Metropolitan Bank Holding Corp.: Form 10-Q for the period ended Sep 30, 2023

Company Background

The Company is a bank holding company headquartered in New York, New York and registered under the BHC Act. Through its wholly owned bank subsidiary, Metropolitan Commercial Bank (the “Bank”), a New York state chartered bank, the Company provides a broad range of business, commercial and retail banking products and services to small businesses, middle-market enterprises, public entities and affluent individuals primarily in the New York metropolitan area. See the “Glossary of Common Terms and Acronyms” for the definition of certain terms and acronyms used throughout this Form 10-Q.

The Company’s primary market includes the New York metropolitan area, specifically Manhattan and the outer boroughs, and Nassau County, New York. This market is well-diversified and represents a large market for middle market businesses (defined as businesses with annual revenue of $5 million to $400 million). The Company’s market area has a diversified economy typical of most urban population centers, with the majority of employment provided by services, wholesale/retail trade, finance/insurance/real estate, technology companies and construction. A relationship-led strategy has provided the Company with select opportunities in other U.S. markets, with a particular focus on South Florida. In addition, through its Global Payments Group, the Company issues prepaid cards for nationwide card programs managed by third-party program managers.

The Company’s primary lending products are CRE loans, including multi-family loans, and C&I loans. Substantially all loans are secured by specific items of collateral including business and consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flows from operations of commercial enterprises. The Company’s primary deposit products are checking, savings, and term deposit accounts, all of which are insured by the FDIC up to the maximum amounts allowed by law. In addition to traditional commercial banking products, the Company offers corporate cash management and retail banking services, and its Global Payments Group (“global payments business”) provides services to non-bank financial service companies, including serving as an issuing bank for third-party debit card programs, as well as providing other financial infrastructure, including cash settlement and custodian deposit services. The Company operates six banking centers strategically located within close proximity to target clients. The strength of the Company’s deposit franchise comes from its long-standing relationships with clients and the strong ties it has in its market area. The Company has also developed a diversified funding strategy, which enables it to be less reliant on branches. Deposit funding is provided by the following core deposit verticals: (i) borrowing clients; (ii) non-borrowing retail clients; (iii) global payments business; and (iv) corporate cash management clients.

Recent Events

There have been and continue to be ongoing investigations by governmental entities concerning a prepaid debit card product program that was offered by GPG. As previously disclosed, the Bank has been in discussions with both the FRB and NYSDFS with respect to consensual resolutions of their investigations. The Bank entered into (i) an Order to Cease and Desist and Order of Assessment of a Civil Money Penalty Issued Upon Consent with the FRB (the “FRB Consent Order”), effective October 16, 2023, and (ii) a Consent Order with the NYSDFS (the “NYSDFS Consent Order”), effective October 18, 2023. The FRB Consent Order and NYSDFS Consent Order constitute separate consensual resolutions with each of the FRB and the NYSDFS with respect to their investigations, each of which is now closed as a result of such order.

The FRB Consent Order provides for a civil money penalty of $14.5 million and requires the Bank’s board of directors to submit a plan to further strengthen board oversight of the management and operations of the GPG and the Bank to develop, among other things, a written plan to enhance the Bank’s customer identification program, a plan to improve the Bank’s customer due diligence program and a plan to enhance the Bank’s third party risk management program. The NYSDFS Consent Order provides for a civil money penalty of $15.0 million and requires the Bank to provide certain information regarding the Bank’s program to supervise third-party program managers and various status reports regarding certain compliance-related matters in connection with the Bank’s oversight of third-party program managers of the Bank’s prepaid debit card program. The Company was fully reserved with respect to the foregoing amounts payable to the FRB and

NYSDFS through a regulatory settlement reserve disclosed in prior periods. For further discussion see Part II, “Item 1. Legal Proceedings.”

