Enterprise Financial Services Corp: Form 10-Q for the period ended Sep 30, 2024

RESULTS OF OPERATIONS

Forward Looking Statements

This Quarterly Report on Form 10-Q contains information and statements that are considered “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company, and include, without limitation, statements about the Company’s plans, strategies, goals, objectives, expectations, or consequences of statements about the future performance, operations, products and services of the Company and its subsidiaries, as well as statements about the Company’s expectations regarding revenue and asset growth, financial performance and profitability, loan and deposit growth, yields and returns, loan diversification and credit management, products and services, shareholder value creation and the impact of acquisitions. Forward-looking statements are typically identified with the use of terms such as “may,” “might,” “will,” “would,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “could,” “continue,” “intend,” and the negative and other variations of these terms and similar words and expressions, although some forward-looking statements may be expressed differently. Forward-looking statements are inherently subject to risks and uncertainties and our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. You should be aware that our actual results could differ materially from those contained in the forward-looking statements.

While there is no assurance that any list of risks and uncertainties or risk factors is complete, important factors that could cause actual results to differ materially from those in the forward-looking statements include the following, without limitation: our ability to efficiently integrate acquisitions into our operations, retain the customers of these businesses and grow the acquired operations; credit risk; changes in the appraised valuation of real estate securing impaired loans; our ability to recover our investment in loans; fluctuations in the fair value of collateral underlying loans; outcomes of litigation and other contingencies; exposure to general and local economic and market conditions, including risk of recession, high unemployment rates, higher inflation and its impacts (including U.S. federal government measures to address higher inflation), U.S. fiscal debt, budget and tax matters, and any slowdown in global economic growth; risks associated with rapid increases or decreases in prevailing interest rates; changes in business prospects that could impact goodwill estimates and assumptions; consolidation within the banking industry; competition from banks and other financial institutions; the ability to attract and retain relationship officers and other key personnel; burdens imposed by federal and state regulation; changes in legislative or regulatory requirements, as well as current, pending or future legislation or regulation that could have a negative effect on our revenue and business, including rules and regulations relating to bank products and financial services; changes in accounting policies and practices or accounting standards; natural disasters; terrorist activities, war and geopolitical matters (including the war in Israel and potential for a broader regional conflict and the war in Ukraine and the imposition of additional sanctions and export controls in connection therewith), or pandemics, or other health emergencies and their effects on economic and business environments in which we operate, including the related disruption to the financial market and other economic activity; and other risks discussed under the caption “Risk Factors” under Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2023, and other reports filed with the SEC, all of which could cause the Company’s actual results to differ from those set forth in the forward-looking statements. The Company cautions that the preceding list is not exhaustive of all possible risk factors and other factors could also adversely affect the Company’s results.

Readers are cautioned not to place undue reliance on our forward-looking statements, which reflect management’s analysis and expectations only as of the date of such statements. Forward-looking statements speak only as of the date they are made, and the Company does not intend, and undertakes no obligation, to publicly revise or update forward-looking statements after the date of this report, whether as a result of new information, future events or otherwise, except as required by federal securities law. You should understand that it is not possible to predict or identify all risk factors. Readers should carefully review all disclosures we file from time to time with the SEC which are available on our website at www.enterprisebank.com (http://www.enterprisebank.com) under “Investor Relations.”

Introduction

The following discussion describes the significant changes to the financial condition of the Company that have occurred during the first nine months of 2024 compared to the financial condition as of December 31, 2023. In addition, this discussion summarizes the significant factors affecting the results of operations of the Company for the three months ended September 30, 2024, compared to the linked second quarter of 2024 (“linked quarter”) and the results of operations, liquidity and cash flows for the nine months ended September 30, 2024 compared to the same period in 2023 (“prior year-to-date period”). In light of the nature of the Company’s business, the Company’s management believes that the comparison to the linked quarter is the most relevant to understand the financial results from management’s perspective. For purposes of the Quarterly Report on Form 10-Q, the Company is presenting a comparison to the corresponding prior year-to-date period. This discussion should be read in conjunction with the accompanying condensed consolidated financial statements included in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2023.

Critical Accounting Policies and Estimates

The Company’s critical accounting policies are considered important to the understanding of the Company’s financial condition and results of operations. These accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experience. If different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected.

A full description of our critical accounting policies and the impact and any associated risks related to those policies on our business operations are discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2023.

The Company has prepared all of the consolidated financial information in this report in accordance with GAAP. The Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Such estimates include the valuation of loans, goodwill, intangible assets, and other long-lived assets, along with assumptions used in the calculation of income taxes, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using loss experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statement in future periods. There can be no assurances that actual results will not differ from those estimates.

