Western Alliance Bancorporation: Form 10-Q for the period ended Sep 30, 2023

This discussion is designed to provide insight into management's assessment of significant trends related to the Company's consolidated financial condition, results of operations, liquidity, capital resources, and interest rate sensitivity. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2022 and the interim Unaudited Consolidated Financial Statements and Notes to Unaudited Consolidated Financial Statements hereto and financial information appearing elsewhere in this report. Unless the context requires otherwise, the terms "Company," "we," and "our" refer to Western Alliance Bancorporation and its wholly-owned subsidiaries on a consolidated basis.

Forward-Looking Information

Certain statements contained in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2023 are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, including without limitation, statements regarding our expectations with respect to our business, financial and operating results, including our deposits, liquidity and funding, changes in economic conditions and the related impact on the Company's business, and statements that are related to or are dependent on estimates or assumptions relating to expectations, beliefs, projections, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts.

The forward-looking statements contained in this Form 10-Q reflect the Company's current views about future events and financial performance and involve certain risks, uncertainties, assumptions, and changes in circumstances that may cause the Company's actual results to differ significantly from historical results and those expressed in any forward-looking statement. Risks and uncertainties include those set forth in the Company's filings with the SEC and the following factors that could cause actual results to differ materially from those presented: 1) adverse financial market and economic conditions, including the effects of any recession in the United States, the impact of the bank failures that occurred earlier in 2023 and related adverse developments in the banking industry, the potential impact on borrowers of supply chain disruptions and the economic and market impacts of the military conflicts in Ukraine and the Middle East; 2) changes in interest rates and increased rate competition; 3) exposure of financial instruments to certain market risks that may increase the volatility of earnings and AOCI; 4) the inherent risk associated with accounting estimates, including the impact to the allowance, provision for credit losses, and capital levels; 5) exposure to natural and man-made disasters in markets that we operate and the impact of climate change and ESG practices on us and our customers; 6) the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts, geopolitical conflicts or public health events (such as the COVID-19 pandemic), and of governmental and societal responses thereto; 7) dependency on real estate and events that negatively impact the real estate market; 8) concentrations in certain business lines or product types within our loan portfolio; 9) residual risk retained by us on reference pools covered by credit linked notes; 10) exposure to environmental liabilities related to the properties to which we acquire title; 11) ability to compete in a highly competitive market; 12) expansion strategies through acquisitions or implementation of new lines of business or new products and services that may not be successful; 13) uncertainty associated with digital payment initiatives; 14) ability to recruit and retain qualified employees and implement adequate succession planning to mitigate the loss of key members of our senior management team; 15) ability to meet capital adequacy and liquidity requirements; 16) dependence on low-cost deposits; 17) risks related to representations and warranties made on third-party loan sales; 18) ability to borrow from the FHLB or the FRB; 19) a change in our creditworthiness; 20) information security breaches; 21) reliance on third parties to provide key components of our infrastructure; 22) perpetration of fraud; 23) ability to implement and improve our controls and processes to keep pace with growth; 24) the replacement of LIBOR; 25) risk of operating in a highly regulated industry and our ability to remain in compliance; 26) ability to adapt to technological change; 27) failure to comply with state and federal banking agency laws and regulations; 28) results of any tax audit findings, challenges to our tax positions, or adverse changes or interpretations of tax laws; and 29) risks related to ownership and price of our common stock; and 30) ability to continue to declare quarterly dividends.

For more information regarding risks that may cause the Company's actual results to differ materially from any forward-looking statements, see “Risk Factors” in Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2022 and “Risk Factors” in Part II, Item 1A of this Form 10-Q. All forward-looking statements that are made or attributable to us are expressly qualified in their entirety by this cautionary notice. The forward-looking statements included herein are only made as of the date of this Form 10-Q. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Recent Banking Industry and Market Developments

The bank failures that occurred in early 2023 caused significant disruption in the United States banking industry, particularly among mid-sized banks, such as the Company. The closures of these banks triggered a surge in deposit outflows and stock price volatility at many mid-sized banks.

In response to these bank failures, the FRB announced the BTFP, which offers loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral valued at par. Under this program, the Bank has access to $1.3 billion in borrowing capacity. During the first quarter of 2023, the Company drew $1.3 billion from the BTFP, all of which was outstanding at September 30, 2023.

Additionally, the Department of the Treasury, FRB, and FDIC issued a joint statement, which stated that losses to support uninsured deposits of those failed banks would be recovered via a special assessment on banks. The FDIC has proposed an annual special assessment rate of approximately 12.5 basis points. The assessment base for the special assessments would be equal to an institution’s estimated uninsured deposits as of December 31, 2022, adjusted to exclude the first $5 billion from estimated uninsured deposits. The special assessments would be collected over an eight-quarter collection period, at a quarterly special assessment rate of 3.13 basis points, with the first quarterly assessment period beginning on January 1, 2024. The comment period for the proposal ended on July 21, 2023, with a final rule expected later this year. If adopted as proposed, the Company expects to recognize a one-time charge of $62 million.

The recent volatility in the banking industry and other recent regulatory actions have had and may continue to have a material impact on the Company's operations, as further discussed below.

Capital and liquidity

While the Company believes it has sufficient capital, funding, and access to contingent sources of liquidity, the Company has taken several actions to ensure the strength of its capital and liquidity position. These actions included disposition of selected assets, including $821 million of AFS securities and $4.3 billion of loans during the nine months ended September 30, 2023 and increasing its borrowing capacity with the FRB.

The Company's deposit balances stabilized as of March 20, 2023 and from such date through September 30, 2023 deposits increased, and were up $643 million from December 31, 2022. The Company also strengthened its insured deposit ratio from 45% as of December 31, 2022 to 77% as of September 30, 2023. Insured and collateralized deposits as a percentage of total deposits was 82% at September 30, 2023 and 47% at December 31, 2022.

Financial position and results of operations

The Company's financial position and results of operations as of and for the nine months ended September 30, 2023 have been impacted by this disruption. Recent events in the banking industry contributed to the $53.3 million provision for credit losses recognized during the nine months ended September 30, 2023, of which $17.1 million related to a charge-off of a corporate debt security from a financial institution issuer. The Company's actions to strengthen its capital and liquidity position contributed to a $117.3 million pre-tax fair value loss adjustment primarily related to the transfer of loans to HFS, a loss of $26.0 million on sales of investment securities, and a $13.4 million gain on extinguishment of debt. The continued uncertainty regarding the severity and duration of the volatility in the banking industry and related economic effects may continue to affect the Company’s estimate of its allowance for credit losses and resulting provision for credit losses. To the extent the impact of the recent banking industry volatility is prolonged and economic conditions worsen or persist longer than forecast, such estimates may be insufficient and may change significantly in the future. The Company’s net interest margin also may be negatively impacted in future periods if the Company's borrowings remain elevated. These uncertainties and the economic environment will continue to affect earnings, growth, and may result in deterioration of asset quality in the Company's loan and investment portfolios.

Depositors in the technology industry were generally considered to be the most impacted by these adverse events and may have greater sensitivity to the recent volatility in the banking industry with potentially longer recovery periods than other types of businesses. The Company's deposit exposure to the technology industry totaled $4.1 billion, or 7.6% of total deposits, as of September 30, 2023.