Critical Accounting Policies

Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Management believes that the most critical accounting policy, which involves the most complex or subjective decisions or assessments, is as follows:

Allowance for Credit Losses

The ACL has been determined in accordance with GAAP. The Company is responsible for the timely and periodic determination of the amount of the ACL. Management believes that the ACL is adequate to cover expected credit losses over the life of the loan portfolio. Although management evaluates available information to determine the adequacy of the ACL, the level of allowance is an estimate which is subject to significant judgment and short-term change. Because of uncertainties associated with local and national economic forecasts, the operating and regulatory environment, collateral values and future cash flows from the loan portfolio, it is possible that a material change could occur in the ACL in the near term. The evaluation of the adequacy of loan collateral is often based upon estimates and appraisals. Because of changing economic conditions, the valuations determined from such estimates and appraisals may also change. Accordingly, the Company may ultimately incur losses that vary from management’s current estimates. Adjustments to the ACL will be reported in the period in which such adjustments become known and can be reasonably estimated. All loan losses are charged to the ACL when the loss actually occurs or when the collectability of the principal is unlikely. Recoveries are credited to the allowance at the time of recovery. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s ACL. As a result of such examinations, the Company may need to recognize additions to the ACL based on the regulators’ judgments.

In estimating the ACL, the Company relies on models and economic forecasts developed by external parties as the primary driver of the ACL. These models and forecasts are based on nationwide sets of data. Economic forecasts can change significantly over an economic cycle and have a significant level of uncertainty associated with them. The performance of the models is dependent on the variables used in the models being reasonable proxies for the loan portfolio’s performance. However, these variables may not capture all sources of risk within the portfolio. As a result, the Company reviews the results and makes qualitative adjustments to the models to capture limitations of the models as necessary. Such qualitative factors may include adjustments to better capture the imprecision associated with the economic forecasts, and the ability of the models to capture emerging risks within the portfolio that may not be represented in the data. These judgments are evaluated through the Company’s review process and revised on a quarterly basis to account for changes in facts and circumstances.

One of the more significant judgments involved in estimating the Company’s ACL relates to the macroeconomic forecasts used to estimate credit losses and the relative weightings applied to them. To illustrate the impact of changes in these forecasts to the Company’s ACL, the Company performed a hypothetical sensitivity analysis that decreased the weight on the baseline scenario by 33% and equally allocated the difference to increase the weights on the more optimistic and adverse scenarios. All else equal, the impact of this hypothetical forecast would result in a net increase of approximately $4.9 million, or 9.3%, in the Company’s total ACL for loans and loan commitments as of September 30, 2023. This hypothetical analysis is intended to illustrate the impact of adverse changes in the macroeconomic environment at a point in time and is not intended to reflect the full nature and extent of potential future change in the ACL. It is difficult to estimate how potential changes in any one of the quantitative inputs or qualitative factors might affect the overall ACL and the Company’s current assessments may not reflect the potential future impact of changes to those inputs or factors.

Emerging Growth Company

As of December 31, 2022, which was the last day of the fiscal year of the Company following the fifth anniversary of the Company’s initial public offering of common equity securities, the Company no longer qualified as an EGC, as defined in Section 3(a) of the Securities Act of 1933, as amended by the JOBS Act.

Discussion of Financial Condition

The Company had total assets of $6.7 billion at September 30, 2023, an increase of $416.0 million, or 6.6%, from December 31, 2022.

Total cash and cash equivalents were $177.4 million at September 30, 2023, a decrease of $80.1 million, or 31.1%, from December 31, 2022. The decrease from December 31, 2022, primarily reflected the $514.0 million net deployment into loans partially offset by the $243.7 million increase in deposits, $105.0 million increase in borrowings and $73.2 million of cash from operations.

Total securities were $910.8 million at September 30, 2023, a decrease of $47.5 million, or 5.0%, from December 31, 2022. The decrease was primarily due to the $88.4 million paydown and maturities of AFS and HTM securities, partially offset by the purchase of $52.5 million of AFS and HTM securities.

Loans

Total loans, net of deferred fees and unamortized costs, were $5.4 billion at September 30, 2023, an increase of $514.0 million, or 10.6%, from December 31, 2022. At September 30, 2023, 80.9% of the CRE and C&I loan portfolio is concentrated in the New York Metropolitan Area, mainly New York City, and Florida. The increase in total loans from December 31, 2022, was due primarily to an increase of $458.1 million in CRE (including owner-occupied) loans and $68.2 million in C&I loans, partially offset by a $9.6 million decrease in one-to-four family and consumer loans.

