UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-35654
NATIONAL BANK HOLDINGS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
27-0563799
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
7800 East Orchard Road, Suite 300, Greenwood Village, Colorado 80111
(Address of principal executive offices) (Zip Code)
Registrant’s telephone, including area code: (303) 892-8715
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol
Name of each exchange on which registered:
Class A Common Stock
NBHC
NYSE
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
⌧
Accelerated filer
◻
Non-accelerated filer
Smaller reporting company
☐
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of November 4, 2022, the registrant had outstanding 37,594,260 shares of Class A voting common stock, each with $0.01 par value per share, excluding 153,630 shares of restricted Class A common stock issued but not yet vested.
6
Page
Part I. Financial Information
Item 1.
Financial Statements (Unaudited)
Consolidated Statements of Financial Condition as of September 30, 2022 and December 31, 2021
Consolidated Statements of Operations for the three and nine months ended September 30, 2022 and 2021
7
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2022 and 2021
8
Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2022 and 2021
9
Consolidated Statements of Cash Flows for the nine months ended September 30, 2022 and 2021
10
Notes to Consolidated Financial Statements
11
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
45
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
76
Item 4.
Controls and Procedures
Part II. Other Information
Legal Proceedings
77
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 5.
Other Information
Item 6.
Exhibits
78
Table of Contents
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, notwithstanding that such statements are not specifically identified. Any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believe,” “can,” “would,” “should,” “could,” “may,” “predict,” “seek,” “potential,” “will,” “estimate,” “target,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “intend” and similar words or phrases. These statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties. We have based these statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, liquidity, results of operations, business strategy and growth prospects.
Forward-looking statements involve certain important risks, uncertainties and other factors, any of which could cause actual results to differ materially from those in such statements and, therefore, you are cautioned not to place undue reliance on such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
● difficulties and delays in integrating the mergers of NBHC, Community Bancorporation, and Bancshares of Jackson Hole Incorporated (the “mergers”) businesses or fully realizing cost savings and other benefits;
● business disruption following the mergers;
● our ability to execute our business strategy, including our digital strategy, as well as changes in our business strategy or development plans;
● business and economic conditions generally and in the financial services industry;
● effects of any potential government shutdowns;
● economic, market, operational, liquidity, credit and interest rate risks associated with our business;
● effects of any changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;
● changes imposed by regulatory agencies to increase our capital to a level greater than the current level required for well-capitalized financial institutions;
● effects of inflation, including its associated impact on labor costs, as well as, interest rate, securities market and monetary supply fluctuations;
● changes in the economy or supply-demand imbalances affecting local real estate values;
● changes in consumer spending, borrowings and savings habits;
● with respect to our mortgage business, our inability to negotiate our fees with Fannie Mae, Freddie Mac, Ginnie Mae or other investors for the purchase of our loans, our obligation to indemnify purchasers or to repurchase the related loans if the loans fail to meet certain criteria, or higher rate of delinquencies and defaults as a result of the geographic concentration of our servicing portfolio;
● our ability to identify potential candidates for, obtain regulatory approval for, and consummate, acquisitions, consolidations or other expansion opportunities on attractive terms, or at all;
● our ability to integrate acquisitions or consolidations and to achieve synergies, operating efficiencies and/or other expected benefits within expected time-frames, or at all, or within expected cost projections, and to preserve the goodwill of acquired financial institutions;
● our ability to realize the anticipated benefits from enhancements or updates to our core operating systems from time to time without significant change in our client service or risk to our control environment;
3
● our dependence on information technology and telecommunications systems of third-party service providers and the risk of system failures, interruptions or breaches of security, including those that could result in disclosure or misuse of confidential or proprietary client or other information;
● our ability to achieve organic loan and deposit growth and the composition of such growth;
● changes in sources and uses of funds, including loans, deposits and borrowings;
● increased competition in the financial services industry, nationally, regionally or locally, resulting in, among other things, lower returns;
● continued consolidation in the financial services industry;
● our ability to maintain or increase market share and control expenses;
● the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board (“FASB”) and other accounting standard setters;
● the trading price of shares of the Company's stock;
● the effects of tax legislation, including the potential of future increases to prevailing tax rates, or challenges to our
positions;
● our ability to realize deferred tax assets or the need for a valuation allowance, or the effects of changes in tax laws on our deferred tax assets;
● costs and effects of changes in laws and regulations and of other legal and regulatory developments, including, but not limited to, changes in regulation that affect the fees that we charge, the resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations, reviews or other inquiries; and changes in regulations that apply to us as a Colorado state-chartered bank;
● technological changes;
● the timely development and acceptance of new products and services, including in the digital technology space and our digital solution 2UniFiSM, and perceived overall value of these products and services by our clients;
● changes in our management personnel and our continued ability to attract, hire and retain qualified personnel;
● ability to implement and/or improve operational management and other internal risk controls and processes and our reporting system and procedures;
● regulatory limitations on dividends from our bank subsidiary;
● changes in estimates of future credit reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements;
● widespread natural and other disasters, dislocations, political instability, pandemics, acts of war or terrorist activities, cyberattacks or international hostilities through impacts on the economy and financial markets generally or on us or our counterparties specifically;
● a cyber-security incident, data breach or a failure of a key information technology system;
● adverse effects due to the novel Coronavirus Disease 2019 (“COVID-19”) on the Company and its clients, counterparties, employees and third-party service providers, and the adverse impacts on our business, financial position, results of operations and prospects;
● impact of reputational risk on such matters as business generation and retention;
● other risks and uncertainties listed from time to time in the Company’s reports and documents filed with the Securities and Exchange Commission; and
4
● our success at managing the risks involved in the foregoing items.
Any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events or circumstances, except as required by applicable law.
5
PART I: FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
NATIONAL BANK HOLDINGS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition (Unaudited)
(In thousands, except share and per share data)
September 30, 2022
December 31, 2021
ASSETS
Cash and due from banks
$
255,458
845,195
Interest bearing bank deposits
749
500
Cash and cash equivalents
256,207
845,695
Investment securities available-for-sale (at fair value)
730,791
691,847
Investment securities held-to-maturity (fair value of $508,961 and $599,260 at September 30, 2022 and December 31, 2021, respectively)
606,245
609,012
Non-marketable securities
64,004
50,740
Loans
5,721,985
4,513,383
Allowance for credit losses
(65,623)
(49,694)
Loans, net
5,656,362
4,463,689
Loans held for sale
33,043
139,142
Other real estate owned
3,695
7,005
Premises and equipment, net
105,801
96,747
Goodwill
167,882
115,027
Intangible assets, net
30,843
12,322
Other assets
268,048
182,785
Total assets
7,922,921
7,214,011
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Non-interest bearing demand deposits
2,735,832
2,506,265
Interest bearing demand deposits
597,035
555,401
Savings and money market
2,631,855
2,332,591
Time deposits
838,830
833,916
Total deposits
6,803,552
6,228,173
Securities sold under agreements to repurchase
20,044
22,768
Long-term debt, net
39,559
39,478
Other liabilities
140,340
83,486
Total liabilities
7,003,495
6,373,905
Shareholders’ equity:
Common stock, par value $0.01 per share: 400,000,000 shares authorized; 51,487,907 and 51,487,907 shares issued; 33,189,253 and 29,958,764 shares outstanding at September 30, 2022 and December 31, 2021, respectively
515
Additional paid-in capital
1,079,560
1,014,294
Retained earnings
323,448
289,876
Treasury stock of 18,129,309 and 21,384,676 shares at September 30, 2022 and December 31, 2021, respectively, at cost
(394,758)
(457,616)
Accumulated other comprehensive loss, net of tax
(89,339)
(6,963)
Total shareholders’ equity
919,426
840,106
Total liabilities and shareholders’ equity
See accompanying notes to the consolidated interim financial statements.