Allowance for Credit Losses on Loans

The Company maintains separate allowances for funded loans, unfunded loans, and held-to-maturity securities, collectively referred to as the ACL. The ACL is a valuation account to adjust the cost basis to the amount expected to be collected, based on management’s experience, current conditions, and reasonable and supportable forecasts. For purposes of determining the allowance for funded and unfunded loans, the portfolios are segregated into pools that share similar risk characteristics and are then further segregated by credit grades. Loans that do not share similar risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. The Company estimates the amount of the allowance based on loan loss experience, adjusted for current and forecasted economic conditions, including unemployment, changes in GDP, and commercial and residential real estate prices. The Company’s forecast of economic conditions uses internal and external information and considers a weighted average of a baseline, upside, and downside scenarios. Because economic conditions can change and are difficult to predict, the anticipated amount of estimated loan defaults and losses, and therefore the adequacy of the allowance, could change significantly and have a direct impact on the Company’s credit costs. The Company’s allowance for credit losses on loans was $139.8 million at September 30, 2024 based on the weighting of the different economic scenarios. As a hypothetical example, if the Company had only used the upside scenario, the allowance would have decreased $26.5 million. Conversely, the allowance would have increased $45.8 million using only the downside scenario.

Executive Summary

Below are highlights of the Company’s financial performance for the periods indicated.

($ in thousands, except per share data)

36

Financial results and other notable items include:

• PPNR1 of $65.1 million for the third quarter 2024 and $185.7 million for the nine months ended September 30, 2024 increased $1.8 million and decreased $23.3 million from the linked quarter and prior year-to-date period, respectively. The increase from the linked quarter was primarily due to higher noninterest income and higher net interest income that benefited from an increase in average earning assets. The increase in noninterest income was primarily from tax credit income, a net gain on the sale of other real estate owned and an increase in income on community development investments. The increase in operating revenue was partially offset by an increase in noninterest expense, primarily deposit services costs and employee compensation and benefits. The decrease compared to the prior year-to-date period was primarily due to the higher interest rate environment that increased deposit interest expense and the cost of deposit services charges, as well as an increase in employee compensation and benefits.
• Net interest income of $143.5 million for the third quarter 2024 and $421.7 million for the nine months ended September 30, 2024 increased $2.9 million and decreased $0.1 million from the linked and prior year-to-date period, respectively. The NIM was 4.17% for both the third quarter 2024 and the nine months ended September 30, 2024, compared to 4.19% and 4.50% for the linked and prior year-to-date period, respectively. Compared to the linked quarter, the increase in net interest income reflects the benefit of organic growth and an additional day in the quarter. The decrease from the prior year-to-date period reflects higher interest expense on the deposit portfolio, as lagged deposit rates have increased, partially offset by the benefit of higher market interest rates. In late September 2024, the Federal Reserve reduced the federal funds target rate by 50 basis points. In response, the Company has adjusted deposit pricing to partially mitigate the impact on income from the repricing of variable rate loans.
• Noninterest income of $21.4 million for the third quarter 2024 and $49.1 million for the nine months ended September 30, 2024 increased $5.9 million and $5.8 million from the linked quarter and prior year-to-date period, respectively. The increase from the linked quarter and prior year-to-date period was primarily due to an increase in tax credit income, a net gain on the sale of other real estate and an increase in income on community development investments.
• Noninterest expense of $98.0 million for the third quarter 2024 and $285.5 million for the nine months ended September 30, 2024 increased $4.0 million and $29.9 million from the linked quarter and prior year-to-date period, respectively. The increase from the linked quarter was primarily driven by higher deposit costs ($2.1 million), employee compensation ($0.8 million) and expenses related to the core system conversion ($0.1 million). The increase from the prior year-to-date period was primarily due to deposit servicing costs ($15.1 million) employee compensation ($10.2 million), and expenses related to the core system conversion ($3.0 million).