Asset valuation

Sustained declines in the Company's stock price and/or other liquidity related impacts, such as increases in deposit outflows, could give rise to triggering events in the future that could result in a write-down in the value of our goodwill, which could have a material adverse impact on our results of operations.

Financial Overview and Highlights

WAL is a bank holding company headquartered in Phoenix, Arizona, incorporated under the laws of the state of Delaware. WAL provides a full spectrum of customized loan, deposit and treasury management capabilities, including 24/7 funds transfer and other digital payment offerings through its wholly-owned banking subsidiary, WAB.

WAB operates the following full-service banking divisions: ABA, BON and FIB, Bridge, and TPB. The Company also provides an array of specialized financial services across the country, including mortgage banking services through AmeriHome and digital payment services for the class action legal industry through DST.

Financial Results Highlights for the Third Quarter of 2023

• Net income available to common stockholders of $213.4 million, compared to $260.8 million for the third quarter 2022
• Diluted earnings per share of $1.97, compared to $2.42 per share for the third quarter 2022
• Net revenue of $716.2 million, compared to $663.9 million for the third quarter 2022, with non-interest expense of $426.2 million, compared to $305.8 million for the third quarter 2022
• PPNR of $290.0 million, down 19.0% from $358.1 million in the third quarter 20221
• Total loans HFI of $49.4 billion, down $2.4 billion, or 4.7%, from December 31, 2022
• Total deposits of $54.3 billion, up $643 million, or 1.2%, from December 31, 2022
• Stockholders' equity of $5.7 billion, an increase of $390 million from December 31, 2022
• Nonperforming assets (nonaccrual loans and repossessed assets) increased to 0.35% of total assets compared to 0.15% at September 30, 2022
• Annualized net loan charge-offs (recoveries) to average loans outstanding of 0.07%, compared to (0.02)% for the third quarter 2022
• Net interest margin of 3.67%, decreased from 3.78% in the third quarter 2022
• Tangible common equity ratio of 6.8%, an increase compared to 5.9% at September 30, 20221
• Book value per common share of $49.78, an increase of 14.7% from $43.39 at September 30, 2022
• Tangible book value per share, net of tax, of $43.66, an increase of $6.50, or 17.5%, from $37.16 at September 30, 20221
• Efficiency ratio of 58.8% in the third quarter 2023, compared to 45.5% in the third quarter 20221

The impact to the Company from these items, and others of both a positive and negative nature, are discussed in more detail below as they pertain to the Company’s overall comparative performance for the three and nine months ended September 30, 2023.

1 See Non-GAAP Financial Measures section beginning on page 64.

As a bank holding company, management focuses on key ratios in evaluating the Company's financial condition and results of operations.

Results of Operations and Financial Condition

A summary of the Company's results of operations, financial condition, and selected metrics are included in the following tables:

(in millions, except per share amounts)

(1) See Non-GAAP Financial Measures section beginning on page 64.

(in millions)

(1) See Non-GAAP Financial Measures section beginning on page 64.

For all banks and bank holding companies, asset quality plays a significant role in the overall financial condition of the institution and results of operations. The Company measures asset quality in terms of nonaccrual loans as a percentage of gross loans and net charge-offs as a percentage of average loans. Net charge-offs are calculated as the difference between charged-off loans and recovery payments received on previously charged-off loans. The following table summarizes the Company's key asset quality metrics for loans HFI:

(dollars in millions)

(1) Annualized on an actual/actual basis for the three months ended September 30, 2023. Actual year-to-date for the year ended December 31, 2022.

Asset and Deposit Growth

The Company’s assets and liabilities are comprised primarily of loans and deposits. Therefore, the ability to originate new loans and attract new deposits is fundamental to the Company’s growth.

Total assets increased to $70.9 billion at September 30, 2023 from $67.7 billion at December 31, 2022. The increase in total assets of $3.2 billion, or 4.7%, was driven by an increase in borrowings, which contributed to an increase in investment securities of $2.7 billion and an increase in cash of $2.5 billion. Loans HFI decreased by $2.4 billion, or 4.7%, to $49.4 billion as of September 30, 2023, compared to $51.9 billion as of December 31, 2022. The decrease in loans HFI from December 31, 2022 was driven by the transfer of $6.0 billion of loans HFI to HFS during the first quarter 2023. The Company completed loan dispositions from this transferred loan pool totaling $4.3 billion through September 30, 2023 and transferred all remaining HFS loans back to HFI at the end of the period as a result of a change in management's intentions. By loan type, commercial and industrial loans and residential real estate loans decreased $2.4 billion and $1.1 billion, respectively, from December 31, 2022, partially offset by increases in construction and land development loans and CRE, non-owner occupied loans of $656 million and $491 million, respectively. Loans HFS were up $582 million from $1.2 billion as of December 31, 2022 due to an increase in non-EBO loans.

Total deposits increased $643 million, or 1.2%, to $54.3 billion as of September 30, 2023 from $53.6 billion as of December 31, 2022. By type, the increase in deposits from December 31, 2022 was driven by an increase of $3.7 billion in certificates of deposit and $3.3 billion in interest bearing demand deposits, partially offset by decreases of $4.7 billion in savings and money market accounts and $1.7 billion in non-interest bearing demand deposits.

RESULTS OF OPERATIONS

The following table sets forth a summary financial overview:

(in millions, except per share amounts)

63

Non-GAAP Financial Measures

The following discussion and analysis contains financial information determined by methods other than those prescribed by GAAP. The Company's management uses these non-GAAP financial measures in their analysis of the Company's performance. Management believes presentation of these non-GAAP financial measures provides useful supplemental information that is essential to a complete understanding of the operating results of the Company. Since the presentation of these non-GAAP performance measures and their impact differ between companies, these non-GAAP disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

Pre-Provision Net Revenue

Banking regulations define PPNR as the sum of net interest income and non-interest income less expenses before adjusting for loss provisions. Management believes that this is an important metric as it illustrates the underlying performance of the Company, it enables investors and others to assess the Company's ability to generate capital to cover credit losses through the credit cycle, and provides consistent reporting with a key metric used by bank regulatory agencies.

The following table shows the components used in the calculation of PPNR:

(in millions)

Efficiency Ratio

The following table shows the components used in the calculation of the efficiency ratio, which management uses as a metric for assessing cost efficiency:

(dollars in millions)

64

Earnings Per Share, Adjusted

The Company's earnings for the three months ended March 31, 2023 were impacted by significant non-operating losses that were incurred as a result of actions undertaken by the Company to reposition its balance sheet to ensure the strength of its capital and liquidity position in response to the bank failures in early 2023. The following table shows the components used in the calculation of earnings per share for the nine months ended September 30, 2023, adjusted to exclude non-operating items, which management believes is more comparable to historical earnings trends:

(in millions)

65

Tangible Common Equity and Return on Average Tangible Common Equity

The following tables present financial measures related to tangible common equity. Tangible common equity represents total stockholders' equity reduced by goodwill and intangible assets and preferred stock. Management believes that tangible common equity financial measures are useful in evaluating the Company's capital strength, financial condition, and ability to manage potential losses.

(dollars and shares in millions)

(dollars in millions)

(1) Using adjusted net income available to common stockholders of $660.8 million, return on average tangible common equity was 18.7% for the nine months ended September 30, 2023.