Consolidated Statements of Operations (Unaudited)
For the three months ended
For the nine months ended
September 30,
2022
2021
Interest and dividend income:
Interest and fees on loans
63,875
45,512
159,707
134,342
Interest and dividends on investment securities
6,460
4,750
17,195
12,771
Dividends on non-marketable securities
212
210
632
629
Interest on interest-bearing bank deposits
1,822
329
3,196
722
Total interest and dividend income
72,369
50,801
180,730
148,464
Interest expense:
Interest on deposits
2,945
3,227
7,961
10,790
Interest on borrowings
333
1,000
16
Total interest expense
3,278
3,232
8,961
10,806
Net interest income before provision for credit losses
69,091
47,569
171,769
137,658
Provision expense (release) for credit losses
12,678
—
14,860
(9,425)
Net interest income after provision for credit losses
56,413
156,909
147,083
Non-interest income:
Service charges
4,326
3,947
11,992
10,989
Bank card fees
4,681
4,530
13,345
13,217
Mortgage banking income
4,474
16,615
21,088
52,973
Bank-owned life insurance income
573
558
1,645
1,659
Other non-interest income
3,303
2,872
5,098
8,276
OREO-related income
1
35
Total non-interest income
17,358
28,522
53,174
87,149
Non-interest expense:
Salaries and benefits
30,540
32,556
88,652
97,518
Occupancy and equipment
8,026
6,469
21,087
19,150
Telecommunications and data processing
2,899
2,282
7,733
6,934
Marketing and business development
979
582
2,326
1,604
FDIC deposit insurance
508
475
1,476
1,375
Bank card expenses
1,409
1,457
4,075
3,931
Professional fees
5,810
3,251
8,110
4,642
Other non-interest expense
3,547
2,828
9,264
7,652
Problem asset workout
215
1,119
522
1,851
(Gain) loss on OREO sales, net
(378)
(648)
192
Core deposit intangible asset amortization
383
295
975
887
Banking center consolidation-related expense
1,589
Total non-interest expense
53,938
51,314
143,572
147,325
Income before income taxes
19,833
24,777
66,511
86,907
Income tax expense
3,994
4,952
11,958
16,070
Net income
15,839
19,825
54,553
70,837
Earnings per share—basic
0.51
0.64
1.78
2.29
Earnings per share—diluted
0.50
1.77
2.27
Weighted average number of common shares outstanding:
Basic
31,259,188
30,800,590
30,539,266
30,858,759
Diluted
31,531,075
31,064,815
30,834,630
31,162,132
Consolidated Statements of Comprehensive (Loss) Income (Unaudited)
(In thousands)
Other comprehensive loss, net of tax:
Securities available-for-sale:
Net unrealized losses arising during the period, net of tax benefit of $9,184 and $922 for the three months ended September 30, 2022 and 2021, respectively; and net of tax benefit of $25,030 and $3,331 for the nine months ended September 30, 2022 and 2021, respectively
(29,482)
(2,970)
(80,349)
(10,727)
Less: amortization of net unrealized holding losses, net of tax benefit of $22 and $38 for the three months ended September 30, 2022 and 2021, respectively; and net of tax benefit of $75 and $135 for the nine months ended September 30, 2022 and 2021, respectively
(71)
(122)
(242)
(436)
Cash flow hedges:
Net unrealized losses arising during the period, net of tax benefit of $559 and $0 for the three months ended September 30, 2022 and 2021, respectively; and net of tax benefit of $559 and $0 for the nine months ended September 30, 2022 and 2021, respectively
(1,795)
Less: reclassification adjustment for gains included in net income, net of tax expense of $3 and $0 for the three months ended September 30, 2022 and September 30, 2021, respectively; and net of tax expense of $3 and $0 for the nine months ended September 30, 2022 and September 30, 2021, respectively
Other comprehensive loss
(31,338)
(3,092)
(82,376)
(11,163)
Comprehensive (loss) income
(15,499)
16,733
(27,823)
59,674
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
For the three months ended September 30,
Accumulated
Additional
other
Common
paid-in
Retained
Treasury
comprehensive
stock
capital
earnings
loss, net
Total
Balance, June 30, 2021
1,011,200
260,821
(422,365)
1,695
851,866
Stock-based compensation
1,734
Issuance of stock under purchase and equity compensation plans, including gain on reissuance of treasury stock of $313, net
130
369
499
Repurchase of 527,214 shares
(19,370)
Cash dividends declared ($0.22 per share)
(6,746)
Balance, September 30, 2021
1,013,064
273,900
(441,366)
(1,397)
844,716
Balance, June 30, 2022
1,014,330
314,616
(455,909)
(58,001)
815,551
1,494
Issuance of stock under purchase and equity compensation plans, including gain on reissuance of treasury stock of $64,175, net
106
509
615
Reissuance of treasury stock of 3,096,745 for acquisition of Community Bancorporation
63,630
60,642
124,272
Cash dividends declared ($0.23 per share)
(7,007)
Balance, September 30, 2022
For the nine months ended September 30,
Balance, December 31, 2020
1,011,362
223,175
(424,127)
9,766
820,691
4,216
Issuance of stock under purchase and equity compensation plans, including gain on reissuance of treasury stock of $3,500, net
(2,514)
2,131
(383)
Cash dividends declared ($0.65 per share)
(20,112)
Balance, December 31, 2021
4,342
Issuance of stock under purchase and equity compensation plans, including gain on reissuance of treasury stock of $67,024, net
(2,706)
2,216
(490)
Cash dividends declared ($0.69 per share)
(20,981)
Consolidated Statements of Cash Flows (Unaudited)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
12,386
Depreciation and amortization
10,712
11,536
Change in current income tax receivable
5,677
3,476
Change in deferred income taxes
(21,295)
(207)
Net excess tax benefit from stock-based compensation
(216)
(396)
Discount accretion, net of premium amortization on securities
1,192
3,398
Gain on sale of mortgages, net
(20,733)
(47,322)
Origination of loans held for sale, net of repayments
(710,743)
(1,506,880)
Proceeds from sales of loans held for sale
845,406
1,649,747
Originations of mortgage serving rights
(3,895)
(6,649)
Proceeds from sales of mortgage servicing rights
11,375
Gain on sale of mortgage servicing rights
(1,290)
Impairment on other real estate owned
227
799
Impairment on fixed assets related to banking center consolidations
118
1,552
Gain on sale of fixed assets
(1,674)
(2,708)
Gain from banking center divestiture
(778)
Operating lease payments
(3,515)
(3,910)
Change in other assets
(35,110)
3,440
Change in other liabilities
43,665
(35,945)
Net cash provided by operating activities
181,097
144,866
Cash flows from investing activities:
Proceeds from non-marketable securities
64
1,912
Proceeds from maturities of investment securities available-for-sale
116,002
185,025
Proceeds from maturities of investment securities held-to-maturity
93,201
108,993
Proceeds from sales of other real estate owned
3,563
936
Purchase of non-marketable securities
(11,494)
(25,772)
Purchase of investment securities available-for-sale
(260,249)
(196,257)
Purchase of investment securities held-to-maturity
(91,607)
(377,687)
(Purchases) sales of premises and equipment, net
(9,912)
8,572
Net increase in loans
(673,939)
(71,913)
Proceeds from the sale of loans
933
Net cash activity from acquisition
244,742
Net cash used in investing activities
(588,696)
(366,191)
Cash flows from financing activities:
Net (decrease) increase in deposits
(159,101)
459,166
Net decrease in repurchase agreements and other short-term borrowings
(2,724)
(1,470)
Issuance of stock under purchase and equity compensation plans
(1,210)
(2,020)
Proceeds from exercise of stock options
639
1,557
Payment of dividends
(21,004)
(20,208)
Repurchase of common stock
Net cash (used in) provided by financing activities
(183,400)
417,655
(Decrease) increase in cash, cash equivalents and restricted cash(1)
(590,999)
196,330
Cash, cash equivalents and restricted cash at beginning of the year(1)
850,220
615,565
Cash, cash equivalents and restricted cash at end of period(1)
259,221
811,895
Supplemental disclosure of cash flow information during the period:
Cash paid for interest
9,587
12,719
Net tax payments
5,567
9,334
Supplemental schedule of non-cash activities:
Loans transferred from loans held for sale to loans
4,762
5,798
Treasury stock reissued for acquisition
(1)
Included in restricted cash at September 30, 2022 and 2021 is $3.0 million and $4.5 million, respectively, placed in escrow for certain potential liabilities, for which the Company is indemnified, pursuant to the Peoples merger agreement. The restricted cash is included in other assets in the Company’s consolidated statements of financial condition.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1 Basis of Presentation
National Bank Holdings Corporation ("NBHC" or the "Company") is a bank holding company that was incorporated in the State of Delaware in 2009. The Company is headquartered in Greenwood Village, Colorado, and its primary operations are conducted through its wholly owned subsidiary, NBH Bank (the "Bank"), a Colorado state-chartered bank and a member of the Federal Reserve System. The Company provides a variety of banking products to both commercial and consumer clients through a network of 86 banking centers, as of September 30, 2022, located primarily in Colorado, the greater Kansas City region, Utah, Texas and New Mexico, as well as through online and mobile banking products and services.
The accompanying interim unaudited consolidated financial statements serve to update the National Bank Holdings Corporation Annual Report on Form 10-K for the year ended December 31, 2021 and include the accounts of the Company and its wholly owned subsidiary, NBH Bank. The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and, where applicable, with general practices in the banking industry or guidelines prescribed by bank regulatory agencies. However, they may not include all information and notes necessary to constitute a complete set of financial statements under GAAP applicable to annual periods and accordingly should be read in conjunction with the financial information contained in the Company's most recent Form 10-K. The unaudited consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results presented. All such adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications of prior years' amounts are made whenever necessary to conform to current period presentation. The results of operations for the interim period are not necessarily indicative of the results that may be expected for the full year or any other interim period. All amounts are in thousands, except share data, or as otherwise noted.
GAAP requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses and disclosures of contingent assets and liabilities. By their nature, estimates are based on judgment and available information. Management has made significant estimates in certain areas, such as the fair values of financial instruments, contingent liabilities and the allowance for credit losses (“ACL”). Because of the inherent uncertainties associated with any estimation process and future changes in market and economic conditions, it is possible that actual results could differ significantly from those estimates.