Balance sheet highlights:

• Loans – Total loans increased $195.8 million, or 1.80%, to $11.1 billion at September 30, 2024, compared to $10.9 billion at December 31, 2023. Average loans totaled $11.0 billion for the nine months ended September 30, 2024 compared to $10.2 billion for the nine months ended September 30, 2023.
• Deposits – Total deposits increased $289.0 million, to $12.5 billion at September 30, 2024 from $12.2 billion at December 31, 2023. Total estimated insured deposits1, which includes collateralized deposits, reciprocal deposits and accounts that qualify for pass through insurance, totaled $8.8 billion at September 30, 2024, compared to $8.3 billion at December 31, 2023. Average deposits totaled $12.4 billion for the nine months ended September 30, 2024 compared to $11.4 billion for the prior year-to-date period. Noninterest-bearing deposit accounts represented 31.6% of total deposits and the loan to deposit ratio was 88.9% at September 30, 2024, compared to 32.5% and 89.4%, respectively, at December 31, 2023.
• Asset quality – The allowance for credit losses on loans to total loans was 1.26% at September 30, 2024, compared to 1.24% at December 31, 2023. The ratio of nonperforming assets to total assets was 0.22% at September 30, 2024 compared to 0.34% at December 31, 2023. A provision for credit losses of $4.1 million and $14.7 million was recorded in the third quarter of 2024 and the nine months ended September 30, 2024, respectively. This compares to $4.8 million in the linked quarter and $18.6 million in the prior year-to-date period.
• Shareholders’ equity – Total shareholders’ equity was $1.83 billion at September 30, 2024, compared to $1.72 billion at December 31, 2023, and the tangible common equity to tangible assets ratio2 was 9.50% at September 30, 2024 compared to 8.96% at December 31, 2023. The Company and the Bank’s regulatory capital ratios exceeded the “well-capitalized” levels at September 30, 2024.

The Company’s board of directors approved a quarterly dividend of $0.28 per common share, payable on December 31, 2024 to shareholders of record as of December 16, 2024. The board of directors also declared a cash dividend of $12.50 per share of Series A Preferred Stock (or $0.3125 per depositary share) representing a 5% per annum rate for the period commencing (and including) September 15, 2024 to (but excluding) December 15, 2024. The dividend will be payable on December 15, 2024 and will be paid on December 16, 2024 to holders of record of Series A Preferred Stock as of November 29, 2024.

1 PPNR and total estimated insured deposits are non-GAAP measures. Refer to discussion and reconciliation of these measures in the accompanying financial tables.

2 Tangible common equity to tangible assets ratio is a non-GAAP measure. Refer to discussion and reconciliation of this measure in the accompanying financial tables.

RESULTS OF OPERATIONS

Net Interest Income and Net Interest Margin

Average Balance Sheet

The following tables present, for the periods indicated, certain information related to our average interest-earning assets and interest-bearing liabilities, as well as the corresponding interest rates earned and paid, all on a tax equivalent basis.

($ in thousands)

39

($ in thousands)

40

Rate/Volume

The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume.

($ in thousands)

1 Change in volume multiplied by yield/rate of prior period.

2 Change in yield/rate multiplied by volume of prior period.

3 Nontaxable income is presented on a tax equivalent basis.

NOTE: The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Net interest income on a tax equivalent basis of $145.6 million for the quarter ended September 30, 2024 and $427.9 million for the nine months ended September 30, 2024, increased $3.0 million and decreased $0.1 million from the linked and prior year-to-date period, respectively. The increase from the linked quarter was primarily due to higher interest-earning asset balances and an extra day in the quarter. This increase was partially offset by an increase in cost and average interest-bearing deposit balances. The decrease from the prior year-to-date period reflects higher interest expense on the deposit portfolio, as lagged deposit rates have increased. The effective federal funds rate for the current quarter was 5.27%, a decrease of 6 basis points compared to the linked quarter. The effective federal funds rate for the first nine months of 2024 was 5.31%, an increase of 38 basis points compared to the prior year-to-date period.

Compared to the linked quarter, tax equivalent interest income increased $4.7 million primarily due to a $193.2 million increase in all average interest earning balances, including loans, securities and interest-earning cash accounts. Interest on securities increased $1.4 million from the linked quarter due to a $77.5 million increase in average balances, and a 5 basis point increase in yield.

Tax equivalent interest income increased $77.8 million over the prior year-to-date period due to a $64.2 million increase in loan interest and a $13.6 million increase in interest on securities and interest-earning cash. Loan yields in the first nine months of 2024 increased 32 basis points to 6.92%, compared to 6.60% in the prior year-to-date period. Average loans increased $750.8 million, or 7.36% over the prior year-to-date period. Average securities increased $137.2 million, or 6.0% over the prior year-to-date period.

Compared to the linked quarter, interest expense increased $1.7 million primarily due to an increase in interest expense on money market accounts. Average money market balances increased $116.8 million in the third quarter 2024. The average cost of interest-bearing deposits was 3.22%, an increase of 3 basis points compared to the linked quarter. The total cost of deposits, including noninterest-bearing demand accounts, was 2.18% during the third quarter 2024, compared to 2.16% in the linked quarter. While the total cost of deposits increased over the linked quarter, the monthly cost of total deposits has been relatively stable since March 2024.