As of September 30, 2023, total loans consisted primarily of CRE loans (including multi-family mortgage loans) and C&I loans. The Company’s commercial loan portfolio includes loans to the following industries (dollars in thousands):

(1) CRE, not including one-to-four family loans

Asset Quality

Non-performing loans increased to $31.0 million at September 30, 2023 from $24,000 at December 31, 2022, due to one CRE loan that is fully secured and two C&I loans where payment is expected in full. The table below sets forth key asset quality ratios (dollars in thousands):

N.M. – not meaningful

Allowance for Credit Losses

The ACL was $52.3 million at September 30, 2023, as compared to $44.9 million at December 31, 2022. The increase from December 31, 2022 was partially due to the Company adopting ASU No. 2016-13, Financial Instruments – Credit Losses (ASC 326) effective January 1, 2023. ASU No. 2016-13 requires the measurement of all expected credit losses for financial assets held at amortized cost to be based on historical experience, current condition, and reasonable and supportable forecasts. Upon adoption, the Company recorded a $2.3 million increase to the ACL for loans, a $777,000 increase to the ACL for loan commitments, and a $2.1 million decrease to retained earnings, net of taxes. The Company also recorded a $5.7 million provision for credit losses for the nine months ended September 30, 2023, primarily driven by loan growth.

Deposits

Total deposits were $5.5 billion at September 30, 2023, an increase of $243.7 million, or 4.6%, from December 31, 2022. The increase from December 31, 2022, was due primarily to an increase of $660.4 million of retail deposits and $64.8 million in all other deposit verticals, partially offset by the decrease of $488.9 million in digital currency business deposits. The decrease in digital currency business deposits reflects the Company’s final exit from the crypto-related vertical. Non-interest-bearing demand deposits were 31.6% of total deposits at September 30, 2023, compared to 45.9% at December 31, 2022.

The table below summarizes the Company’s deposit composition by segment for the periods indicated (dollars in thousands):

At September 30, 2023, the aggregate estimated amount of FDIC uninsured deposits was $1.5 billion. In addition, as of September 30, 2023, the aggregate estimated amount of the Company’s uninsured time deposits was $21.0 million. The following table presents the scheduled maturities of time deposits greater than $250,000 (in thousands):

Borrowings

Federal Funds Purchased and FHLB Advances

To support a more efficient balance sheet, particularly related to the decrease in deposits related to the exit of the digital currency business, the Company may at times utilize FHLB advances or other funding sources. At September 30, 2023, the Company had $0.0 million of Federal funds purchased and $355.0 million of FHLBNY advances. At December 31, 2022, the Company had $150.0 million of Federal funds purchased and $100.0 million of FHLBNY advances.

Accumulated Other Comprehensive Income

Accumulated other comprehensive loss, net of tax, was $60.2 million at September 30, 2023, an increase of $5.9 million from December 31, 2022. The increase from December 31, 2022 was due to an increase in unrealized losses on AFS securities due to changes in prevailing interest rates and the reclassification to net income of gains on a terminated cash flow hedge, partially offset by net unrealized gains on outstanding cash flow hedges.

In 2023, the Company entered into interest rate swap derivative contracts as a part of its asset liability management strategy to help manage its interest rate risk position. The interest rate swaps are designated as cash flow hedges of certain deposit liabilities and borrowings of the Company. The interest rate swaps have a notional amount of $700.0 million and contractual maturities of one- to five- years.

In 2020, the Company entered into an interest rate cap derivative contract as a part of its asset liability management strategy to help manage its interest rate risk position. The interest rate cap was designated as a cash flow hedge of certain deposit liabilities. In the third quarter of 2022, the Company terminated the interest rate cap and monetized the gain on the derivative. The unrecognized value of $12.7 million at termination will be released from AOCI and recorded as a credit to Licensing fees expense through March 2025.

Results of Operations

Net Income

Net income was $22.1 million for the third quarter of 2023 a decrease of $2.9 million as compared to $25.0 million for the third quarter of 2022. This decrease was due primarily to the $9.8 million decrease in net interest income due to changes in prevailing interest rates and non-interest bearing crypto-related deposits being replaced with interest bearing funding due to the final exit from the digital currency business, partially offset by discrete tax benefits related to the exercise of stock options and the reversal of the regulatory settlement reserve in the third quarter of 2023.