Regulatory Capital

The following table presents certain financial measures related to regulatory capital under Basel III, which includes CET1 and total capital. The FRB and other banking regulators use CET1 and total capital as a basis for assessing a bank's capital adequacy; therefore, management believes it is useful to assess financial condition and capital adequacy using this same basis. Specifically, the total capital ratio takes into consideration the risk levels of assets and off-balance sheet financial instruments. In addition, management believes that the classified assets to CET1 plus allowance measure is an important regulatory metric for assessing asset quality.

As permitted by the regulatory capital rules, the Company elected to delay the estimated impact of CECL on its regulatory capital over a five-year transition period ending December 31, 2024. Accordingly, capital ratios and amounts for 2022 include a 25% reduction to the capital benefit that resulted from the increased ACL related to the adoption of ASC 326, which has increased to include a 50% reduction beginning in 2023.

(dollars in millions)

67

Net Interest Margin

The net interest margin is reported on a TEB. A tax equivalent adjustment is added to reflect interest earned on certain securities and loans that are exempt from federal and state income tax. The following tables set forth the average balances, interest income, interest expense, and average yield (on a fully TEB) for the periods indicated:

(dollars in millions)

(1) Yields on loans and securities have been adjusted to a TEB. The taxable-equivalent adjustment was $8.9 million and $8.5 million for the three months ended September 30, 2023 and 2022, respectively.

(2) Included in the yield computation are net loan fees of $28.0 million and $31.9 million for the three months ended September 30, 2023 and 2022, respectively.

(3) Includes non-accrual loans.

(4) Net interest margin is computed by dividing net interest income by total average earning assets, annualized on an actual/actual basis.

(dollars in millions)

(1) Yields on loans and securities have been adjusted to a TEB. The taxable-equivalent adjustment was $26.4 million and $24.7 million for the nine months ended September 30, 2023 and 2022, respectively.

(2) Included in the yield computation are net loan fees of $100.4 million and $97.4 million for the nine months ended September 30, 2023 and 2022, respectively.

(3) Includes non-accrual loans.

(4) Net interest margin is computed by dividing net interest income by total average earning assets, annualized on an actual/actual basis.

(in millions)

(1) Changes attributable to both volume and rate are designated as volume changes.

Comparison of interest income, interest expense and net interest margin

The Company's primary source of revenue is interest income. For the three months ended September 30, 2023, interest income was $1.0 billion, an increase of $287.2 million, or 38.8%, compared to $739.4 million for the three months ended September 30, 2022. This increase was primarily the result of a $205.5 million increase in interest income from loans HFI that was driven primarily by higher yields and a $46.9 million increase in interest income from investment securities due to higher investment yields and an increase in the average investment balance of $1.6 billion. Interest income from cash and other also increased $36.5 million due to an increase in cash balances resulting from higher short-term borrowings and the higher rate environment.

For the nine months ended September 30, 2023, interest income was $3.0 billion, an increase of $1.2 billion, or 66.1%, compared to $1.8 billion for the nine months ended September 30, 2022. This increase was primarily the result of higher rates on HFI loans coupled with a $3.8 billion increase in the average balance, which drove a $901.1 million increase in HFI loan interest income for the nine months ended September 30, 2023. An increase in investment yields and in the average investment balance of $1.3 billion resulted in an increase in interest income of $148.1 million, and an increase in cash balances and rates on those balances drove a $102.3 million increase in interest income.

For the three months ended September 30, 2023, interest expense was $439.6 million, an increase of $302.3 million, compared to $137.3 million for the three months ended September 30, 2022. The increase in interest expense was due to an increase in interest expense on deposits of $238.6 million driven by increased interest rates and a $6.1 billion increase in the average interest-bearing deposit balance combined with a $63.1 million increase in interest expense on other borrowings resulting from an increase in average borrowings of $1.7 billion and an increase in borrowing rates.

For the nine months ended September 30, 2023, interest expense was $1.2 billion, an increase of $1.0 billion, compared to $226.9 million for the nine months ended September 30, 2022. Interest expense on deposits increased $680.1 million driven by an increase in deposit rates and an increase in the average interest-bearing deposit balance of $5.3 billion coupled with an increase in the average balance of other borrowings of $5.9 billion, which drove a $339.7 million increase in interest expense.

For the three months ended September 30, 2023, net interest income was $587.0 million, a decrease of $15.1 million, or 2.5%, compared to $602.1 million for the three months ended September 30, 2022. The decrease in net interest income was driven by the higher rate environment and reflects a $7.7 billion increase in average interest-bearing liabilities, partially offset by an increase in yields on interest-earning assets. The decrease in net interest margin of 11 basis points to 3.67% is largely the result of an increase in both the rates and balances of deposits and borrowings, partially offset by higher yields on HFI loans compared to the same period in 2022.

For the nine months ended September 30, 2023, net interest income was $1.7 billion, an increase of $170.6 million, or 10.8%, compared to $1.6 billion for the nine months ended September 30, 2022. The increase in net interest income was driven by the higher rate environment and reflects a $5.3 billion increase in average interest-earning assets, partially offset by an increase of $11.2 billion in average interest-bearing liabilities. The increase in net interest margin of 6 basis points to 3.62% is the result of an increase in loan yields and balances, partially offset by an increase in the balance of deposits and other borrowings and higher rates compared to the same period in 2022.

Provision for Credit Losses

The provision for credit losses in each period is reflected as a reduction in earnings for that period and includes amounts related to funded loans, unfunded loan commitments, and investment securities. The provision is equal to the amount required to maintain the ACL at a level that is adequate to absorb estimated lifetime credit losses inherent in the loan and investment securities portfolios based on remaining contractual maturity, adjusted for estimated prepayments as of each period end. The Company's CECL models incorporate historical experience, current conditions, and reasonable and supportable forecasts in measuring expected credit losses. For the three and nine months ended September 30, 2023, the Company recorded a provision for credit losses of $12.1 million and $53.3 million, respectively, compared to $28.5 million and $65.0 million, respectively, for the three and nine months ended September 30, 2022. The decrease in the provision for credit losses from the three and nine months ended September 30, 2022 is primarily related to a significant decline in loan growth, offset by heightened economic uncertainty, particularly in the commercial real estate market.

Non-interest Income

The following table presents a summary of non-interest income:

(in millions)

Total non-interest income for the three months ended September 30, 2023 compared to the same period in 2022 increased $67.4 million. The increase in non-interest income from the three months ended September 30, 2022 was primarily driven by a net increase in mortgage banking income as net gain on loan origination and sale activities increased $37.5 million from higher production volume and spreads, a net fair value gain adjustment of $17.8 million related to HFS loans, compared to a net fair value loss adjustment of $2.8 million on equity securities in the prior year, and an increase of $16.8 million in service charges and fees.

Total non-interest income for the nine months ended September 30, 2023 compared to the same period in 2022 decreased $72.9 million. The decrease in non-interest income was primarily driven by non-operating charges incurred during the first quarter 2023 following the execution of the Company's balance sheet repositioning strategy, which included sales of selected loans and investment securities and the transfer of $6.0 billion of loans HFI to HFS. Consequently, during the nine months ended September 30, 2023, the Company recognized net fair value loss adjustments totaling $117.3 million primarily related to the transfer of loans to HFS and a net loss of $26.0 million on sales of investment securities. These decreases were offset in part by a net increase in mortgage banking income of $50.8 million from higher production volume and spreads.