Interest expense increased $78.0 million over the prior year-to-date period, primarily due to the higher rate environment and organic growth in deposit balances. The average cost of interest-bearing deposits increased 94 basis points year-over-year. The total cost of deposits, including noninterest-bearing demand accounts, was 2.16% during the nine months ended September 30, 2024, compared to 1.42% during the prior year-to-date period.

NIM, on a tax equivalent basis, was 4.17% in the third quarter 2024 and the first nine months of 2024, a decrease of 2 basis points and 33 basis points from the linked and prior year-to-date period, respectively.

Noninterest Income

The following table presents a comparative summary of the major components of noninterest income for the periods indicated.

($ in thousands)

Total noninterest income for the third quarter 2024 was $21.4 million, an increase of $5.9 million from the linked quarter. The increase from the linked quarter was primarily due to an increase in tax credit income from a positive change in credits carried at fair value, and a net gain on the sale of other real estate owned that is included in Other income. Tax credit income varies based on transaction volumes and fair value changes on credits carried at fair value.

Total noninterest income for the nine months ended September 30, 2024 was $49.1 million, an increase from the prior year-to-date period of $5.8 million which was primarily due to increases in tax credit income ($3.4 million), deposit service charges ($1.4 million), and other income ($0.7 million). Other income for the nine months ended September 30, 2024 increased compared to the prior year-to-date period primarily due to a net gain on the sale of other real estate owned ($3.0 million), partially offset by a lower level of income on community development investments ($0.9 million) which are not a consistent source of income and fluctuate based on distributions from the underlying funds.

Noninterest Expense

The following table presents a comparative summary of the major components of noninterest expense for the periods indicated.

($ in thousands)

Noninterest expense was $98.0 million for the third quarter 2024, an increase of $4.0 million from $94.0 million in the linked quarter. Employee compensation and benefits increased $0.8 million from the linked quarter primarily due to an increase in the number of work days in the quarter and the success in recruiting new relationship bankers. Deposit costs relate to certain deposit accounts that receive an earnings credit allowance for expenses related to the maintenance of the deposit accounts. These expenses are impacted by interest rates and average balances. Deposit costs increased $2.1 million from the linked quarter primarily due to an increase of $151.6 million in average deposit vertical balances from the linked quarter. Expenses related to the core system conversion included in Data processing for the current and linked quarters were $1.4 million and $1.3 million, respectively, due to the continued progress on the project.

Total noninterest expense of $285.5 million for the first nine months of 2024 increased $29.9 million from the prior year-to-date period, primarily due to an increase in the associate base, merit increases throughout 2023 and 2024, and a $15.1 million increase in variable deposit costs due to higher earnings credit rates and average balances.

Income Taxes

The Company’s effective tax rate was 19.4% for the third quarter 2024 and 20.0% for the nine months ended September 30, 2024. This compares to the linked quarter and prior year-to-date effective tax rate of 20.5% and 21.7%, respectively. The decreases from the linked and prior year-to-date effective tax rates were driven by tax credit opportunities the Company has deployed as part of its tax planning strategy.

3 Core efficiency ratio is a non-GAAP measure. Refer to discussion and reconciliation of this measure in the accompanying financial tables.

Summary Balance Sheet

($ in thousands)

Total assets were $15.0 billion at September 30, 2024, an increase of $435.5 million from December 31, 2023 primarily due to a $195.8 million increase in loans and a $269.7 million increase in investment securities. Total liabilities of $13.1 billion increased $319.6 million from December 31, 2023 primarily due to a $289.0 million increase in deposits.

Investment Securities

Investment securities were $2.6 billion or 18% of total assets at September 30, 2024. At December 31, 2023, investment securities were $2.4 billion or 16% of total assets. The portfolio is comprised of both available-for-sale and held-to-maturity securities.

The table below sets forth the carrying value of investment securities, excluding the allowance for credit losses:

($ in thousands)

($ in thousands)

Investment purchases in the third quarter 2024 had a weighted average, tax equivalent yield of 4.97%. The average duration of the investment portfolio was 4.9 years at September 30, 2024. The Company leverages the investment portfolio to lengthen the overall duration of the balance sheet, primarily using high-quality municipal securities. The expected cash flow from pay downs, maturities and interest over the next 12 months is approximately $434.5 million.

