarios that are detailed in the table below. In the down interest rate shock scenario, the main drivers of the negative impact on net interest income are the downward pricing of variable rate loans receivable and the level of term deposit repricing; and the assumed prepayment and scheduled repayment of existing fixed rate loans receivable and fixed rate investments. These factors result in the negative impact to net interest income in the down interest rate shock scenario.

The change in the economic value of equity from the base case for September 30, 2023, and December 31, 2022 is due to being in a liability sensitive position and the level of convexity in our pre-payable assets. Generally, with a liability sensitive position, as interest rates increase, the value of your assets decrease faster than the value of liabilities and, as interest rates decrease, the value of your assets increase at a faster rate than liabilities. Due to the level of convexity in our fixed rate pre-payable assets, we do not experience a similar change in the value of assets in a down interest rate shock scenario; however, due to the current level of convexity in our fixed rate pre-payable assets becoming less negative and positive, in some cases, on a portion of or portfolio has resulted in the overall value of assets increasing more than liabilities. In addition, the mix of interest-bearing deposit and non-interest-bearing deposits impact the level of deposit decay and the resulting benefit of discounting from the non-interest-bearing deposits. At September 30, 2023, non-interest-bearing deposits were approximately $161.7 million, or 14.73%, lower than that deposit type at December 31, 2022. Substantially all investments and approximately 42.5% of loans are prepayable and fixed rate and as rates decrease the level of modeled prepayments increase. The prepaid principal is assumed to reprice at the assumed current rates, resulting in a smaller positive impact to the economic value of equity.

Management utilizes static balance sheet rate shocks to estimate the potential impact on various rate scenarios. This analysis estimates a percentage of change in the metric from the stable rate base scenario versus alternative scenarios of rising and falling market interest rates by instantaneously shocking a static balance sheet. The following table summarizes the simulated immediate change in net interest income for twelve months as of the dates indicated.

Market Risk

The following table summarizes the simulated immediate impact on economic value of equity as of the dates indicated.

Evaluation of disclosure controls and procedures

An evaluation of the effectiveness of the design and operation of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and management was required to apply judgment in evaluating its controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified by the SEC rules and forms.

Changes in internal control over financial reporting

There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Other than the risk factors set forth below, there have been no material changes in the Company’s risk factors previously disclosed in our Annual Report on Form 10-K filed with the SEC on March 9, 2023.

Recent negative developments affecting the banking industry, and resulting media coverage, have eroded customer confidence in the banking system.

The recent high-profile bank failures involving Silicon Valley Bank, Signature Bank and First Republic Bank have generated significant market volatility among publicly traded bank holding companies and, in particular, regional banks like Equity Bank. These market developments have negatively impacted customer confidence in the safety and soundness of regional banks. As a result, customers may choose to maintain deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact Equity Bank's liquidity, loan funding capacity, net interest margin, capital and results of operations. While the Department of the Treasury, the Federal Reserve, and the FDIC have made statements ensuring that depositors of these recently failed banks would have access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in regional banks and the banking system more broadly.

Any regulatory examination scrutiny or new regulatory requirements arising from the recent events in the banking industry could increase the Company’s expenses and affect the Company’s operations.

The Company and Equity Bank anticipate increased regulatory scrutiny and new regulations directed towards banks of similar size to the Bank, designed to address the recent negative developments in the banking industry, all of which may increase the Company’s costs of doing business and reduce its profitability. Among other things, there may be an increased focus by both regulators and investors on deposit composition and the level of uninsured deposits. As a result, the Bank could face increased scrutiny or be viewed as higher risk by regulators and the investor community. Equity Bank's level of uninsured deposits as a percentage of non-brokered deposits was 36.4% at September 30, 2023, and 25.3% at December 31, 2022.