Non-interest Expense

The following table presents a summary of non-interest expense:

(in millions)

Total non-interest expense for the three months ended September 30, 2023 increased $120.4 million compared to the same period in 2022. The increase in non-interest expense was primarily driven by an increase in deposit and insurance costs. The increase in deposit costs from the prior year relates primarily to higher average ECR rates, while the increase in insurance costs is due to elevated insured and brokered deposit levels.

Total non-interest expense for the nine months ended September 30, 2023 increased $338.2 million compared to the same period in 2022. The increase in non-interest expense for this period was also primarily driven by increases in deposit and insurance costs and are due to the same factors discussed above for the three-month comparable period, with the addition that the increase in deposit costs for the nine-month comparable period is also related to an increase in overall deposits since 2022.

Income Taxes

The Company's effective tax rate was 22.1% and 19.9% for the three months ended September 30, 2023 and 2022, respectively. For the nine months ended September 30, 2023 and 2022, the Company's effective tax rate was 20.5% and 19.7%, respectively. The increase in the three-month and nine-month effective tax rate was primarily due to an increase in nondeductible discrete items.

Business Segment Results

The Company's reportable segments are aggregated with a focus on products and services offered and consist of three reportable segments:

• Commercial: provides commercial banking and treasury management products and services to small and middle-market businesses, specialized banking services to sophisticated commercial institutions and investors within niche industries, as well as financial services to the real estate industry.
• Consumer Related: offers consumer banking services, such as mortgage banking and commercial banking services to enterprises in consumer-related sectors.
• Corporate & Other: consists of the Company's investment portfolio, Corporate borrowings and other related items, income and expense items not allocated to other reportable segments, and inter-segment eliminations.

The following tables present selected operating segment information:

(in millions)

(in millions)

73

BALANCE SHEET ANALYSIS

Total assets increased $3.2 billion to $70.9 billion at September 30, 2023, compared to $67.7 billion at December 31, 2022. The increase in total assets was driven by an increase in borrowings, which contributed to an increase in investment securities of $2.7 billion as well an increase in cash of $2.5 billion. Loans HFI decreased by $2.4 billion, or 4.7%, to $49.4 billion as of September 30, 2023, compared to $51.9 billion as of December 31, 2022. The decrease in loans HFI from December 31, 2022 was driven by the transfer of $6.0 billion of loans HFI to HFS during the first quarter 2023. The Company completed loan dispositions from this transferred loan pool totaling $4.3 billion through September 30, 2023 and transferred all remaining HFS loans back to HFI at the end of the period as a result of a change in management's intentions. By loan type, commercial and industrial loans and residential real estate loans decreased $2.4 billion and $1.1 billion, respectively, from December 31, 2022, partially offset by increases in construction and land development loans and CRE, non-owner occupied loans of $656 million and $491 million, respectively. Loans HFS increased $582 million from $1.2 billion as of December 31, 2022 due to an increase in non-EBO loans.

Total liabilities increased $2.8 billion to $65.1 billion at September 30, 2023, compared to $62.4 billion at December 31, 2022. The increase in liabilities is due primarily to an increase in borrowings and an increase in total deposits of $643 million, or 1.2%, to $54.3 billion. By type, the increase in deposits from December 31, 2022 was driven by increases of $3.7 billion in certificates of deposit and $3.3 billion in interest bearing demand deposits, partially offset by a decrease of $4.7 billion in savings and money market accounts and $1.7 billion in non-interest bearing demand deposits. Other borrowings increased $2.4 billion from December 31, 2022 due to an increase in short-term borrowings.

Total stockholders’ equity of $5.7 billion at September 30, 2023 increased by $390 million, or 7.3%, from December 31, 2022. The increase in stockholders' equity is primarily a function of net income, offset by quarterly dividends to common and preferred stockholders and unrealized fair value losses on AFS securities recorded net of tax in other comprehensive income.

Investment securities

Debt securities are classified at the time of acquisition as either HTM, AFS, or trading based upon various factors, including asset/liability management strategies, liquidity and profitability objectives, and regulatory requirements. HTM securities are carried at amortized cost, adjusted for amortization of premiums or accretion of discounts. AFS securities are debt securities that may be sold prior to maturity based upon asset/liability management decisions. Investment securities classified as AFS are carried at fair value with unrealized gains or losses on these securities recorded in AOCI in stockholders’ equity, net of tax. Amortization of premiums or accretion of discounts on MBS is periodically adjusted for estimated prepayments. Trading securities are reported at fair value, with unrealized gains and losses on these securities included in current period earnings.

The Company's investment securities portfolio is utilized as collateral for borrowings, required collateral for public deposits and repurchase agreements, and to manage liquidity, capital, and interest rate risk.

The following table summarizes the carrying value of the Company's investment securities portfolio:

(in millions)

74

Loans HFS

The Company purchases and originates residential mortgage loans through its AmeriHome mortgage banking business channel that are held for sale or securitization. These loans have historically made up the entire balance of loans HFS. However, as part of the Company's balance sheet repositioning strategy, the Company transferred $5.9 billion of loans, net of a fair value loss adjustment (primarily commercial and industrial loans) to HFS as of March 31, 2023. The Company completed loan dispositions from this transferred loan pool totaling $4.3 billion through September 30, 2023 and transferred all remaining HFS loans back to HFI at the end of the period as a result of a change in management's intentions. As of September 30, 2023, the loans HFS balance totaled $1.8 billion, compared to $1.2 billion at December 31, 2022, an increase of $582 million primarily related to an increase in non-EBO loans.

Loans HFI

The table below summarizes the distribution of the Company’s held for investment loan portfolio:

(in millions)

Loans classified as HFI are stated at the amount of unpaid principal, adjusted for net deferred fees and costs, premiums and discounts on acquired and purchased loans, and an ACL. Net deferred loan fees of $112 million and $141 million reduced the carrying value of loans as of September 30, 2023 and December 31, 2022, respectively. Net unamortized purchase premiums on acquired and purchased loans of $177 million and $195 million increased the carrying value of loans as of September 30, 2023 and December 31, 2022, respectively.

Concentrations of Lending Activities

The Company monitors concentrations of lending activities at the product and borrower relationship level. As of September 30, 2023 and December 31, 2022, no borrower relationships at both the commitment and funded loan level exceeded 5% of total loans HFI.

Commercial and industrial loans made up 37% and 40% of total loans HFI as of September 30, 2023 and December 31, 2022, respectively.

The Company’s loan portfolio also includes credit exposure to the CRE market as CRE-non-owner occupied loans accounted for approximately 20% and 18% of total loans HFI at September 30, 2023 and December 31, 2022, respectively. Approximately $2.6 billion, or 5.3%, of total loans HFI consisted of CRE non-owner occupied office loans as of September 30, 2023, compared to $2.4 billion, or 4.6%, as of December 31, 2022. These office loans primarily consist of shorter-term bridge loans that enable borrowers to reposition or redevelop projects with more modern standards attractive to in-office employers in today’s environment, including enhanced on-site amenities. The vast majority of these projects are located in suburban locations with Central Business District or downtown exposure totaling approximately 3% and midtown exposure totaling approximately 9% of office loans.

The office loan portfolio largely consists of value-add loans that require significant up-front cash equity contributions from institutional sponsors and large regional and national developers. Leverage is low with initial loan-to-value ratios less than 55% and a weighted average loan-to-cost of approximately 62% at time of origination. The properties underlying these loans have stable business trends and low vacancy rates. In addition to adhering to conservative underwriting standards, asset-specific credit risk is mitigated through continued sponsor support of projects by re-appraisal rights by the Company, re-margining requirements and ongoing debt service, and debt yield covenants. To a large extent, the financing structures of these loans do not carry junior liens or mezzanine debt, which enables maximum flexibility when working with clients and sponsors.