Loans by Type

The Company has a diversified loan portfolio, with no particular concentration of credit in any one economic sector; however, a substantial portion of the portfolio, including the C&I category, is secured by real estate. The ability of the Company’s borrowers to honor their contractual obligations is partially dependent upon the local economy and its effect on the real estate market.

The following table sets forth the composition of the loan portfolio by type of loans

($ in thousands)

Loans totaled $11.1 billion at September 30, 2024 compared to $10.9 billion at December 31, 2023. The increase was primarily due to an increase of $135.9 million in construction loans and an increase of $111.6 million in CRE loans, partially offset by a decrease in C&I loans of $44.1 million. Average revolving line draw utilization was 44% for the third quarter 2024, compared to 43% for the year ended December 31, 2023.

The following table provides additional information on certain categories of loans that are included in total loans above:

($ in thousands)

These lending categories, including sponsor finance, life insurance premium financing, and tax credits, consist primarily of C&I loans. Sponsor finance and life insurance premium financing loans are sourced through relationships developed with private equity funds and estate planning firms and are not bound geographically by our markets. These loan products offer opportunities to expand and diversify geographically by entering new markets. The Company continues to focus on originating high-quality C&I relationships, as they typically have variable interest rates and allow for cross selling opportunities involving other banking products. Life insurance premium financing and tax credits are typically lower risk products due to the high collateral value securing the loans.

SBA loans are also generated on a national basis, and primarily consist of loans collateralized by first lien, owner-occupied real estate properties. These loans predominantly have a 75% guarantee from the SBA. The Company may sell the guaranteed portion of the loan and retain servicing rights, and in the first quarter 2024, SBA loans totaling $23.1 million were sold.

Provision and Allowance for Credit Losses

The following table presents the components of the provision for credit losses:

($ in thousands)

The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the ACL on loans at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. The Company also records reversals of interest on nonaccrual loans and interest recoveries directly through the provision of credit losses.

A provision for credit losses of $4.1 million for the third quarter 2024 and $14.7 million for the nine months ended September 30, 2024, decreased $0.7 million and $3.9 million from the linked quarter and prior year-to-date period, respectively. The provision for credit losses in the third quarter 2024 was primarily related to charge-offs and updates to qualitative factors used in the allowance calculation.The provision for credit losses for the nine months ended September 30, 2024 declined primarily due to a $5.1 million decrease in the provision for available-for-sale securities related to the impairment of an investment security in the prior year-to-date period.

The following table summarizes the allocation of the ACL on loans:

($ in thousands)

The ACL on loans was 1.26% of total loans at September 30, 2024, compared to 1.24% of loans at December 31, 2023. The decrease in the ratio of ACL on loans to total loans is primarily due to loan growth and charge-offs. Excluding guaranteed loans, the ACL on loans to total loans was 1.38%4 at September 30, 2024, compared to 1.35% at December 31, 2023.

4 ACL on loans to total loans adjusted for guaranteed loans is a non-GAAP measure. Refer to discussion and reconciliation of this measure in the accompanying financial tables.

The following table is a summary of net charge-offs (recoveries) to average loans for the periods indicated:

($ in thousands)

(1) Excludes loans held for sale.

(2) Annualized.

($ in thousands)

To the extent the Company does not recognize charge-offs and economic forecasts improve in future periods, the Company could recognize provision reversals. Conversely, if economic conditions and the Company’s forecast worsens and charge-offs increase, the Company could recognize elevated levels of provision for credit losses. The provision is also reflective of charge-offs (recoveries) in the period.

Nonperforming assets

The following table presents the categories of nonperforming assets and other ratios, excluding government guaranteed portions, as of the dates indicated.

($ in thousands)

Nonperforming loans based on loan type were as follows:

($ in thousands)

The following table summarizes the changes in nonperforming loans:

($ in thousands)

Nonperforming loans at September 30, 2024 decreased $15.4 million, or 35%, when compared to December 31, 2023. The decrease in nonperforming loans during the nine months ended September 30, 2024 was primarily due to gross charge-offs and the positive resolution and repayment of certain nonperforming loans.

Other real estate

The following table summarizes the changes in other real estate:

($ in thousands)

Deposits

The following table shows the breakdown of deposits by type:

($ in thousands)

The following table shows the average balance and average rate of the Company’s deposits by type:

($ in thousands)

49

($ in thousands)

Total deposits excluding brokered certificates of deposits were $12.0 billion at September 30, 2024, an increase of $290.8 million from December 31, 2023. The Company has deposit verticals focusing on property management, community associations, and escrow industries. These deposits increased to $3.1 billion at September 30, 2024 from $2.8 billion at December 31, 2023 due to continued success at generating organic deposit growth.