The Company's significant accounting policies followed in the preparation of the unaudited consolidated financial statements are disclosed in note 2 of the audited financial statements and notes for the year ended December 31, 2021 and are contained in the Company's Annual Report on Form 10-K. There have been no significant changes to the application of significant accounting policies since December 31, 2021, with the exception of the following:
Acquired loans —ASC Topic 805, Business Combinations, requires all acquired loans be recorded at fair value at the date of acquisition. The fair value for acquired loans at the time of acquisition is based on a variety of factors including discounted expected cash flows, adjusted for estimated prepayments and credit losses. In accordance with ASC 326, the fair value adjustment is recorded as premium or discount to the unpaid principal balance of each acquired loan. Loans that have been identified as having experienced a more-than-insignificant deterioration in credit quality since origination are purchased credit deteriorated (“PCD”) loans. The net premium or discount on PCD loans is adjusted by our allowance for credit losses recorded at the time of acquisition. The remaining net premium or discount is accreted or amortized into interest income over the remaining life of the loan using a level yield method. The net premium or discount on loans that are not classified as PCD (“non-PCD”), that includes credit quality and interest rate considerations, is accreted or amortized into interest income over the remaining life of the loan using the level yield method. The Company then records the necessary allowance for credit losses on the non-PCD loans through provision for credit losses expense.
Note 2 Recent Accounting Pronouncements
The Company has not adopted any recent accounting pronouncements in addition to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021.
Note 3 Acquisition Activities
Rock Canyon Bank
On September 1, 2022, the Company completed its acquisition of Community Bancorporation, the bank holding company of Utah-based Rock Canyon Bank (“RCB”). Immediately following the completion of the acquisition, RCB merged into NBH Bank. Pursuant to the merger agreement executed in April 2022, the Company paid $16.1 million of cash consideration and issued 3,096,745 shares of the Company’s Class A common stock in exchange for all of the outstanding common stock of Community Bancorporation. The transaction was valued at $140.4 million in the aggregate, based on the Company’s closing price of $40.13 on August 31, 2022. The acquisition added seven banking centers to the Company’s footprint within the Provo and Greater Salt Lake City regions.
RCB acquisition-related costs totaled $9.1 million and $9.8 million for the three and nine months ended September 30, 2022, respectively, including a Day 1 CECL provision expense of $5.4 million. The results of RCB are included in the results of the Company subsequent to the acquisition date. The Company closed on its acquisition of Bancshares of Jackson Hole, the holding company for Bank of Jackson Hole (“BOJH”) on October 1, 2022. Refer to note 20 Subsequent Events in our unaudited consolidated financial statements for more information. Total acquisition-related costs for RCB and BOJH were $12.4 million and $13.6 million, which were included in the Company’s consolidated statements of operations for the three and nine months ended September 30, 2022, respectively.
The Company determined that the acquisition of RCB constitutes a business combination as defined in ASC Topic 805, Business Combinations. Accordingly, as of the date of the acquisition, the Company recorded the assets acquired and liabilities assumed at fair value. The Company determined fair values in accordance with the guidance provided in ASC Topic 820, Fair Value Measurements and Disclosures. In many cases, the determination of these fair values required management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change. Actual results could differ materially. The Company has made the determination of fair values using the best information available at the time; however, purchase accounting is not complete and the assumptions used are subject to change and, if changed, could have a material effect on the Company's financial position and results of operations.
12
The table below summarizes preliminary net assets acquired (at fair value) and consideration transferred in connection with the RCB acquisition:
September 1, 2022
Assets:
260,883
Investment securities available-for-sale
402
977
535,197
3,069
Premises and equipment
3,413
Core deposit and other intangibles
16,463
11,749
Total assets acquired
832,153
734,480
10,115
Total liabilities assumed
744,595
Identifiable net assets acquired
87,558
Consideration:
NBHC common stock paid, closing price of $40.13 on August 31, 2022
Cash
16,141
140,413
52,855
In connection with the RCB acquisition, the Company recorded $52.9 million of goodwill. The amount of goodwill recorded reflects the expanded market presence, synergies and operational efficiencies that are expected to result from the acquisition. The following is a description of the methods used to determine the fair values of significant assets and liabilities presented above:
Cash and due from banks—The carrying amount of these assets was deemed a reasonable estimate of fair value based on the short-term nature of these assets.
Loans, net—The fair value of loans were based on a discounted cash flow methodology that considered the loans’ underlying characteristics including account type, remaining terms of loan, annual interest rates or coupon, interest types, past delinquencies, timing of principal and interest payments, current market rates, loan to value ratios, loss exposure and remaining balance. The discount rates applied were based upon a build-up approach considering the alternative cost of funds, capital charges, servicing costs, and a liquidity premium. Loans were aggregated according to similar characteristics when applying the valuation method.
Core deposit and other intangibles—The Company recorded a core deposit intangible asset of $13.3 million and a Small Business Administration (“SBA”) servicing rights asset of $3.1 million. The core deposit intangible was valued utilizing a discounted cash flow methodology based upon assumptions regarding retained balances, such as account retention rate and growth rates, interest expense including maintenance costs, and alternative costs of funding. The discount rate applied is consistent to that applied to loans above. The SBA servicing asset was valued using a discounted cash flow methodology that included assumptions for pre-payment speeds and defaults discounted at a market-based discount rate. The valuation methodology was applied to each loan individually based upon its specific characteristics.
The core deposit intangible will be amortized straight-line over ten years, and the SBA servicing rights asset will be amortized over the life of the underlying portfolio.
13
Deposits—By definition, the fair value of demand and saving deposits equals the amount payable. For time deposits acquired, the Company utilized an income approach, discounting the contractual cash flows on the instruments over their remaining contractual lives at prevailing market rates.
The fair value of the acquired assets and liabilities noted in the table may change during the provisional period, which may last up to twelve months subsequent to the acquisition date. The Company may obtain additional information to refine the valuation of the acquired assets and liabilities and adjust the recorded fair value.
Accounting for acquired loans
A Day 1 CECL allowance for credit losses on the non-PCD loans was recorded through provision for credit loss expense within the consolidated statements of income. At the date of acquisition, of the $537.7 million of loans acquired from RCB, $11.1 million, or 2.1% of RCB’s loan portfolio, were accounted for as PCD loans. The gross contractual amounts receivable of PCD loans, inclusive of all principal and interest, was $13.1 million. The Company’s best estimate of the contractual cash flows for PCD loans not expected to be collected was $2.5 million.
The following table provides a summary of PCD loans purchased as part of the RCB acquisition as of the acquisition date:
Commercial
Commercial real estate non-owner occupied
Residential real estate
Consumer
Unpaid principal balance
12,079
220
843
13,145
PCD allowance for credit loss at acquisition
(2,257)
(2)
(215)
(2,474)
(Discount) premium on acquired loans
(787)
19
(5)
(773)
Loans previously charged-off by RCB
(2,051)
(3)
(2,054)
Purchase price of PCD loans
6,984
237
623
7,844
Pro forma information
The following pro forma information combines the historical results of RCB and the Company. The pro forma financial information does not include the potential impacts of possible business model changes, current market conditions, revenue enhancements, expense efficiencies, or other factors. If the RCB acquisition had been completed on January 1, 2021, pro forma total revenue for the Company would have been approximately $100.7 million and $89.1 million for the three months ended September 30, 2022 and 2021, respectively. Pro forma net income for the Company would have been approximately $29.0 million and $22.8 million for the three months ended September 30, 2022 and 2021, respectively. Pro forma basic and diluted earnings per share for the Company would have been $0.87 and $0.86 for the three months ended September 30, 2022, respectively, and $0.67 and $0.67 for the three months ended September 30, 2021, respectively. For the three months ended September 30, 2022, the pro forma information reflects adjustments made to exclude acquisition-related expenses of the Company totaling $12.4 million and estimated acquisition-related expenses incurred by RCB prior to the acquisition date totaling $0.7 million. Adjustments also included estimated amortization of acquired identifiable intangibles of $0.2 million and $0.3 million for the three months ended September 30, 2022 and 2021, respectively.
For the nine months ended September 30, 2022 and 2021, pro forma total revenue for the Company would have been approximately $263.3 million and $263.1 million. For the nine months ended September 30, 2022 and 2021, pro forma net income for the Company would have been approximately $74.3 million and $80.6 million, respectively. Pro forma basic and diluted earnings per share for the Company would have been $2.23 and $2.21 for the nine months ended September 30, 2022, respectively, and $2.37 and $2.35 for the nine months ended September 30, 2021, respectively. For the nine months ended September 30, 2022, the pro forma information reflects adjustments made to exclude acquisition-related expenses of the Company totaling $13.6 million and estimated acquisition-related expenses incurred by RCB prior to the acquisition date totaling $0.7 million. Adjustments also included estimated amortization and accretion of purchase premiums and discounts of $0.2 million for the nine months ended September 30, 2022 and 2021, estimated accretion of fair value marks on time deposits of $0.1 million for the nine months ended September 30, 2022 and 2021 and estimated amortization of acquired identifiable intangibles of $0.9 million and $1.0 million for the nine months ended September 30, 2022 and 2021, respectively.