In addition, construction and land loans were 9% and 8% of total loans HFI at September 30, 2023 and December 31, 2022, respectively.

Non-performing Assets

Total non-performing loans increased $257 million to $344 million at September 30, 2023, from $87 million at December 31, 2022.

(dollars in millions)

(1) Includes loan modifications to borrowers experiencing financial difficulty of $36 million and TDR loans of $12 million at September 30, 2023 and December 31, 2022, respectively.

(2) Excludes government guaranteed residential mortgage loans of $439 million and $582 million at September 30, 2023 and December 31, 2022, respectively.

Interest income that would have been recorded under the original terms of nonaccrual loans was $4.5 million and $1.3 million for the three months ended September 30, 2023 and 2022, respectively, and $8.1 million and $3.6 million for the nine months ended September 30, 2023 and 2022, respectively.

The composition of nonaccrual loans HFI by loan portfolio segment were as follows:

(dollars in millions)

(dollars in millions)

76

Restructurings for Borrowers Experiencing Financial Difficulty

The Company adopted the amendments in ASU 2022-02, which eliminated the accounting guidance on TDR loans for creditors and requires enhanced disclosures for loan modifications to borrowers experiencing financial difficulty that were made on or after January 1, 2023.

The following table presents the amortized cost of loans HFI that were modified during the period by loan portfolio segment:

(in millions)

(dollars in millions)

The performance of these modified loans is monitored for 12 months following the modification. As of September 30, 2023, modified loans on nonaccrual status totaled $36 million and the remaining $107 million were current with contractual payments.

In the normal course of business, the Company also modifies EBO loans, which are delinquent FHA, VA, or USDA insured or guaranteed loans repurchased under the terms of the GNMA MBS program and can be repooled or resold when loans are brought current. During the three and nine months ended September 30, 2023, the Company completed modifications of EBO loans with an amortized cost of $84 million and $176 million, respectively. These modifications were largely payment delays and term extensions, or both.

Troubled Debt Restructured Loans

Prior to the adoption of ASU 2022-02, the Company accounted for a modification to the contractual terms of a loan that resulted in granting a concession to a borrower experiencing financial difficulties as a TDR. The loan terms that were modified or restructured due to a borrower’s financial situation included, but were not limited to, a reduction in the stated interest rate, an extension of the maturity or renewal of the loan at an interest rate below current market, a reduction in the face amount of the debt, a reduction in the accrued interest, or deferral of interest payments. The majority of the Company's modifications were extensions in terms or deferral of payments which resulted in no lost principal or interest. Consistent with regulatory guidance, a TDR loan that was subsequently modified in another restructuring agreement but had shown sustained performance and classification as a TDR, was removed from TDR status provided that the modified terms were market-based at the time of modification.

The following table presents TDR loans:

As of December 31, 2022, the ACL on TDR loans totaled $4 million and there were no outstanding commitments on TDR loans.

Allowance for Credit Losses on Loans HFI

The ACL consists of an ACL on loans and on unfunded loan commitments. The ACL on AFS and HTM securities is estimated separately from loans and is discussed within the Investment Securities section.

The following table summarizes the allocation of the ACL on loans HFI by loan portfolio segment:

(dollars in millions)

During the three months ended September 30, 2023 and 2022, net loan charge-offs (recoveries) to average loans outstanding were 0.07% and (0.02)%, respectively, and 0.06% and 0.00% for the nine months ended September 30, 2023 and 2022, respectively.

In addition to the ACL on funded loans HFI, the Company maintains a separate ACL related to off-balance sheet credit exposures, including unfunded loan commitments. This allowance balance totaled $37.9 million and $47.0 million at September 30, 2023 and December 31, 2022, respectively, and is included in Other liabilities on the Consolidated Balance Sheet.

Problem Loans

The Company classifies loans consistent with federal banking regulations using a nine category grading system. The following table presents information regarding potential and actual problem loans, consisting of loans graded as Special Mention, Substandard, Doubtful, and Loss, but which are still performing:

(dollars in millions)

(dollars in millions)

Mortgage Servicing Rights

The fair value of the Company's MSRs related to residential mortgage loans totaled $1.2 billion and $1.1 billion as of September 30, 2023 and December 31, 2022, respectively. The increase in MSRs is primarily related to new production of MSRs and valuation gains, partially offset by sales.

The following is a summary of the UPB of loans underlying the Company's MSR portfolio by type:

(in millions)

79

Goodwill and Other Intangible Assets

Goodwill represents the excess consideration paid for net assets acquired in a business combination over their fair value. Goodwill and other intangible assets acquired in a business combination that are determined to have an indefinite useful life are not subject to amortization, but are subsequently evaluated for impairment at least annually. The Company has goodwill totaling $527 million at September 30, 2023 and December 31, 2022.

The Company performs its annual goodwill and intangible assets impairment tests as of October 1 each year, or more often if events or circumstances indicate that the carrying value may not be recoverable. The Company evaluated whether the continued effects from the bank failures earlier in 2023 may give rise to a triggering event and elected to perform a Step 0 goodwill impairment assessment, which included assessing the financial performance of the Company and analyzing qualitative factors applicable to the Company. As of September 30, 2023, the Company does not believe that these events or circumstances have significantly altered the long-term financial performance of the Company. Accordingly, it was determined that it is more likely than not that the fair value of the Company and its reporting units exceeds their respective carrying values as of September 30, 2023.

Deferred Tax Assets

As of September 30, 2023, the net DTA balance totaled $365 million, an increase of $54 million from $311 million at December 31, 2022. This overall increase in the net DTA was primarily the result of a decrease in the fair market value of AFS securities and a decrease to MSR deferred tax liabilities.

At September 30, 2023 and December 31, 2022, the Company had no deferred tax valuation allowance.

Deposits

Deposits are the primary source for funding the Company's asset growth. Total deposits increased to $54.3 billion at September 30, 2023, from $53.6 billion at December 31, 2022, an increase of $643 million, or 1.2%. By deposit type, the increase in deposits is attributable to increases in certificates of deposit of $3.7 billion and interest bearing demand deposits of $3.3 billion, partially offset by decreases in savings and money market accounts of $4.7 billion and non-interest bearing demand deposits of $1.7 billion.

Brokered deposits provide an additional source of deposits and are placed with the Bank through third-party brokers. At September 30, 2023 and December 31, 2022, the Company held wholesale brokered deposits of $6.5 billion and $4.8 billion, respectively, excluding reciprocal deposits. In addition, WAB is a participant in the IntraFi Network, a network that offers deposit placement services such as CDARS and ICS, and other reciprocal deposit networks which offer products that qualify large deposits for FDIC insurance. At September 30, 2023, the Company had $12.5 billion of reciprocal deposits, compared to $2.8 billion at December 31, 2022. These reciprocal deposit structures offer protection to depositors by fully insuring deposits with other network banks and also provides the Company with funding stability and drove the increase in the Company’s insured deposit ratio from 45% at December 31, 2022 to 77% at September 30, 2023 and including collateralized deposits, this ratio increased to 82% at September 30, 2023 from 47% at December 31, 2022.