To provide customers a deposit product with enhanced FDIC insurance, the Company participates in several programs through third parties that provide full FDIC insurance on deposit amounts by exchanging or reciprocating larger depository relationships with other member banks. Total reciprocal deposits were $1.2 billion at both September 30, 2024 and December 31, 2023. The Company considers reciprocal accounts as customer-related deposits due to the customer relationship that generated the transaction.

At September 30, 2024, estimated uninsured/uncollateralized deposits totaled $3.7 billion, or 30% of total deposits, compared to $3.8 billion, or 31% of total deposits, at December 31, 2023.

The total cost of deposits was 2.18% for the current quarter, compared to 2.16% for the linked quarter. For the nine months ended September 30, 2024, the total cost of deposits was 2.16%, compared to 1.42% in the prior year-to-date period.

Shareholders’ Equity

Shareholders’ equity totaled $1.8 billion at September 30, 2024, an increase of $115.9 million from December 31, 2023. Significant activity during the first nine months of 2024 was as follows:

• Increase from net income of $136.4 million,
• Increase in fair value of securities and cash flow hedges of $22.2 million,
• Decrease from dividends paid on common and preferred stock of $32.0 million, and
• Decrease from common stock repurchases of $18.4 million.

Liquidity and Capital Resources

Liquidity

The objective of liquidity management is to ensure we have the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to meet our commitments as they become due. Typical demands on liquidity are changes in deposit levels, maturing time deposits which are not renewed, and fundings under credit commitments to customers. Funds are available from a number of sources, such as the core deposit base and loan and security repayments and maturities.

Additionally, liquidity is provided from lines of credit with the FHLB, the Federal Reserve Bank, and correspondent banks; the ability to acquire large and brokered deposits, sales of the securities portfolio, and the ability to sell loans or loan participations to other banks. These alternatives are an important part of our liquidity plan and provide flexibility and efficient execution of the asset-liability management strategy.

The Company’s Asset-Liability Management Committee oversees our liquidity position, the parameters of which are approved by the Bank’s Board of Directors. Our liquidity position is monitored daily. Our liquidity management framework includes measurement of several key elements, such as the loan to deposit ratio, a liquidity ratio, and a dependency ratio. The Company’s liquidity framework also incorporates contingency planning to assess the nature and volatility of funding sources and to determine alternatives to these sources. While core deposits and loan and investment repayments are principal sources of liquidity, funding diversification is another key element of liquidity management and is achieved by strategically varying depositor types, terms, funding markets, and instruments.

Liquidity from assets is available primarily from cash balances and the investment portfolio. Cash and interest-bearing deposits with other banks totaled $426.4 million at September 30, 2024 and $433.0 million at December 31, 2023. Investment securities are another important tool in liquidity planning. Securities totaled $2.6 billion and $2.4 billion at September 30, 2024 and December 31, 2023, respectively and included $1.2 billion and $1.6 billion at September 30, 2024 and December 31, 2023, respectively, pledged as collateral for deposits of public institutions, loan notes and other requirements. The unpledged portion of the securities portfolio could be pledged or sold to enhance liquidity, if necessary. The Company also has a portfolio of SBA guaranteed loans, a portion of which could be sold in the secondary market to generate earnings and liquidity.

Available on- and off-balance sheet liquidity sources include the following items:

($ in thousands)

51

Liability liquidity funding sources are available to increase financial flexibility. In addition to amounts borrowed at September 30, 2024, the Company could borrow an additional $1.2 billion from the FHLB of Des Moines under blanket loan pledges and has additional real estate loans that could be pledged. In the first nine months of 2024, the Company pledged additional loans to the FHLB to increase the borrowing capacity by $334.6 million. The Company also has $2.6 billion available from the Federal Reserve Bank under a pledged loan agreement. In the first quarter 2024, the Federal Reserve Bank borrowing capacity declined due to the expiration of the Bank Term Funding Program on March 11, 2024. The Company also has unsecured federal funds lines with seven correspondent banks totaling $140 million.

In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity. The Company has $2.9 billion in unused commitments to extend credit as of September 30, 2024. However, the nature of these commitments is such that the likelihood of funding them in the aggregate at any one time is low.

At the holding company level, the primary funding sources are dividends and payments from the Bank and proceeds from the issuance of equity (i.e. stock option exercises, stock offerings) and debt instruments. The main use of this liquidity is to provide the funds necessary to pay dividends to shareholders, service debt, invest in subsidiaries as necessary, repurchase common stock and satisfy other operating requirements. The holding company maintains a revolving line of credit for an aggregate amount up to $25 million, all of which was available at September 30, 2024. The line of credit has a one-year term and was renewed in February 2024 for an additional one-year term. The proceeds can be used for general corporate purposes.