14
The pro forma information is theoretical in nature and not necessarily indicative of future consolidated results of operations of the Company or the consolidated results of operations which would have resulted had the Company acquired RCB during the periods presented.
The Company has determined that it is impractical to report the amounts of revenue and earnings of legacy RCB since the acquisition date due to the integration of certain processes occurring shortly after the acquisition date. Such amounts would require significant estimates that cannot be objectively made.
Note 4 Investment Securities
The Company’s investment securities portfolio is comprised of available-for-sale and held-to-maturity investment securities. These investment securities totaled $1.3 billion at September 30, 2022 and included $0.7 billion of available-for-sale securities and $0.6 billion of held-to-maturity securities. At December 31, 2021, investment securities totaled $1.3 billion and included $0.7 billion of available-for-sale securities and $0.6 billion of held-to-maturity securities.
Available-for-sale
Available-for-sale securities are summarized as follows as of the dates indicated:
Amortized
Gross
cost
unrealized gains
unrealized losses
Fair value
U.S. Treasury securities
73,912
(2,816)
71,096
Mortgage-backed securities:
Residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises
272,133
(42,494)
229,651
Other residential MBS issued or guaranteed by U.S. Government agencies or sponsored enterprises
496,878
(69,896)
426,982
Municipal securities
230
(6)
224
Corporate debt
2,000
(42)
1,958
Other securities
880
Total investment securities available-for-sale
846,033
(115,254)
231,523
1,436
(5,263)
227,696
467,490
1,889
(8,045)
461,334
111
2,111
469
701,712
3,443
(13,308)
During the nine months ended September 30, 2022 and 2021, purchases of available-for-sale securities totaled $260.2 million and $196.3 million, respectively. Maturities and paydowns of available-for-sale securities during the nine months ended September 30, 2022 and 2021 totaled $116.0 million and $185.0 million, respectively. There were no sales of available-for-sale securities during the nine months ended September 30, 2022 or 2021.
At September 30, 2022 and December 31, 2021, the Company’s available-for-sale investment portfolio was primarily comprised of mortgage-backed securities, and all mortgage-backed securities were backed by government sponsored enterprises (“GSE”) collateral
15
such as Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”) and the government owned agency Government National Mortgage Association (“GNMA”).
The tables below summarize the available-for-sale securities with unrealized losses as of the dates shown, along with the length of the impairment period:
Less than 12 months
12 months or more
Fair
Unrealized
value
losses
89,723
(8,558)
136,713
(33,936)
226,436
297,858
(36,381)
129,124
(33,515)
460,859
(47,803)
265,837
(67,451)
726,696
163,579
(4,404)
22,852
(859)
186,431
237,759
(5,593)
48,750
(2,452)
286,509
401,338
(9,997)
71,602
(3,311)
472,940
Management evaluated all of the available-for-sale securities in an unrealized loss position at September 30, 2022 and December 31, 2021. The portfolio included 245 securities, which were in an unrealized loss position at September 30, 2022, compared to 49 securities at December 31, 2021. The unrealized losses in the Company's investment portfolio at September 30, 2022 were caused by changes in interest rates. The Company has no intention to sell these securities and believes it will not be required to sell the securities before the recovery of their amortized cost. Management believes that default of the available-for-sale securities is highly unlikely. FHLMC, FNMA and GNMA guaranteed mortgage-backed securities and U.S. Treasury securities have a long history of zero credit losses, an explicit guarantee by the U.S. government (although limited for FNMA and FHLMC securities) and yields that generally trade based on market views of prepayment and liquidity risk rather than credit risk.
Certain securities are pledged as collateral for public deposits, securities sold under agreements to repurchase and to secure borrowing capacity at the Federal Reserve Bank (“FRB”), if needed. The fair value of available-for-sale investment securities pledged as collateral totaled $407.9 million and $363.4 million at September 30, 2022 and at December 31, 2021, respectively. The Bank may also pledge available-for-sale investment securities as collateral for Federal Home Loan Bank (“FHLB”) advances. No securities were pledged for this purpose at September 30, 2022 or December 31, 2021.
A summary of the available-for-sale securities by maturity is shown in the following table as of September 30, 2022. Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. Additionally, the Company holds other available-for-sale securities with an amortized cost and fair value of $0.9 million that have no stated contractual maturity date.
Weighted
Amortized Cost
Fair Value
Average Yield
After one but within five years
2.54%
3.17%
After five but within ten years
5.87%
As of September 30, 2022 and December 31, 2021, accrued interest receivable (“AIR”) from available-for-sale investment securities totaled $1.5 million and $1.0 million, respectively, and was included within other assets in the statements of financial condition.
Held-to-maturity
Held-to-maturity investment securities are summarized as follows as of the dates indicated:
unrealized
gains
48,973
(1,561)
47,412
291,306
(46,440)
244,866
265,966
(49,283)
216,683
Total investment securities held-to-maturity
(97,284)
508,961
312,916
2,061
(5,363)
309,614
296,096
122
(6,572)
289,646
2,183
(11,935)
599,260
During the nine months ended September 30, 2022 and 2021, purchases of held-to-maturity securities totaled $91.6 million and $377.7 million, respectively. Maturities and paydowns of held-to-maturity securities totaled $93.2 million and $109.0 million during the nine months ended September 30, 2022 and 2021, respectively.
The held-to-maturity portfolio included 104 securities, which were in an unrealized loss position as of September 30, 2022, compared to 48 securities at December 31, 2021. The tables below summarize the held-to-maturity securities with unrealized losses as of the dates shown, along with the length of the impairment period:
17
90,673
(10,880)
154,193
(35,560)
92,466
(14,168)
124,217
(35,115)
230,551
(26,609)
278,410
(70,675)
197,095
(3,499)
45,353
(1,864)
242,448
276,098
473,193
(10,071)
518,546
The Company does not measure expected credit losses on a financial asset, or group of financial assets, in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Management evaluated held-to-maturity securities noting they are backed by loans guaranteed by either U.S. government agencies or U.S. government sponsored entities, and management believes that default is highly unlikely given this governmental backing and long history without credit losses. Additionally, management notes that yields on which the portfolio generally trades are based upon market views of prepayment and liquidity risk and not credit risk. The Company has no intention to sell any held-to-maturity securities and believes it will not be required to sell any held-to-maturity securities before the recovery of their amortized cost.
Certain securities are pledged as collateral for public deposits, securities sold under agreements to repurchase and to secure borrowing capacity at the FRB, if needed. The carrying value of held-to-maturity investment securities pledged as collateral totaled $280.7 million and $147.3 million at September 30, 2022 and December 31, 2021, respectively. The Bank may also pledge held-to-maturity investment securities as collateral for FHLB advances. No held-to-maturity investment securities were pledged for this purpose at September 30, 2022 or December 31, 2021.
A summary of the held-to-maturity securities by maturity is shown in the following table as of September 30, 2022. Actual maturities of mortgage-backed securities may differ from scheduled maturities depending on the repayment characteristics and experience of the underlying financial instruments.
3.14%
As of September 30, 2022 and December 31, 2021, AIR from held-to-maturity investment securities totaled $1.3 million and $0.9 million, respectively, and was included within other assets in the statements of financial condition.
18
Note 5 Non-marketable Securities
Non-marketable securities totaled $64.0 million and $50.7 million at September 30, 2022 and December 31, 2021, respectively, and included FRB stock, FHLB stock and other non-marketable securities. At September 30, 2022, other non-marketable securities totaled $48.5 million and consisted of equity method investments totaling $21.5 million and convertible preferred stock without a readily determinable fair value totaling $27.0 million. At December 31, 2021, other non-marketable securities totaled $36.2 million and consisted of equity method investments totaling $14.2 million and convertible preferred stock without a readily determinable fair value totaling $22.0 million. During the nine months ended September 30, 2022 and 2021, purchases of non-marketable securities totaled $11.5 million and $25.8 million, respectively. Proceeds from non-marketable securities totaled $0.1 million and $1.9 million during the nine months ended September 30, 2022 and 2021, respectively.
At September 30, 2022, the Company held $13.9 million of FRB stock and $1.6 million of FHLB stock for regulatory or debt facility purposes. At December 31, 2021, the Company held $13.9 million of FRB stock and $0.7 million of FHLB stock. These are restricted securities which, lacking a market, are carried at cost. There have been no identified events or changes in circumstances that may have an adverse effect on the investments carried at cost.
Note 6 Loans
The loan portfolio is comprised of loans originated by the Company and loans that were acquired in connection with the Company’s acquisitions. The tables below show the loan portfolio composition including carrying value by segment as of the dates shown. The carrying value of loans is net of discounts, fees, costs and fair value marks of $5.9 million and $9.4 million as of September 30, 2022 and December 31, 2021, respectively.