Net income was $62.7 million for the nine months ended September 30, 2023 a decrease of $4.5 million as compared to $67.2 million for the nine months ended September 30, 2022. This decrease was due primarily to the $12.3 million increase in non-interest expense, partially offset by the $2.0 million decrease in the provision for credit losses and $1.2 million increase in non-interest income.

Net Interest Income Analysis

Net interest income is the difference between interest earned on assets and interest incurred on liabilities. The following tables present an analysis of net interest income by each major category of interest-earning assets and interest-bearing liabilities. The tables present the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Yields and costs were derived by dividing income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. Average balances were derived from daily balances over the periods indicated. Interest income includes fees that management considers to be adjustments to yields. The yield on AFS securities is based on amortized cost of the securities. Yields on tax-exempt obligations were not computed on a tax-equivalent basis. Non-accrual loans were included in the computation of average balances and therefore have a zero yield. The yields set forth below include the effect of deferred loan origination fees and costs, and purchase discounts and premiums that are amortized or accreted to interest income.

(dollars in thousands)

(1) Annualized.

(2) Amount includes deferred loan fees and non-performing loans.

(3) Determined by subtracting the annualized average cost of total interest-bearing liabilities from the annualized average yield on total interest-earning assets.

(4) Determined by dividing annualized net interest income by total average interest-earning assets.

(5) Determined by dividing annualized interest expense on deposits by total average interest-bearing and non-interest bearing deposits.

(6) Determined by dividing annualized interest expense by the sum of total average interest-bearing liabilities and total average non-interest-bearing deposits.

(dollars in thousands)

(1) Annualized.

(2) Amount includes deferred loan fees and non-performing loans.

(3) Determined by subtracting the annualized average cost of total interest-bearing liabilities from the annualized average yield on total interest-earning assets.

(4) Determined by dividing annualized net interest income by total average interest-earning assets.

(5) Determined by dividing annualized interest expense on deposits by total average interest-bearing and non-interest bearing deposits.

(6) Determined by dividing annualized interest expense by the sum of total average interest-bearing liabilities and total average non-interest-bearing deposits.

Net interest margin for the third quarter of 2023 was 3.27% compared to 3.85% for the third quarter of 2022. The 58 basis point decrease was due primarily to the 258 basis point increase in the total cost of funds reflecting the increase in prevailing market interest rates and the shift from non-interest bearing deposits to interest bearing funding primarily related to the final exit from the crypto-related deposit vertical, partially offset by the increase in the average balance of loans and loan yields.

Net interest margin for the nine months ended September 30, 2023 was 3.53% compared to 3.29% for the nine months ended September 30, 2022. The 24 basis point increase was driven primarily by the increase in the $801.1 million increase in the average balance of loans and the 155 basis point increase in loan yields, partially offset by the higher cost of funds. Total cost of funds for the nine months ended September 30, 2023 was 248 basis points compared to 33 basis points for the nine months ended September 30, 2022, which reflects the increase in prevailing interest rates and the shift from non-interest bearing deposits to interest bearing funding primarily related to the final exit from the crypto-related deposit vertical.

Interest Income

Interest income increased $27.8 million to $97.9 million for the third quarter of 2023 as compared to $70.1 million for the third quarter of 2022, primarily due to the increase in the average balance of loans and increase in yields for loans and overnight deposits. The average balance of loans increased $778.9 million for the third quarter of 2023 as compared to the third quarter of 2022. The yields on loans and overnight deposits increased 150 basis points and 343 basis points, respectively, for the third quarter of 2023 as compared to the third quarter of 2022 due to the increase in prevailing market interest rates.

Interest income increased $90.0 million to $270.1 million for the nine months ended September 30, 2023 as compared to $180.2 million for the nine months ended September 30, 2022, primarily due to the increase in the average balance of loans and increase in yields for loans and overnight deposits, partially offset by the decline in the average balance of overnight deposits. The average balance of loans increased $801.1 million for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022. The yields on loans and overnight deposits increased 155 basis points and 428 basis points, respectively, for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022 due to the increase in prevailing market interest rates. The average balance of overnight deposits decreased $1.2 billion for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022, reflecting the final exit from the crypto-related deposit vertical.