The Company has an effective automatic shelf registration statement on Form S-3 allowing for the issuance of various forms of equity and debt securities. The Company’s ability to offer securities pursuant to the registration statement depends on market conditions and the Company’s continuing eligibility to use the Form S-3 under rules of the SEC.

Strong capital ratios, credit quality and core earnings are essential to retaining cost-effective access to the wholesale funding markets. Deterioration in any of these factors could have a negative impact on the Company’s ability to access these funding sources and, as a result, these factors are monitored on an ongoing basis as part of the liquidity management process. The Bank is subject to regulations and, among other things, may be limited in its ability to pay dividends or transfer funds to the parent company. Accordingly, consolidated cash flows as presented in the consolidated statements of cash flows may not represent cash immediately available for the payment of cash dividends to the Company’s shareholders or for other cash needs.

Through the normal course of operations, the Company has entered into certain contractual obligations and other commitments. Such obligations relate to funding operations through deposits or debt issuances, as well as leases for premises and equipment. As a financial services provider, the Company routinely enters into commitments to extend credit. While contractual obligations represent future cash requirements of the Company, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans made by the Company. The Company also enters into derivative contracts under which the Company either receives cash from or pays cash to counterparties depending on changes in interest rates. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. The fair value of these contracts changes daily as market interest rates change.

Capital Resources

The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its bank affiliate must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The banking affiliate’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total, Tier 1, and common equity tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. To be categorized as “well capitalized”, banks must maintain minimum total risk-based (10%), Tier 1 risk-based (8%), common equity tier 1 risk-based (6.5%), and Tier 1 leverage ratios (5%). In addition, the Company must maintain an additional CCB above the regulatory minimum ratio requirements. The CCB is designed to insulate banks from periods of stress and impose constraints on dividends, share repurchases and discretionary bonus payments when capital levels fall below prescribed levels. As of September 30, 2024, and December 31, 2023, the Company and the Bank met all capital adequacy requirements to which they are subject and exceeded the amounts required to be “well capitalized”.

The following table summarizes the Company’s various capital ratios:

($ in thousands)

The Company believes the tangible common equity ratio is an important measure of capital strength, even though it is considered a non-GAAP measure. A reconciliation has been included in this section under the caption “Use of Non-GAAP Financial Measures.”

Use of Non-GAAP Financial Measures:

The Company’s accounting and reporting policies conform to generally accepted accounting principles in the United States (“GAAP”) and the prevailing practices in the banking industry. However, the Company provides additional financial measures, such as tangible common equity, adjusted ROAA, adjusted return on average common equity, ROATCE, adjusted ROATCE, ACL on loans to total loans adjusted for guaranteed loans, core efficiency ratio, PPNR, estimated insured deposits, tangible book value per common share and the tangible common equity ratio, in this report that are considered “non-GAAP financial measures.” Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position, or cash flows that exclude (or include) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP.

The Company considers its tangible common equity, adjusted ROAA, adjusted return on average common equity, ROATCE, adjusted ROATCE, ACL on loans to total loans adjusted for guaranteed loans, core efficiency ratio, PPNR, estimated insured deposits, tangible book value per common share and the tangible common equity ratio, collectively “core performance measures,” presented in this report and the included tables as important measures of financial performance, even though they are non-GAAP measures, as they provide supplemental information by which to evaluate the impact of certain non-comparable items, and the Company’s operating performance on an ongoing basis. Core performance measures exclude certain other income and expense items, such as the FDIC special assessment, core conversion expenses, merger-related expenses, facilities charges, the gain or loss on the sale of other real estate owned, and the gain or loss on sale of investment securities, that the Company believes to be not indicative of or useful to measure the Company’s operating performance on an ongoing basis. The attached tables contain a reconciliation of these core performance measures to the GAAP measures. The Company believes that the tangible common equity ratio provides useful information to investors about the Company’s capital strength even though it is considered to be a non-GAAP financial measure and is not part of the regulatory capital requirements to which the Company is subject.

The Company believes these non-GAAP measures and ratios, when taken together with the corresponding GAAP measures and ratios, provide meaningful supplemental information regarding the Company’s performance and capital strength. The Company’s management uses, and believes that investors benefit from referring to, these non-GAAP measures and ratios in assessing the Company’s operating results and related trends and when forecasting future periods. However, these non-GAAP measures and ratios should be considered in addition to, and not as a substitute for or preferable to, ratios prepared in accordance with GAAP. In the attached tables, the Company has provided a reconciliation of, where applicable, the most comparable GAAP financial measures and ratios to the non-GAAP financial measures and ratios, or a reconciliation of the non-GAAP calculation of the financial measures for the periods indicated.