Total loans
% of total
3,923,483
68.6%
950,402
16.6%
830,146
14.5%
17,954
0.3%
100.0%
3,162,417
70.1%
664,729
14.7%
668,656
14.8%
17,581
0.4%
Information about delinquent and non-accrual loans is shown in the following tables at September 30, 2022 and December 31, 2021:
Greater
30-89 days
than 90 days
Total past
past due and
Non-accrual
due and
accruing
loans
non-accrual
Current
Commercial:
Commercial and industrial
945
55
1,887
2,887
1,803,906
1,806,793
Municipal and non-profit
968,865
Owner occupied commercial real estate
93
2,681
2,774
805,394
808,168
Food and agribusiness
116
4,503
4,619
335,038
339,657
Total commercial
1,154
9,071
10,280
3,913,203
Commercial real estate non-owner occupied:
Construction
212,961
Acquisition/development
63,104
Multifamily
68,802
Non-owner occupied
177
708
885
604,650
605,535
Total commercial real estate
949,517
Residential real estate:
Senior lien
173
4,454
4,627
756,548
761,175
Junior lien
103
100
416
619
68,352
68,971
Total residential real estate
276
4,870
5,246
824,900
126
17,828
1,548
332
14,657
16,537
5,705,448
Non-accrual loans
with a related
with no related
allowance for
credit loss
1,090
797
2,511
170
2,159
2,344
5,760
3,311
3,282
1,172
3,698
10,174
4,483
20
481
1,490
1,971
1,494,176
1,496,147
202
928,843
929,045
207
4,525
4,732
528,904
533,636
89
153
203,436
203,589
6,079
7,058
3,155,359
86,126
9,609
92,174
94
217
121
432
476,388
476,820
664,297
399
198
4,251
4,848
609,780
614,628
179
374
553
53,475
54,028
578
4,625
5,401
663,255
36
48
17,533
1,687
420
10,832
12,939
4,500,444
3,274
3,648
9,855
Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. Non-accrual loans include non-accrual loans and troubled debt restructurings (“TDRs”) on non-accrual status. There was no interest income recognized from non-accrual loans during the three or nine months ended September 30, 2022 or 2021.
The Company’s internal risk rating system uses a series of grades, which reflect our assessment of the credit quality of loans based on an analysis of the borrower's financial condition, liquidity and ability to meet contractual debt service requirements and are categorized as “Pass”, “Special mention”, “Substandard” and “Doubtful”. For a description of the general characteristics of the risk grades, refer to note 2 Summary of Significant Accounting Policies in our audited consolidated financial statements in our 2021 Annual Report on Form 10-K.
21
The amortized cost basis for all loans as determined by the Company’s internal risk rating system and year of origination is shown in the following tables as of September 30, 2022 and December 31, 2021:
Revolving
Origination year
amortized
converted
2020
2019
2018
Prior
cost basis
to term
Commercial and industrial:
Pass
398,113
337,365
124,435
98,318
112,867
76,695
633,732
1,264
1,782,789
Special mention
2,455
501
613
6,480
1,052
11,101
Substandard
91
159
209
10,872
11,402
Doubtful
688
583
1,501
Total commercial and industrial
398,149
337,456
127,155
99,666
113,689
94,630
634,784
Municipal and non-profit:
80,096
240,715
89,704
62,972
76,668
418,708
2
Total municipal and non-profit
Owner occupied commercial real estate:
210,412
170,909
88,920
89,869
72,920
120,814
24,542
25
778,411
8,184
4,322
13,239
25,745
263
1,947
3,402
373
234
610
Total owner occupied commercial real estate
90,485
98,319
77,242
136,000
24,776
Food and agribusiness:
32,042
23,781
28,872
11,450
21,736
31,383
173,644
322,908
4,572
6,309
11,079
1,811
1,247
920
1,206
5,184
232
250
486
Total food and agribusiness
25,824
33,694
12,701
32,501
181,159
720,699
774,904
341,038
273,658
289,335
681,839
840,721
1,289
Construction:
46,923
107,357
17,043
34,887
6,536
Total construction
Acquisition/development:
20,784
21,890
9,229
1,245
2,482
5,435
2,039
Total acquisition/development
Multifamily:
25,738
7,338
11,677
5,518
15,742
2,186
603
Total multifamily
144,452
81,831
74,950
81,694
25,804
158,510
5,121
572,362
9,779
5,560
12,738
28,077
637
4,391
5,028
68
Total non-owner occupied
91,473
32,001
175,707
Total commercial real estate non-owner occupied
237,897
218,416
112,899
133,123
50,225
183,543
14,299
197,370
234,459
87,454
29,021
18,121
167,800
21,568
125
755,918
340
193
191
480
868
3,079
4,917
Total senior lien
197,563
234,650
87,934
29,889
18,227
171,219
2,789
1,808
2,815
2,474
1,427
3,187
52,703
489
67,692
349
57
313
251
721
Total junior lien
2,798
2,906
1,484
3,849
53,163
200,361
236,458
90,840
32,363
19,711
175,068
74,731
614
6,471
5,035
2,073
703
315
560
2,766
23
17,946
Total consumer
565
2,769
1,165,428
1,234,813
546,850
439,847
359,586
1,041,015
932,520
1,926
22
2017
424,813
155,268
146,420
128,002
49,408
18,529
519,678
5,975
1,448,093
1,122
3,446
22,654
4,440
1,824
35,736
99
744
10,399
303
105
11,739
375
54
49
101
579
156,864
148,509
132,246
82,510
23,373
521,607
6,225
234,827
93,310
69,509
81,175
147,115
302,574
535
122,641
81,072
84,359
71,183
48,086
77,100
13,666
1,688
499,795
9,155
3,864
1,429
13,443
27,891
1,527
2,028
4,967
389
550
44
983
82,653
95,591
75,047
49,735
92,615
11,245
20,606
6,966
21,427
2,443
24,047
107,978
24
194,736
4,670
1,234
1,897
8,016
259
837
25,276
8,200
2,702
24,840
109,875
793,526
358,103
321,809
309,895
282,062
443,402
645,683
7,937
39,584
10,047
29,496
222
6,777
1,691
385
766
1,830
30
4,907
3,101
32,619
2,184
15,977
37,713
91,787
387
38,100
59,060
58,964
122,452
18,425
92,349
95,265
557
447,072
5,747
5,584
9,745
3,898
24,974
729
4,045
4,774
128,199
24,738
102,094
103,208
103,436
102,015
160,645
42,545
102,539
146,215
7,334
223,120
100,476
38,696
21,889
29,554
177,051
18,278
188
609,252
290
325
684
318
299
3,416
5,086
223,164
100,801
39,380
22,207
29,853
180,757
1,320
2,150
2,731
1,639
951
3,209
40,921
328
53,249
322
346
62
131
221
433
2,169
1,701
1,082
3,430
40,945
650
224,484
102,970
42,111
23,908
30,935
184,187
59,223
838
Consumer:
8,815
3,528
1,241
631
2,653
17,575
563
1,130,261
566,616
525,806
376,979
415,667
774,367
714,893
8,794
Loans evaluated individually
We evaluate loans individually when they no longer share risk characteristics with pooled loans. These loans include loans on non-accrual status, loans in bankruptcy, and TDRs as described below. If a specific allowance is warranted based on the borrower’s overall financial condition, the specific allowance is calculated based on discounted expected cash flows using the loan’s initial contractual effective interest rate or the fair value of the collateral less selling costs for collateral-dependent loans.
A loan is considered collateral-dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. Management individually evaluates collateral-dependent loans with an amortized cost basis of $250 thousand or more and includes collateral-dependent loans less than $250 thousand within the general allowance population. The amortized cost basis of collateral-dependent loans over $250 thousand was as follows at September 30, 2022 and December 31, 2021:
Total amortized
Real property
Business assets
1,471
Owner-occupied commercial real estate
3,804
3,115
309
3,424
Total Commercial
7,149
1,780
8,929
Commercial real estate non owner-occupied
538
3,095
1,626
4,721
460
3,555
5,181
11,242
3,406
14,648
3,270
1,261
4,531
4,012
255
4,267
7,282
1,516
8,798
2,212
9,494
11,010
Loan modifications and troubled debt restructurings
The Company’s policy is to review each prospective credit to determine the appropriateness and the adequacy of security or collateral prior to making a loan. In the event of borrower default, the Company seeks recovery in compliance with lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include restructuring a loan to provide a concession by the Company to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Additionally, if a borrower’s repayment obligation has been discharged by a court, and that debt has not been reaffirmed by the borrower, regardless of past due status, the loan is considered to be a TDR.