In addition, deposits for which the Company provides account holders with earnings credits or referral fees totaled $17.1 billion and $12.9 billion at September 30, 2023 and December 31, 2022, respectively. The Company incurred $123.7 million and $17.3 million in deposit related costs on these deposits during the three months ended September 30, 2023 and 2022, respectively. The Company incurred $297.1 million and $26.0 million in deposit related costs on these deposits during the nine months ended September 30, 2023 and 2022, respectively. These costs are reported as Deposit costs in non-interest expense. The increase in these costs from the prior year is due to an increase in average earnings credit rates as well as an increase in average deposit balances eligible for earnings credits or referral fees.

The average balances and weighted average rates paid on deposits are presented below:

(dollars in millions)

(dollars in millions)

Other Borrowings

Short-Term Borrowings

The Company utilizes short-term borrowed funds to support short-term liquidity needs. The majority of these short-term borrowed funds consist of warehouse borrowings, advances from the FHLB, the BTFP, repurchase agreements, and federal funds purchased from correspondent banks or the FHLB. The Company’s borrowing capacity with the FHLB is determined based on collateral pledged, generally consisting of securities and loans. In addition, the Company has repurchase facilities, collateralized by securities and EBO loans, including assets sold under agreements to repurchase, which are reflected at the amount of cash received in connection with the transaction, and may require additional collateral based on the fair value of the underlying securities. Total short-term borrowings increased $3.0 billion to $8.0 billion at September 30, 2023 from $5.0 billion at December 31, 2022. The increase was driven by increases in warehouse and BTFP borrowings of $1.3 billion, EBO repurchase agreements of $481 million, and FHLB advances of $400 million.

Long-Term Borrowings

The Company's long-term borrowings consist of AmeriHome senior notes and credit linked notes, inclusive of issuance costs and fair market value adjustments. At September 30, 2023, the carrying value of long-term borrowings was $763 million, compared to $1.3 billion at December 31, 2022. The decrease in long-term borrowings from December 31, 2022 primarily relates to the payoff of credit linked notes on the Company's mortgage warehouse and equity fund resource loans during the nine months ended September 30, 2023.

Qualifying Debt

Qualifying debt consists of subordinated debt and junior subordinated debt, inclusive of issuance costs and fair market value adjustments. At September 30, 2023, the carrying value of qualifying debt was $890 million, compared to $893 million at December 31, 2022.

Capital Resources

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements could trigger certain mandatory or discretionary actions that, if undertaken, could have a direct material effect on the Company’s business and financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items (discussed in "Note 14. Commitments and Contingencies" to the Unaudited Consolidated Financial Statements) as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

As permitted by the regulatory capital rules, the Company elected the CECL transition option that delayed the estimated impact on regulatory capital resulting from the adoption of CECL over a five-year transition period ending December 31, 2024. Accordingly, capital ratios and amounts for 2022 include a 25% reduction to the capital benefit that resulted from the increased ACL related to the adoption of ASC 326, which has increased to include a 50% reduction beginning in 2023.

As of September 30, 2023 and December 31, 2022, the Company and the Bank exceeded the capital levels necessary to be classified as well-capitalized, as defined by the various banking agencies. The actual capital amounts and ratios for the Company and the Bank are presented in the following tables:

(dollars in millions)

The Company is also required to maintain specified levels of capital to remain in good standing with certain federal government agencies, including FNMA, FHLMC, GNMA, and HUD. These capital requirements are generally tied to the unpaid balances of loans included in the Company's servicing portfolio or loan production volume. Noncompliance with these capital requirements can result in various remedial actions up to, and including, removing the Company's ability to sell loans to and service loans on behalf of the respective agency. The Company believes that it is in compliance with these requirements as of September 30, 2023.

Critical Accounting Estimates

Critical accounting estimates are defined as those that are reflective of significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. The critical accounting estimates upon which the Company's financial condition and results of operations depend, and which involve the most complex subjective decisions or assessments, are included in the discussion entitled "Critical Accounting Policies" in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2022, and all amendments thereto, as filed with the SEC. There were no material changes to the critical accounting policies disclosed in the Annual Report on Form 10-K.

Liquidity

Liquidity is the ongoing ability to accommodate liability maturities and deposit withdrawals, fund asset growth and business operations, and meet contractual obligations through unconstrained access to funding at reasonable market rates. Liquidity management involves forecasting funding requirements and maintaining sufficient capacity to meet the needs and accommodate fluctuations in asset and liability levels due to changes in the Company's business operations or unanticipated events.

The ability to have readily available funds sufficient to repay fully maturing liabilities is of primary importance to depositors, creditors, and regulators. The Company's liquidity, represented by cash and amounts due from banks, federal funds sold, loans HFS, and non-pledged marketable securities, is a result of the Company's operating, investing, and financing activities and related cash flows. The Company actively monitors and manages liquidity, and no less than quarterly will estimate probable liquidity needs on a 12-month horizon. Liquidity needs can also be met through short-term borrowings or the disposition of short-term assets.

The following table presents the available and outstanding balances on the Company's lines of credit:

(in millions)

In addition to lines of credit, the Company has borrowing capacity with the FHLB and FRB from pledged loans and securities and warehouse borrowing lines of credit. The borrowing capacity, outstanding borrowings, and available credit are presented in the following table:

(in millions)

The Company has a formal liquidity policy and, in the opinion of management, its liquid assets are considered adequate to meet cash flow needs for loan funding and deposit cash withdrawals for the next 90-120 days. At September 30, 2023, there were $8.9 billion in liquid assets, comprised of $3.5 billion in cash and cash equivalents and $5.4 billion in unpledged marketable securities. At December 31, 2022, the Company maintained $7.7 billion in liquid assets, comprised of $1.1 billion of cash and cash equivalents, $1.1 billion in loans HFS, and $5.5 billion of unpledged marketable securities.

The Parent maintains liquidity that would be sufficient to fund its operations and certain non-bank affiliate operations for an extended period should funding from normal sources be disrupted. In the Company's analysis of Parent liquidity, it is assumed that the Parent is unable to generate funds from additional debt or equity issuances, receives no dividend income from subsidiaries and does not pay dividends to stockholders, while continuing to make non-discretionary payments needed to maintain operations and repayment of contractual principal and interest payments owed by the Parent and affiliated companies. Under this scenario, the amount of time the Parent and its non-bank subsidiary can operate and meet all obligations before the current liquid assets are exhausted is considered as part of the Parent liquidity analysis. Management believes the Parent maintains adequate liquidity capacity to operate without additional funding from new sources for over twelve months.

WAB maintains sufficient funding capacity to address large increases in funding requirements, such as deposit outflows. This capacity is comprised of liquidity derived from a reduction in asset levels and various secured funding sources. On a long-term basis, the Company’s liquidity will be met by changing the relative distribution of its asset portfolios (for example, by reducing investment or loan volumes, or selling or encumbering assets). Further, the Company can increase liquidity by soliciting higher levels of deposit accounts through promotional activities and/or borrowing from correspondent banks, the FHLB of San Francisco, and the FRB. At September 30, 2023, the Company's long-term liquidity needs primarily relate to funds required to support loan originations, commitments, and deposit withdrawals, which can be met by cash flows from investment payments and maturities, and investment sales, if necessary.