Core Efficiency Ratio

($ in thousands)

54

Tangible Common Equity, Tangible Book Value per Share, and Tangible Common Equity Ratio

(in thousands, except per share data)

ACL on Loans to Total Loans Adjusted for Guaranteed Loans

($ in thousands)

Pre-Provision Net Revenue (PPNR)

($ in thousands)

55

Return on Average Common Equity, Return on Average Tangible Common Equity (ROATCE) and Return on Average Assets (ROAA)

($ in thousands)

Calculation of Estimated Insured Deposits

($ in thousands)

56

The disclosures set forth in this item are qualified by the cautionary language regarding forward-looking statements in the introduction to Item 2 of Part I of this Quarterly Report on Form 10-Q and other cautionary statements set forth elsewhere in this report.

Interest Rate Risk

Our interest rate risk management practices are aimed at optimizing net interest income, while guarding against deterioration that could be caused by certain interest rate scenarios. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. We attempt to maintain interest-earning assets, comprised primarily of both loans and investments, and interest-bearing liabilities, comprised primarily of deposits, maturing or repricing in similar time horizons in order to manage any impact from market interest rate changes according to our risk tolerances. The Company uses a simulation model to measure the sensitivity to changing rates on earnings.

The Company determines the sensitivity of its short-term future earnings to a hypothetical plus or minus 100 to 300 basis point parallel rate shock through the use of simulation modeling. The simulation includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate-sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project net interest income based on a hypothetical change in interest rates. The resulting net interest income for the next 12-month period is compared to the baseline amounts calculated using flat rates. The difference represents the Company’s sensitivity to a positive or negative 100 basis points parallel rate shock.

The following table summarizes the expected impact of interest rate shocks on net interest income at September 30, 2024:

The Company occasionally uses interest rate derivative instruments as an asset/liability management tool to hedge mismatches in interest rate exposure indicated by the net interest income simulation described above. They are used to modify the Company’s exposures to interest rate fluctuations and provide more stable spreads between loan yields and the rate on their funding sources. At September 30, 2024, the Company had derivative contracts to manage interest rate risk, including $350.0 million in notional value on derivatives to hedge the cash flows on floating rate loans and $32.1 million in notional value on derivative on floating rate debt. Derivative financial instruments are also discussed in “Item 1. Note 6 – Derivative Financial Instruments.”

As of September 30, 2024, the Financial Conduct Authority has ceased publishing the most common USD LIBOR settings (overnight, 1-month. 3-month, 6-month and 12-month). LIBOR was the most liquid and common interest rate index in the world and was commonly referenced in financial instruments. With the cessation of LIBOR, the Company has selected term SOFR as the replacement index for the majority of its variable rate loans and began providing customer notifications in early 2023. The Company ceased using LIBOR and ICE swap rates in new contracts and began issuing SOFR based loans in December 2021.

The Company had $6.7 billion in variable rate loans at September 30, 2024. Of these loans, $4.5 billion have an interest rate floor and nearly all of those loans were at or above the floor. Variable rate loans include $2.8 billion indexed to the prime rate, $3.1 billion indexed to SOFR, and $806.6 million indexed to other rates.

At September 30, 2024, the Company’s available-for-sale and held-to-maturity investment securities totaled $1.8 billion and $851.6 million, respectively. These portfolios consist primarily of fixed-rate securities that are subject to changes in market value due to changes in interest rates. At September 30, 2024, net unrealized losses were $122.2 million and $46.4 million on the available-for-sale and held-to-maturity investment portfolios, respectively.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of the Company’s Chief Executive Officer (the “CEO”) and the Chief Financial Officer (the “CFO”), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15, as of September 30, 2024. Disclosure controls and procedures include without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, 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, the CEO and CFO concluded the Company’s disclosure controls and procedures were effective as of September 30, 2024 to provide reasonable assurance of the achievement of the objectives described above.

Changes to Internal Controls

There were no changes during the period covered by this Quarterly Report on Form 10-Q in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, those controls.

For information regarding risk factors affecting the Company, please see the cautionary language regarding forward-looking statements in the introduction to Item 2 of Part I of this Quarterly Report on Form 10-Q, and Part I, Item 1A of our Report on Form 10-K for the fiscal year ended December 31, 2023. There have been no material changes to the risk factors described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023.