Interest Expense

Interest expense increased $37.6 million to $44.3 million for the third quarter of 2023 as compared to $6.7 million for the third quarter of 2022 due primarily to the increase in prevailing interest rates and higher borrowing balances related to the final exit from the crypto-related deposit vertical. The yield on interest bearing deposits increased 312 basis points for the third quarter of 2023 as compared to the third quarter of 2022. The average balance of borrowings increased $551.9 million for the third quarter of 2023 as compared to the third quarter of 2022.

Interest expense increased $89.4 million to $104.3 million for the nine months ended September 30, 2023 as compared to $14.9 million for the nine months ended September 30, 2022 due primarily to the increase in prevailing interest rates and higher borrowing balances related to the final exit from the crypto-related deposit vertical. The yield on interest bearing deposits increased 298 basis points for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022. The average balance of borrowings increased $424.0 million for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022.

Provision for Loan Losses

The provision for loan losses for the three and nine months ended September 30, 2023, based on ASC 326, was $791,000 and $5.7 million, respectively, primarily driven by loan growth. The provision for loan losses for the three and nine months ended September 30, 2022, based on the incurred loss method, was $2.0 million and $7.8 million, respectively, primarily driven by loan growth.

Non-Interest Income

Non-interest income increased $695,000 to $6.5 million for the third quarter of 2023, as compared to the third quarter of 2022 driven by increases in other service charges and fees. Non-interest income increased $1.1 million to $21.3 million for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022 driven by increases in other service charges and fees.

Non-Interest Expense

Non-interest expense decreased $266,000 to $30.9 million for the third quarter of 2023, compared to the third quarter of 2022 due primarily to the $3.0 million reversal of the regulatory settlement reserve recorded in the fourth quarter of 2022 and the $2.2 million reduction in professional fees, partially offset by the $2.6 million increase in compensation and benefits.

Non-interest expense increased $12.3 million to $94.4 million for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022 due primarily to the $7.4 million increase in compensation and benefits expense due to the increase in the number of full-time employees, the $3.8 million increase in professional fees, including legal fees, and $2.8 million increase in FDIC assessments, partially offset by the $5.5 million reversal of the regulatory settlement reserve recorded in the fourth quarter of 2022.

Income Tax Expense

The estimated effective tax rate for the third quarter of 2023 was 22.2% as compared to 30.6% for the third quarter of 2022. The effective tax rate for the third quarter of 2023 reflects a discrete tax item related to the exercise of stock options in the third quarter of 2023 and the reversal of the regulatory settlement reserve. The estimated effective tax rate for the nine months ended September 30, 2023 was 28.0% as compared to 29.8% for the nine months ended September 30, 2022.

Off-Balance Sheet Arrangements

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, which involve elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Exposure to credit loss is represented by the contractual amount of the instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments.

At September 30, 2023, the Company had $465.0 million in unused commitments and $60.2 million in standby and commercial letters of credit. At December 31, 2022, the Company had $405.6 million in unused commitments and $53.9 million in standby and commercial letters of credit.

Liquidity and Capital Resources

Liquidity is the ability to economically meet current and future financial obligations. The Company’s primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of securities and borrowings. While maturities and scheduled amortization of loans and securities and borrowings are predictable sources of funds, deposit flows, mortgage prepayments and security sales are greatly influenced by the general level of interest rates and changes thereto, economic conditions and competition.

The Company regularly reviews the need to adjust investments in liquid assets based upon its assessment of: (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of its asset/liability program. Excess liquidity is generally invested in interest-earning deposits and short- and intermediate-term securities.

The Company’s most liquid assets are cash and cash equivalents. The levels of these assets are dependent on its operating, financing, lending and investing activities during any given period. At September 30, 2023 and December 31, 2022, cash and cash equivalents totaled $177.4 million and $257.4 million, respectively. Securities classified as AFS and equity investments, which provide additional sources of liquidity, totaled $431.9 million at September 30, 2023 and $447.8 million at December 31, 2022. At September 30, 2023 and December 31, 2022, the carrying value of securities pledged to the FRBNY discount window was $789.5 million and $25.0 million, respectively.

The Company has no material commitments or demands that are likely to affect its liquidity other than as set forth below. In the event loan demand were to increase faster than expected, or any other unforeseen demand or commitment were to occur, the Company could access its borrowing capacity with the FHLB or obtain additional funds through alternative funding sources, including the brokered deposit market.