The Company’s liquidity is comprised of three primary classifications: 1) cash flows provided by operating activities; 2) cash flows used in investing activities; and 3) cash flows provided by financing activities. Net cash provided by or used in operating activities consists primarily of net income, adjusted for changes in certain other asset and liability accounts and certain non-cash income and expense items, such as the provision for credit losses, investment and other amortization and depreciation. For the nine months ended September 30, 2023 and 2022, net cash (used in) provided by operating activities was $(669.8) million and $1.5 billion, respectively.

The Company's primary investing activities are the origination of real estate and commercial loans, the collection of repayments of these loans, and the purchase and sale of securities. The Company's net cash used in investing activities has been primarily influenced by its loan and securities activities. During the nine months ended September 30, 2023, the Company's cash balance increased by $1.9 billion as a result of a net decrease in loans, compared to a reduction in cash of $11.7 billion during the nine months ended September 30, 2022 from a net increase in loans. A net increase in investment securities of $2.6 billion and $1.8 billion for the nine months ended September 30, 2023 and 2022, respectively, partially offset the increase to the Company's cash balance during the nine months ended September 30, 2023 and contributed to the reduction during the nine months ended September 30, 2022.

Net cash provided by financing activities has been impacted significantly by deposit levels. During the nine months ended September 30, 2023, net deposits increased $642.9 million, compared to an increase in net deposits of $8.0 billion during the nine months ended September 30, 2022.

Fluctuations in core deposit levels may increase the Company's need for liquidity as certificates of deposit mature or are withdrawn before maturity, and as non-maturity deposits, such as checking and savings account balances, are withdrawn. Additionally, the Company is exposed to the risk that customers with large deposit balances will withdraw all or a portion of such deposits, due in part to the FDIC limitations on the amount of insurance coverage provided to depositors. To mitigate the uninsured deposit risk, the Company participates in the CDARS and ICS programs, which allow an individual customer to invest up to $50.0 million and $150.0 million, respectively, through one participating financial institution or, a combined total of $200.0 million per individual customer, with the entire amount being covered by FDIC insurance. As of September 30, 2023, the Company had $12.5 billion of total reciprocal deposits.

As of September 30, 2023, the Company has $6.5 billion of wholesale brokered deposits outstanding, excluding reciprocal deposits of $12.5 billion. Although classified as brokered deposits, the Company believes that due to the reciprocal nature of these deposits, these accounts carry a lower risk of withdrawal and deposit volatility. Non-reciprocal brokered deposits are generally considered to be deposits that have been received from a third party who is engaged in the business of placing deposits on behalf of others. A traditional deposit broker will direct deposits to the banking institution offering the highest interest rate available. Federal banking laws and regulations place restrictions on depository institutions regarding brokered deposits because of the general concern that these deposits are not relationship based and are at a greater risk of being withdrawn and placed on deposit at another institution offering a higher interest rate, thus posing liquidity risk for institutions that gather brokered deposits in significant amounts.

Federal and state banking regulations place certain restrictions on dividends paid. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the bank. Dividends paid by WAB to the Parent would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements.

During the three months ended September 30, 2023, WAB paid dividends to the Parent of $60 million. During the nine months ended September 30, 2023, WAB and CSI paid dividends to the Parent of $170 million and $100 million, respectively.

Supervision and Regulation

The following information is intended to update, and should be read in conjunction with, the information contained under the caption “Supervision and Regulation” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Bank Term Funding Program

In response to the bank failures that occurred earlier in 2023, the Federal Reserve System has established a BTFP, which is intended to provide additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors. The BTFP offers loans of up to one year in length to eligible depository institutions pledging any collateral eligible for purchase by the Federal Reserve Banks in open market operations (for example, U.S. Treasuries, U.S. agency securities, and U.S. agency mortgage-backed securities), which will be valued at par. The U.S. Department of the Treasury will provide $25 billion as credit protection to the Federal Reserve Banks in connection with the BTFP. The goal of the BTFP is to be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress. The Company has borrowings under the BTFP that totaled $1.3 billion as of September 30, 2023.

FDIC Special Assessment

To recover the loss to the Deposit Insurance Fund arising from the bank failures that occurred earlier in 2023, the FDIC has proposed an annual special assessment rate of approximately 12.5 basis points. The assessment base for the special assessments would be equal to an institution’s estimated uninsured deposits as of December 31, 2022, adjusted to exclude the first $5 billion from estimated uninsured deposits. The special assessments would be collected over an eight-quarter collection period, at a quarterly special assessment rate of 3.13 basis points, with the first quarterly assessment period beginning on January 1, 2024. The comment period for the proposal ended on July 21, 2023, with a final rule expected later this year. If adopted as proposed, the Company expects to recognize a one-time charge of $62 million.

Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices, and equity prices. The Company's market risk arises primarily from interest rate risk inherent in its lending, investing, and deposit taking activities. To that end, management actively monitors and manages the Company's interest rate risk exposure. The Company generally manages its interest rate sensitivity by evaluating re-pricing opportunities on its earning assets to those on its funding liabilities.

Management uses various asset/liability strategies to manage the re-pricing characteristics of the Company's assets and liabilities, all of which are designed to ensure that exposure to interest rate fluctuations is limited to within the Company's guidelines of acceptable levels of risk-taking. Hedging strategies, including the terms and pricing of loans and deposits and management of the deployment of its securities, are used to reduce mismatches in interest rate re-pricing opportunities of portfolio assets and their funding sources. Derivatives in a hedging relationship are also used to minimize the Company's exposure to changes in benchmark interest rates and volatility of net interest income and EVE to interest rate fluctuations, with their impact reflected in the model results discussed below.

Interest rate risk is addressed by ALCO, which includes members of executive management, finance, and operations. ALCO monitors interest rate risk by analyzing the potential impact on the net EVE and net interest income from potential changes in interest rates and considers the impact of alternative strategies or changes in balance sheet structure. The Company manages its balance sheet in part to keep the potential impact on EVE and net interest income within acceptable ranges despite changes in interest rates.

The Company's exposure to interest rate risk is reviewed at least quarterly by ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine its change in both EVE and net interest income in the event of hypothetical changes in interest rates. If potential changes to EVE and net interest income resulting from hypothetical interest rate changes are not within the limits established by the BOD or, ALCO determines that interest rate exposures should be reduced, ALCO will either take hedging actions or adjust the asset and liability mix to bring interest rate risk within Board-approved limits or in line with ALCO's proposed reduction. ALCO may also decide that the best course of action for a limit breach is to accept the breach and present justification to the BOD. If the BOD does not agree to accept the limit breach, it will direct ALCO to remediate the breach. The Company's net interest income and EVE exposure limits are approved by the Board on an annual basis, or more often if market conditions warrant. During the nine months ended September 30, 2023, there have been no changes to the Company's exposure limits.

Net Interest Income Simulation. To measure interest rate risk at September 30, 2023, the Company used a simulation model to project changes in net interest income that result from forecasted changes in interest rates. This analysis calculates the difference between a baseline net interest income forecast using current yield curves, compared to forecasted net income resulting from an immediate parallel shift in rates upward or downward, along with other scenarios directed by ALCO. The income simulation model includes various assumptions regarding re-pricing relationships for each of the Company's products. Many of the Company's assets are variable rate loans, which are assumed to re-price at the next rate re-set period and, proportional to the change in market rates, depending on their contracted index, including the impact of caps or floors. Some loans and investments contain contractual prepayment features (embedded options) and, accordingly, the simulation model incorporates prepayment assumptions. The Company's non-term deposit products re-price with a certain beta to underlying market rate changes. The Company regularly conducts sensitivity analysis for this assumption to determine the impact on the interest rate risk position. These betas are derived separately by deposit product and are based on both observed and projected market rate and balance trends. Current deposit beta assumptions range between 20% to 90%, depending on product, with an average interest bearing deposit beta of 54%.