During the three months ended September 30, 2022, the Company restructured four loans with an amortized cost basis of $0.6 million to facilitate repayment that are considered TDRs. During the nine months ended September 30, 2022, the Company restructured 10 loans with an amortized cost basis of $3.2 million to facilitate repayment that are considered TDRs. Loan modifications were a reduction of the principal payment, a reduction in interest rate, or an extension of term. The tables below provide additional information related to accruing TDRs at September 30, 2022 and December 31, 2021:
Average year-to-date
Unpaid
Unfunded commitments
amortized cost basis
principal balance
to fund TDRs
2,057
2,286
2,062
150
713
748
730
1,840
1,883
1,998
4,610
4,790
4,066
4,472
4,417
725
767
892
2,395
2,468
2,781
7,186
7,707
8,090
The following table summarizes the Company’s carrying value of non-accrual TDRs as of September 30, 2022 and December 31, 2021:
2,717
644
88
117
1,620
1,605
Total non-accruing TDRs
4,425
2,366
Accrual of interest is resumed on loans that were previously on non-accrual only after the loan has performed sufficiently for a period of time. The Company had two TDRs totaling $2.3 million that were modified within the past 12 months and had defaulted on their restructured terms during the nine months ended September 30, 2022. During the nine months ended September 30, 2021, the Company had one TDR totaling $36 thousand that was modified within the past 12 months and had defaulted on their restructured terms. For purposes of this disclosure, the Company considers “default” to mean 90 days or more past due on principal or interest. The allowance for credit losses related to TDRs on non-accrual status is determined by individual evaluation, including collateral adequacy, using the same process as loans on non-accrual status, which are not classified as TDRs.
Note 7 Allowance for Credit Losses
The tables below detail the Company’s allowance for credit losses as of the dates shown:
Three months ended September 30, 2022
Non-owner
occupied
commercial
Residential
real estate
Beginning balance
32,011
8,426
10,072
351
50,860
Charge-offs
(253)
Recoveries
40
66
Provision expense for credit losses
1,651
3,419
1,988
7,275
Day 1 CECL provision expense
2,261
2,327
596
5,201
2,257
Ending balance
38,220
14,174
12,874
355
65,623
Nine months ended September 30, 2022
31,256
10,033
8,056
49,694
(754)
(582)
(1,338)
115
71
256
3,085
1,791
3,960
9,336
Three months ended September 30, 2021
28,640
11,187
8,851
352
49,030
(172)
(4)
(146)
(322)
61
38
1,124
(388)
(475)
85
29,653
10,799
8,374
49,155
Nine months ended September 30, 2021
30,376
17,448
11,492
461
59,777
(1,112)
(26)
(410)
(1,548)
316
47
110
73
(6,656)
(3,139)
168
(9,554)
At the acquisition date, RCB had $2.1 million of previously charged off loans for which the Company continued to have contractual rights to the cash flows. In accordance with ASC Topic 326, PCD loan accounting is to be applied by the acquirer whereby an allowance for credit losses should be recorded for this subset of loans at the acquisition date, and if deemed non-collectible, the loans
26
are to be fully charged off on the acquirer’s books. Such amounts were fully reserved for, charged off on the acquisition date and excluded from the tables above.
In evaluating the loan portfolio for an appropriate ACL level, excluding loans evaluated individually, loans were grouped into segments based on broad characteristics such as primary use and underlying collateral. Within the segments, the portfolio was further disaggregated into classes of loans with similar attributes and risk characteristics for purposes of developing the underlying data used within the discounted cash flow model including, but not limited to, prepayment and recovery rates as well as loss rates tied to macro-economic conditions within management’s reasonable and supportable forecast. The ACL also includes subjective adjustments based upon qualitative risk factors including asset quality, loss trends, lending management, portfolio growth and loan review/internal audit results.
Net charge-offs on loans during the three and nine months ended September 30, 2022 were $0.2 million and $1.1 million, respectively. The Company recorded an increase in the allowance for credit losses of $15.0 million during the three months ended September 30, 2022, which included a provision expense of $5.2 million of Day 1 allowance reserve funding for the RCB portfolio and a $2.5 million credit allowance for Day 1 PCD loans. The remainder of the provision expense during the quarter was driven by strong loan growth and higher reserve requirements from changes in the CECL model’s underlying macro-economic forecast. During the nine months ended September 30, 2022, the Company recorded an increase in the allowance for credit losses of $17.0 million. The provision expense was driven by record loan growth, higher reserve requirements from changes in the CECL model’s underlying macro-economic forecast and Day 1 reserve requirements for the acquired RCB portfolio.
Net charge-offs on loans during the three and nine months ended September 30, 2021 were $0.2 million and $1.1 million, respectively. The Company recorded a net zero provision for credit losses for the three months ended September 30, 2021, which included a provision expense of $0.3 million for funded loans and a provision release of $0.3 million for unfunded loan commitments. During the nine months ended September 30, 2021, the Company recorded an allowance for credit loss release of $9.4 million, which included a provision release of $9.6 million for funded loans, partially offset by a provision expense of $0.2 million for unfunded loan commitments. Provision release was driven by strong asset quality and an improved outlook in the CECL model’s underlying economic forecast.
The Company has elected to exclude AIR from the allowance for credit losses calculation. As of September 30, 2022 and December 31, 2021, AIR from loans totaled $26.9 million and $15.7 million, respectively.
Note 8 Other Real Estate Owned
A summary of the activity in other real estate owned (“OREO”) during the nine months ended September 30, 2022 and 2021 is as follows:
4,730
Transfers from loan portfolio, at fair value
58
1,522
Impairments
(452)
(799)
Sales
(2,916)
(1,128)
4,325
During the three months ended September 30, 2022, the Company sold OREO properties with net book balances of $1.1 million. During the nine months ended September 30, 2022 and 2021, the Company sold OREO properties with net book balances of $2.9 million and $1.1 million, respectively. Sales of OREO properties resulted in net OREO gains of $0.4 million and $0.6 million, which were included within gain on OREO sales, net in the consolidated statements of operations for the three and nine months ended September 30, 2022, respectively. During the nine months ended September 30, 2022, impairments included $227 thousand recorded within problem asset workout in the consolidated statements of operations and $225 thousand included within other liabilities in the statements of financial condition to reduce the payable for an SBA redemption agreement. During the nine months ended September 30, 2021, impairments included $799 thousand recorded within problem asset workout in the consolidated statements of operations. Net OREO losses of $0.0 million and $0.2 million were included in the consolidated statements of operations for the three and nine months ended September 30, 2021, respectively.
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Note 9 Goodwill and Intangible Assets
Goodwill and core deposit intangible
In connection with our acquisitions, the Company recorded goodwill of $167.9 million. The Company recorded goodwill of $52.9 million, core deposit intangibles of $13.3 million and SBA servicing rights of $3.1 million related to the acquisition of RCB. Goodwill is measured as the excess of the fair value of consideration paid over the fair value of net assets acquired. No goodwill impairment was recorded during the three or nine months ended September 30, 2022 or the year ended December 31, 2021.
The gross carrying amount of the core deposit intangibles (“CDI”) and the associated accumulated amortization at September 30, 2022 and December 31, 2021, are presented as follows:
Net
carrying
amount
amortization
Core deposit intangible
62,171
(43,444)
18,727
48,834
(42,469)
6,365
In connection with the RCB acquisition, the Company added a core deposit intangible of $13.3 million on September 1, 2022. The Company is amortizing the CDI from acquisitions on a straight-line basis over 10 years from the date of the respective acquisition, which represents the expected useful life of the assets. The Company recognized CDI amortization expense of $0.4 million and $1.0 million during the three and nine months ended September 30, 2022, respectively. During the three and nine months ended September 30, 2021, the Company recognized CDI amortization expense of $0.3 million and $0.9 million, respectively.
The following table shows the estimated future amortization expense for the CDI as of September 30, 2022:
Years ending December 31,
Amount
For the three months ending December 31, 2022
595
For the year ending December 31, 2023
2,381
For the year ending December 31, 2024
For the year ending December 31, 2025
For the year ending December 31, 2026
Mortgage servicing rights
Mortgage servicing rights (“MSRs”) represent rights to service loans originated by the Company and sold to government-sponsored enterprises including FHLMC, FNMA, GNMA and FHLB and are included in other assets in the consolidated statements of financial condition. Mortgage loans serviced for others were $1.0 billion and $0.6 billion at September 30, 2022 and 2021, respectively.
Below are the changes in the MSRs for the periods presented:
5,957
10,380
Originations
3,895
6,648
(10,499)
(Impairment) recovery
717
Amortization
(713)
(2,286)
9,133
4,960
Fair value of mortgage servicing rights
13,782
6,179
The fair value of MSRs was determined based upon a discounted cash flow analysis. The cash flow analysis included assumptions for discount rates and prepayment speeds. The discount rate was 9.5%, and the constant prepayment speed ranged from 7.6% to 7.8% for the September 30, 2022 valuation. Discount rates ranged from 9.5% to 10.0%, and the constant prepayment speed ranged from 11.1% to 14.9% for the September 30, 2021 valuation. Included in mortgage banking income in the consolidated statements of operations
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was servicing income of $0.7 million and $1.8 million for the three and nine months ended September 30, 2022, respectively, and $1.0 million and $3.0 million for the three and nine months ended September 30, 2021, respectively.
MSRs are evaluated and impairment is recognized to the extent fair value is less than the carrying amount. The Company evaluates impairment by stratifying MSRs based on the predominant risk characteristics of the underlying loans, including loan type and loan term. The Company is amortizing the MSRs in proportion to and over the period of the estimated net servicing income of the underlying loans.