The Company had $3.0 billion and $1.1 billion of available secured wholesale funding capacity at September 30, 2023 and December 31, 2022, respectively. The increase in secured funding capacity is due to the Company optimizing its liquidity resources through the pledge of additional eligible loan collateral.

The Company’s primary investing activities are the origination of loans, and to a lesser extent, the purchase of loans and securities. For the three and nine months ended September 30, 2023, the Company’s loan production was $333.5 million and $1.0 billion, respectively as compared to $423.6 million and $1.4 billion for the three and nine months ended September 30, 2022, respectively.

Financing activities consisted primarily of activity in deposit accounts and borrowings. The Company generates deposits from businesses and individuals through client referrals and other relationships and through its retail presence. The Company has established deposit concentration thresholds to avoid the possibility of dependence on any single depositor base for funds. Total deposits were $5.5 billion at September 30, 2023, an increase of $243.7 million, or 4.6%, from December 31, 2022.

At September 30, 2023, interest-bearing deposits were comprised of $3.7 billion of money market accounts and $35.7 million of time deposits. Time deposits due within one year of September 30, 2023 totaled $31.0 million, or 0.6% of total deposits. At September 30, 2023, the aggregate estimated amount of FDIC uninsured deposits was $1.5 billon. At December 31, 2022, interest-bearing deposits were comprised of $2.8 billion of money market accounts and $52.1 million of time deposits. Time deposits due within one year of December 31, 2022 totaled $37.6 million, or 0.7% of total deposits. Non-interest-bearing deposits were 31.6% of total deposits at September 30, 2023, as compared to 45.9% at December 31, 2022. At December 31, 2022, the aggregate estimated amount of FDIC uninsured deposits was $2.2 billion.

To support a more efficient balance sheet, particularly related to the decrease in deposits related to the final exit of the digital currency business, the Company may at times utilize FHLB advances or other funding sources. At September 30, 2023, the Company had $0.0 million of Federal funds purchased and $355.0 million of FHLBNY advances.

In March 2023, certain specialized banking institutions with elevated concentrations of uninsured deposits experienced large deposit outflows, resulting in the institutions being placed into FDIC receiverships. In the aftermath, there was substantial market disruption and indications that deposit concerns could spread within the banking industry, leading to deposit outflows and other destabilizing results. In response to these events, the Treasury Department, Federal Reserve, and FDIC jointly announced the Bank Term Funding Program (“BTFP”) on March 12, 2023. This program aims to enhance liquidity by allowing institutions to pledge certain securities at the par value of the securities, and at a borrowing rate of ten basis points over the one-year overnight index swap rate. The BTFP is available to eligible U.S. federally insured depository institutions, with advances having a term of up to one year and no prepayment penalties. The BTFP is available to the Company.

Regulation

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. At September 30, 2023 and December 31, 2022, the Company and the Bank met all applicable regulatory capital requirements to be considered “well capitalized” under regulatory guidelines. The Company and the Bank manage their capital to comply with their internal planning targets and regulatory capital standards administered by federal banking agencies. The Company and the Bank review capital levels on a monthly basis. Below is a table of the Company’s and Bank’s capital ratios for the periods indicated:

At September 30, 2023 and December 31, 2022, total non-owner-occupied CRE loans were 374.8% and 366.0% of risk-based capital, respectively.

General

The principal objective of the Company’s asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity and capital. The Board of Directors has oversight of the Company’s asset and liability management function, which is managed by the Company’s ALCO. The ALCO meets regularly to review, among other things, the sensitivity of assets and liabilities to market interest rate changes, local and national market conditions and market interest rates. That group also reviews liquidity, capital, deposit mix, loan mix and investment positions.

Interest Rate Risk

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

The Company manages its exposure to interest rates primarily by structuring its balance sheet in the ordinary course of business. The Company generally originates fixed and floating rate loans with maturities of less than five years. The interest rate risk on these loans is offset by the cost of deposits, where many of such deposits generally pay interest based on a floating rate index. Based upon the nature of operations, the Company is not subject to FX or commodity price risk and does not own any trading assets. The Company enters into interest rate derivative contracts as part of its interest rate risk management strategy to hedge certain deposit liabilities and to facilitate the needs of lending customers. For further discussion see “NOTE 13 — DERIVATIVES” to the Company’s consolidated financial statements in this Form 10-Q.