This analysis indicates the impact of changes in net interest income for the given set of rate changes and assumptions. It assumes that loan and deposit balances remain static and do not change over the course of the year. It does not account for all factors that could impact the Company's results, including changes by management to mitigate interest rate changes or secondary factors, such as changes to the Company's credit risk profile as interest rates change. Furthermore, loan prepayment rate estimates and spread relationships change regularly. Interest rate changes create changes in actual loan prepayment speeds that will differ from the market estimates incorporated in this analysis. These assumptions are inherently uncertain and as a result, actual results may differ from simulated results due to factors such as timing, magnitude and frequency of interest rate changes as well as changes in market conditions, customer behavior and management strategies, and changes that vary significantly from the modeled assumptions may have a significant effect on the Company's actual net interest income.

This simulation model assesses the changes in net interest income that would occur in response to an instantaneous and sustained increase or decrease (shock) in market interest rates. A Down 200 scenario in this simulation model is also being presented as of September 30, 2023 as current projections of future market rates include consideration of rate decreases in the current high rate environment. The Company will continue to evaluate the scenarios that are presented as interest rates change and will update these scenario disclosures as appropriate.

Sensitivity of Net Interest Income

At September 30, 2023, our net interest income exposure for the next twelve months related to these hypothetical changes in market interest rates was within our current guidelines.

Economic Value of Equity. The Company measures the impact of market interest rate changes on the NPV of estimated cash flows from its assets, liabilities, and off-balance sheet items, defined as EVE, using a simulation model. The Company's simulation model focuses on parallel interest rate shocks and takes into account assumptions related to loan prepayment trends that are sourced using a combination of third-party prepayment models and internal historical experience, terminal maturity for non-maturity deposits, decay attrition, and pricing sensitivity derived from the Company's data and other internally-developed analysis and models. These assumptions are reviewed at least annually and are adjusted periodically to reflect changes in market conditions and the Company's balance sheet composition. As simulated model results are based on a number of assumptions outlined above, including forecasted market conditions, actual amounts may differ significantly from the projections set forth below should market conditions vary from the underlying assumptions. The Company's EVE model assumptions have not changed from the assumptions used in its June 30, 2023 simulation.

This simulation model assesses the changes in the market value of interest rate sensitive financial instruments that would occur in response to an instantaneous and sustained increase or decrease (shock) in market interest rates. As of September 30, 2023, an Up 300 scenario in this simulation model is no longer being presented, replaced with a Down 200 scenario given rate decline expectations in the current high rate environment. The Company will continue to evaluate the scenarios that are presented as interest rates change and will update these scenario disclosures as appropriate.

The following table shows the Company's projected change in EVE for this set of rate shocks at September 30, 2023:

Economic Value of Equity

At September 30, 2023, the Company's EVE exposure related to these hypothetical changes in market interest rates was within the Company's current guidelines.

Derivative Contracts. In the normal course of business, the Company uses derivative instruments to meet the needs of its customers and manage exposure to fluctuations in interest rates. For additional discussion on how derivatives in a hedging relationship (fair value hedges) are used to manage the Company's interest rate risk, see "Note 11. Derivatives and Hedging Activities" to the Unaudited Consolidated Financial Statements.

Evaluation of Disclosure Controls

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, the CEO and CFO have concluded that the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act, as amended, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Additionally, the Company's disclosure controls and procedures were also effective in ensuring that information required to be disclosed by the Company in the reports it files or is subject to under the Exchange Act is accumulated and communicated to the Company's management, including the CEO and CFO, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company's internal control over financial reporting during the quarter ended September 30, 2023, which have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

Risk Factors of the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 includes a discussion of the material risks and uncertainties that could adversely affect our business and impact our results of operations or financial condition. The information presented below updates, and should be read in conjunction with, the risk factors and information disclosed in the Annual Report on Form 10-K.

Adverse developments or concerns affecting the financial services industry in general or financial institutions that are similar to us or that may be viewed as being similar to us, such as the recent bank closures and disruption in the United States banking industry, could adversely affect our financial condition and results of operations.

Actual events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions, transactional counterparties or other companies in the financial services industry or the financial services industry generally, or concerns or rumors about any events of these kinds or other similar events, have in the past and may in the future lead to erosion of customer confidence in the banking system or certain banks, deposit volatility, liquidity issues, stock price volatility and other adverse developments. The closures of Silicon Valley Bank and Signature Bank in March 2023 led to such disruption and volatility, including deposit outflows, at many mid-sized banks, increasing the need for liquidity. Although a statement by the Department of the Treasury, the Federal Reserve and the FDIC indicated that all depositors of Silicon Valley Bank would have access to all of their money after only one business day of closure, including funds held in uninsured deposit accounts, it is not certain that the Federal Reserve or FDIC will treat future bank failures similarly. On May 1, 2023, First Republic Bank was also closed by its primary state regulator, which appointed the FDIC as receiver, and the FDIC announced that JP Morgan Chase Bank, National Association agreed to assume all of First Republic Bank’s deposits and substantially all of its assets.

Shortly following the closures of Silicon Valley Bank and Signature Bank, we and certain other banks experienced a brief period of elevated deposit withdrawals. While we cannot know for certain with respect to all withdrawals, we believe the elevated withdrawals were at least in part due to certain perceived similarities between our loan portfolio and deposit gathering activities and those of these banks. Our deposit balances stabilized as of March 20, 2023 and from such date through September 30, 2023 deposits increased, and were up $643 million from December 31, 2022. During this time, we took additional measures to ensure liquidity, strengthen our capital position and increase customer confidence, which included increasing our borrowing capacity with the FRB, selling certain assets and strengthening our insured and collateralized deposit ratio from 47% as of December 31, 2022 to 82% as of September 30, 2023. We have also participated in the BTFP, with $1.3 billion of funds drawn as of September 30, 2023. Although our deposits have stabilized and increased since we experienced the period of elevated withdrawals, we cannot be assured that similar unusual deposit withdrawal activity will not affect banks generally or us in the future. Our net interest margin also may be negatively impacted if the Company’s borrowings remain elevated in future periods.

Inflation and rapid increases in interest rates have led to a decline in the trading value of previously issued government securities with interest rates below current market interest rates. Any sale of investment securities that are held in an unrealized loss position by financial institutions for liquidity or other purposes will cause actual losses to be realized. Gross unrealized losses on our HTM and AFS investment securities totaled $261 million and $987 million, respectively, as of September 30, 2023. There can be no assurance that there will not be additional bank failures or liquidity concerns in particular segments of the financial services industry or in the U.S. financial system as a whole. The volatility and economic disruption resulting from the bank closures in 2023 have particularly impacted the price of capital stock and other securities issued by financial institutions, including us. Continued uncertainty regarding or worsening of the severity and duration of the volatility in the banking industry and related economic effects may also adversely impact the Company’s estimate of its allowance for credit losses and resulting provision for credit losses.

Any of these impacts, or any other impacts resulting from the events described above or other related or similar events, could have a material adverse effect on our liquidity and our current and/or projected business operations and financial condition and results of operations.