The following table shows the estimated future amortization expense for the MSRs as of September 30, 2022:
272
1,055
930
819
SBA servicing assets
In connection with the RCB acquisition, the Company added an SBA servicing right asset of $3.1 million. The servicing asset represents the value associated with servicing small business real estate loans that have been sold to outside investors with servicing retained. SBA loan servicing assets are amortized over the period of the estimated future net servicing life of the underlying assets. SBA loan servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the SBA loan servicing asset. The Company serviced $133.5 million of SBA loans, as of September 30, 2022. Since the acquisition date, the Company recognized SBA servicing asset amortization, net of fee income, of $68 thousand.
The Company uses assumptions and estimates in determining the fair value of SBA loan servicing rights. These assumptions include prepayment speeds, discount rates, and other assumptions. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. The key assumptions used to determine the fair value of the Company’s SBA loan servicing rights included a weighted average lifetime constant prepayment rate equal to 12.11%, and a weighted average discount rate equal to 11.74%.
Note 10 Borrowings
Borrowings consist of securities sold under agreements to repurchase, long-term debt and FHLB advances.
The Company enters into repurchase agreements to facilitate the needs of its clients. As of September 30, 2022 and December 31, 2021, the Company sold securities under agreements to repurchase totaling $20.0 million and $22.8 million, respectively. The Company pledged mortgage-backed securities with a fair value of approximately $31.8 million and $28.8 million as of September 30, 2022 and December 31, 2021, respectively, for these agreements. The Company monitors collateral levels on a continuous basis and may be required to provide additional collateral based on the fair value of the underlying securities. As of September 30, 2022 and December 31, 2021, the Company had $11.8 million and $6.1 million, respectively, of excess collateral pledged for repurchase agreements.
Long-term debt
On November 5, 2021, the Company entered into a subordinated note purchase agreement to issue and sell a fixed-to-floating rate note totaling $40.0 million. The balance on the note at September 30, 2022, net of long-term debt issuance costs totaling $0.4 million, totaled $39.6 million. Interest expense totaling $0.3 million and $0.9 million was recorded in the consolidated statements of operations during the three and nine months ended September 30, 2022, respectively.
The note is subordinated, unsecured and matures on November 15, 2031. Payments consist of interest only. Interest expense on the note is payable semi-annually in arrears and will bear interest at 3.00% per annum until November 15, 2026 (or any earlier redemption
29
date). From November 15, 2026 until November 15, 2031 (or any earlier redemption date) payments will be made quarterly in arrears, and the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month term secured overnight financing rate (“SOFR”) plus 203 basis points. The Company intends to use the net proceeds from the sale of the note for general corporate purposes. Prior to November 5, 2026, the Company may redeem the note only under certain limited circumstances. Beginning on November 5, 2026 through maturity, the note may be redeemed, at the Company’s option, on any scheduled interest payment date. Any redemption by the Company would be at a redemption price equal to 100% of the principal amount of the note being redeemed, together with any accrued and unpaid interest on the note being redeemed up to but excluding the date of redemption. The note is not subject to redemption at the option of the holder.
FHLB advances
As a member of the FHLB, the Bank has access to a line of credit and term financing from the FHLB with total available credit of $1.0 billion at September 30, 2022. The Bank may utilize its FHLB line of credit as a funding mechanism for originated loans and loans held for sale. At September 30, 2022 and December 31, 2021, the Bank had no outstanding borrowings from the FHLB. The Bank may pledge investment securities and loans as collateral for FHLB advances. There were no investment securities pledged at September 30, 2022 or December 31, 2021. Loans pledged were $1.7 billion and $1.3 billion at September 30, 2022 and December 31, 2021, respectively. There was no interest expense related to FHLB advances and other short-term borrowings for the three and nine months ended September 30, 2022 or 2021.
Note 11 Regulatory Capital
As a bank holding company that has elected to be treated as a financial holding company, the Company and NBH Bank is subject to regulatory capital adequacy requirements implemented by the Federal Reserve, including maintaining capital positions at the “well-capitalized” level. The federal banking agencies have risk based capital adequacy regulations intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations. Under these regulations, assets are assigned to one of several risk categories, and nominal dollar amounts of assets and credit equivalent amounts of off-balance-sheet items are multiplied by a risk adjustment percentage for the category.
Under the Basel III requirements, at September 30, 2022 and December 31, 2021, the Company and the Bank met all capital requirements, including the capital conservation buffer of 2.5%. The Company and Bank had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as detailed in the tables below:
Required to be
well capitalized under
considered
prompt corrective
adequately
Actual
action provisions
capitalized(1)
Ratio
Tier 1 leverage ratio:
Consolidated
10.5%
826,285
N/A
4.0%
316,209
NBH Bank
9.2%
722,231
5.0%
393,330
314,664
Common equity tier 1 risk based capital:
12.8%
7.0%
453,669
11.2%
6.5%
418,972
451,200
Tier 1 risk based capital ratio:
8.5%
550,884
8.0%
515,657
547,886
Total risk based capital ratio:
14.3%
929,103
680,503
12.2%
785,048
10.0%
644,572
676,800
10.4%
731,087
281,463
9.1%
637,115
350,584
280,467
358,813
12.5%
331,427
356,921
435,701
407,910
433,404
15.9%
816,117
538,219
13.4%
682,145
509,888
535,382
Includes the capital conservation buffer of 2.5%.
Note 12 Revenue from Contracts with Clients
Revenue is recognized when obligations under the terms of a contract with clients are satisfied. Below is the detail of the Company’s revenue from contracts with clients.
Service charges and other fees
Service charge fees are primarily comprised of monthly service fees, check orders and other deposit account related fees. Other fees include revenue from processing wire transfers, bill pay service, cashier’s checks and other services. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account-related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to clients’ accounts.
Bank card fees are primarily comprised of debit card income, ATM fees, merchant services income and other fees. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Bank cardholder uses a non-Bank ATM or a non-Bank cardholder uses a Bank ATM. Merchant services income mainly represents fees charged to merchants to process their debit card transactions. The Company’s performance obligation for bank card fees are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.
Gain on OREO sales, net
Gain on OREO sales, net is recognized when the Company meets its performance obligation to transfer title to the buyer. The gain or loss is measured as the excess of the proceeds received compared to the OREO carrying value. Sales proceeds are received in cash at the time of transfer.
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The following table presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, and non-interest expense in-scope of Topic 606 for the three and nine months ended September 30, 2022 and 2021:
Non-interest income
In-scope of Topic 606:
4,867
5,286
13,444
13,653
Non-interest income (in-scope of Topic 606)
9,548
9,816
26,789
26,870
Non-interest income (out-of-scope of Topic 606)
7,810
18,706
26,385
60,279
Non-interest expense
Gain (loss) on OREO sales, net
378
648
(192)
Total revenue in-scope of Topic 606
9,926
27,437
26,678
Contract acquisition costs
The Company utilizes the practical expedient which allows entities to expense immediately contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company has not capitalized any contract acquisition costs.
Note 13 Stock-based Compensation and Benefits
The Company provides stock-based compensation in accordance with shareholder-approved plans and is authorized to issue awards of stock options, stock appreciation rights, restricted stock, restricted stock units, performance units, other stock-based awards, or any combination thereof to eligible persons.
Stock options
The Company issues stock options, which are primarily time-vesting with 1/3 vesting on each of the first, second and third anniversary of the date of grant or date of hire.
The expense associated with the awarded stock options was measured at fair value using a Black-Scholes option-pricing model. The outstanding option awards vest or have vested on a graded basis over 1-4 years of continuous service and have 10-year contractual terms.
The following table summarizes stock option activity for the nine months ended September 30, 2022:
average
remaining
contractual
Aggregate
exercise
term in
intrinsic
Options
price
years
Outstanding at December 31, 2021
695,960
28.19
6.57
10,964
Granted
74,715
40.79
Exercised
(27,741)
24.47
Forfeited
(12,432)
31.38
Outstanding at September 30, 2022
730,502
29.56
6.17
5,958
Options exercisable at September 30, 2022
538,156
27.75
5.32
5,060
Options vested and expected to vest
714,222
29.38
6.11
5,922
Stock option expense is a component of salaries and benefits in the consolidated statements of operations and totaled $0.1 million and $0.6 million for the three and nine months ended September 30, 2022, respectively, and $0.1 million and $0.7 million for the three and nine months ended September 30, 2021, respectively. At September 30, 2022, there was $0.5 million of total unrecognized
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compensation cost related to non-vested stock options granted under the plans. The cost is expected to be recognized over a weighted average period of 2.2 years.
Restricted stock awards
The Company issues primarily time-based restricted stock awards that vest over a range of a 1-3 year period. Restricted stock with time-based vesting was valued at the fair value of the shares on the date of grant as they are assumed to be held beyond the vesting period.