Net Interest Income At-Risk

The Company analyzes its sensitivity to changes in interest rates through a net interest income simulation model, which estimates what net interest income would be for a one-year period based on current interest rates, and then calculates what the net interest income would be for the same period under different interest rate assumptions. For modeling purposes, the Company reclassifies licensing fees on corporate cash management accounts from non-interest expense to interest expense since the fees are indexed to certain market interest rates.

The following table shows the estimated impact on net interest income for the one-year period beginning September 30, 2023 resulting from potential changes in interest rates, expressed in basis points. These estimates require certain assumptions to be made, including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturities and decay rates. These assumptions are inherently uncertain. As a result, no simulation model can precisely predict the impact of changes in interest rates on net interest income.

Although the net interest income table below provides an indication of the Company’s IRR exposure at a particular point in time, such estimates are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results. The following table indicates the sensitivity of projected annualized net interest income to the interest rate movements described above (dollars in thousands):

At September 30, 2023

The table above indicates that at September 30, 2023, in the event of an instantaneous and sustained parallel upward shift of 200 basis points in interest rates, the Company would experience a 7.21% decrease in net interest income. In the event of an instantaneous and sustained parallel downward shift of 200 basis points in interest rates, it would experience a 5.34% increase in net interest income.

Economic Value of Equity Analysis

The Company also analyzes the sensitivity of its financial condition to changes in interest rates through an EVE model. This analysis measures the difference between predicted changes in the fair value of assets and predicted changes in the present value of liabilities assuming various changes in current interest rates. The table below represents an analysis of IRR as measured by the estimated changes in EVE, resulting from an instantaneous and sustained parallel shift in the yield curve (+100, +200, +300 and +400 basis points and -100, -200, -300 and -400 basis points) at September 30, 2023 (dollars in thousands):

(1) Assumes an immediate uniform change in interest rates at all maturities.

(2) EVE is the fair value of expected cash flows from assets, less the fair value of the expected cash flows arising from the Company’s liabilities adjusted for the value of off-balance sheet contracts.

(3) Fair value of assets represents the amount at which an asset could be exchanged between knowledgeable and willing parties in an arms-length transaction.

(4) EVE Ratio represents EVE divided by the fair value of assets.

The table above indicates that at September 30, 2023, in the event of an immediate upward shift of 200 basis points in interest rates, it would experience a 10.94% decrease in its EVE. In the event of an immediate downward shift of 200 basis points in interest rates, the Company would experience an 3.09% increase in its EVE.

The preceding simulation analyses do not represent a forecast of actual results and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, which are subject to change, including: the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. Also, as market conditions vary, prepayment/refinancing levels, the varying impact of interest rate changes on caps and floors embedded in adjustable-rate loans, early withdrawal of deposits, changes in product preferences, and other internal/external variables will likely deviate from those assumed.

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of its Chief Executive Officer, who is the Company’s principal executive officer, and the Chief Accounting Officer, who is the Company’s acting principal financial officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2023 pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, the principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2023. In addition, there have been no changes in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in reports filed by the Company under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Accounting Officer, as appropriate to allow timely decisions regarding required disclosure.

There are risks, many beyond our control, which could cause our results to differ significantly from management’s expectations. For a description of these risks, please see the risk factors included below and see the risk factors previously described in Part I, “Item 1A. Risk Factors” in our 2022 Form 10-K. There have been no material changes to our risk factors since the date of that filing, other than as noted below. Any of the risks described in our 2022 Form 10-K or in this Quarterly Report on Form 10-Q could, by itself or together with one or more other factors, materially and adversely affect our business, results of operations or financial condition. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, results of operations or financial condition.

Financial challenges at other banking institutions could lead to depositor concerns that spread within the banking industry causing disruptive deposit outflows and other destabilizing results.

In March 2023, certain specialized banking institutions with elevated concentrations of uninsured deposits experienced large deposit outflows, resulting in the institutions being placed into FDIC receiverships. In the aftermath, there has been substantial market disruption and indications that deposit concerns could spread within the banking industry, leading to deposit outflows and other destabilizing results that could adversely affect the Company’s business, financial condition and results of operations.