Performance stock units
The Company grants performance stock units which represent initial target awards and do not reflect potential increases or decreases resulting from the final performance results, which are to be determined at the end of the three-year performance period (vesting date). The actual number of shares to be awarded at the end of the performance period will range from 0% - 150% of the initial target awards. For awards granted in years other than 2020 and 2021, 60% of the award is based on the Company’s cumulative earnings per share (EPS target) during the performance period, and 40% of the award is based on the Company’s cumulative total shareholder return (TSR target), or TSR, during the performance period. On the vesting date, the Company’s TSR will be compared to the respective TSRs of the companies comprising the KBW Regional Index at the grant date to determine the shares awarded. The fair value of the EPS target portion of the award was determined based on the closing stock price of the Company’s common stock on the grant date. The fair value of the TSR target portion of the award was determined using a Monte Carlo Simulation at the grant date.
In establishing PSU components during 2021 and 2020, the Compensation Committee determined the EPS target portion of the award would not be an effective metric in light of economic uncertainty surrounding COVID-19. Consequently, the Compensation Committee granted an award based upon a relative return on tangible assets (“ROTA”). Annually, the Company’s ROTA is compared to the respective ROTA of companies comprising the KBW Regional Index. At the end of the measurement period, the Company’s ranking will be averaged to determine the shares awarded. The fair value of the ROTA award was determined based on the closing stock price of the Company’s common stock on the grant date.
The weighted-average grant date fair value per unit for the awards granted during the nine months ended September 30, 2022 of the EPS target portion and the TSR target portion was $40.83 and $35.25, respectively. The initial weighted-average performance price for the TSR target portion granted during 2022 was $43.51. During the nine months ended September 30, 2022, the Company awarded an additional 17,741 units due to final performance results related to performance stock units granted in 2019.
The following table summarizes restricted stock and performance stock unit activity during the nine months ended September 30, 2022:
Restricted
average grant-
Performance
stock shares
date fair value
stock units
Unvested at December 31, 2021
144,467
33.40
160,394
31.36
106,439
40.06
51,931
38.40
Adjustment due to performance
17,741
32.44
Vested
(69,183)
32.99
(67,875)
31.27
(12,378)
36.92
(6,334)
32.70
Unvested at September 30, 2022
169,345
37.50
155,857
33.81
As of September 30, 2022, the total unrecognized compensation cost related to the non-vested restricted stock awards and performance stock units totaled $3.7 million and $3.0 million, respectively, and is expected to be recognized over a weighted average period of approximately 2.1 years and 1.9 years, respectively. Expense related to non-vested restricted stock awards totaled $0.9 million and $2.5 million during the three and nine months ended September 30, 2022, respectively, and $0.8 million and $2.0 million during the three and nine months ended September 30, 2021, respectively. Expense related to non-vested performance stock units totaled $0.4 million and $1.2 million during the three and nine months ended September 30, 2022, respectively, and $0.8 million and $1.5 million during the three and nine months ended September 30, 2021, respectively. Expense related to non-vested restricted stock awards and units is a component of salaries and benefits in the Company’s consolidated statements of operations.
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Employee stock purchase plan
The 2014 Employee Stock Purchase Plan (“ESPP”) is intended to be a qualified plan within the meaning of Section 423 of the Internal Revenue Code of 1986 and allows eligible employees to purchase shares of common stock through payroll deductions up to a limit of $25,000 per calendar year and 2,000 shares per offering period. The price an employee pays for shares is 90.0% of the fair market value of Company common stock on the last day of the offering period. The offering periods are the six-month periods commencing on March 1 and September 1 of each year and ending on August 31 and February 28 (or February 29 in the case of a leap year) of each year. There are no vesting or other restrictions on the stock purchased by employees under the ESPP. Under the ESPP, the total number of shares of common stock reserved for issuance totaled 400,000 shares, of which 262,482 was available for issuance at September 30, 2022.
Under the ESPP, employees purchased 19,414 shares and 20,980 shares during the nine months ended September 30, 2022 and 2021, respectively.
Note 14 Common Stock
The Company had 33,189,253 and 29,958,764 shares of Class A common stock outstanding at September 30, 2022 and December 31, 2021, respectively. Additionally, the Company had 169,345 and 144,467 shares outstanding at September 30, 2022 and December 31, 2021, respectively, of restricted Class A common stock issued but not yet vested under the 2014 Omnibus Incentive Plan that are not included in shares outstanding until such time that they are vested; however, these shares do have voting and certain dividend rights during the vesting period.
On February 24, 2021, the Company’s Board of Directors authorized a program to repurchase up to $75.0 million of the Company’s stock from time to time in either the open market or through privately negotiated transactions. The remaining authorization under the current program as of September 30, 2022 was $38.6 million.
Note 15 Earnings Per Share
The Company calculates earnings per share under the two-class method, as certain non-vested share awards contain non-forfeitable rights to dividends. As such, these awards are considered securities that participate in the earnings of the Company. Non-vested shares are discussed further in note 12.
The Company had 33,189,253 and 30,288,131 shares of Class A common stock outstanding as of September 30, 2022 and 2021, respectively, exclusive of issued non-vested restricted shares. Certain stock options and non-vested restricted shares are potentially dilutive securities, but are not included in the calculation of diluted earnings per share because to do so would have been anti-dilutive for the three and nine months ended September 30, 2022 and 2021.
The following table illustrates the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2022 and 2021:
September 30, 2021
Less: income allocated to participating securities
(39)
(34)
(111)
(101)
Income allocated to common shareholders
15,800
19,791
54,442
70,736
Weighted average shares outstanding for basic earnings per common share
Dilutive effect of equity awards
271,887
264,225
295,364
303,373
Weighted average shares outstanding for diluted earnings per common share
Basic earnings per share
Diluted earnings per share
The Company had 730,502 and 747,666 outstanding stock options to purchase common stock at weighted average exercise prices of $29.56 and $27.68 per share at September 30, 2022 and 2021, respectively, which have time-vesting criteria, and as such, any dilution
34
is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those stock options is dilutive. The Company had 325,202 and 315,861 unvested restricted shares and performance stock units issued as of September 30, 2022 and 2021, respectively, which have performance, market and/or time-vesting criteria, and as such, any dilution is derived only for the time frame in which the vesting criteria had been met and where the inclusion of those restricted shares and units is dilutive.
Note 16 Derivatives
Risk management objective of using derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company has established policies stipulating that neither carrying value nor fair value at risk should exceed established guidelines. The Company has designed strategies to confine these risks within the established limits and identify appropriate trade-offs in the financial structure of its balance sheet. These strategies include the use of derivative financial instruments to help achieve the desired balance sheet repricing structure while meeting the desired objectives of its clients. Currently, the Company employs certain interest rate swaps that are designated as fair value hedges, cash flow hedges and economic hedges. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.
Fair values of derivative instruments on the balance sheet
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification in the consolidated statements of financial condition as of September 30, 2022 and December 31, 2021. Information about the valuation methods used to measure fair value is provided in note 18.
Asset derivatives fair value
Liability derivatives fair value
Balance Sheet
December 31,
location
Location
Derivatives designated as hedging instruments:
Interest rate products
33,779
477
1,827
12,221
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments:
10,132
8,321
10,136
8,329
Interest rate lock commitments
1,792
783
197
Forward contracts
1,923
266
Total derivatives not designated as hedging instruments
12,265
10,204
10,922
8,792
Cash flow hedges
The Company’s objectives in using interest rate derivatives are to add stability to interest income and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses floors and collars as part of its interest rate risk management strategy. Interest rate floors designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates fall below the strike rate on the contract in exchange for an up-front premium. Interest rate collars designated as cash flow hedges involve the payments of variable-rate amounts if interest rates rise above the cap strike rate on the contract and receipt of variable-rate amounts if interest rates fall below the floor strike rate on the contract. Beginning with the third quarter of 2022, such derivatives were used to hedge the variable cash flows associated with existing variable-rate loan assets.
For derivatives that qualify and are designated as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest income in the same period(s) during which the hedged transaction affects earnings. Gains and losses on the derivative representing hedge components excluded from the assessment of effectiveness are recognized over the life of the hedge on a systematic and rational basis. The earnings recognition of excluded components is included in interest income. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest income as interest payments are received on the Company’s variable-rate assets. As of September 30, 2022,
the Company had cash flow hedges with a notional amount of $150.0 million. The Company expects to reclassify $0.9 million from accumulated other comprehensive income (“AOCI”) as a reduction to interest income during the next 12 months.
Fair value hedges
Interest rate swaps designated as fair value hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without the exchange of the underlying notional amount. As of September 30, 2022, the Company had interest rate swaps with a notional amount of $331.7 million, which were designated as fair value hedges of interest rate risk. As of December 31, 2021, the Company had interest rate swaps with a notional amount of $343.1 million that were designated as fair value hedges. These interest rate swaps were associated with $436.5 million and $345.2 million of the Company’s fixed-rate loans as of September 30, 2022 and December 31, 2021, respectively, before a loss of $31.5 million and a gain of $16.1 million from the fair value hedge adjustment in the carrying amount, and are included in loans receivable in the statements of financial condition as of September 30, 2022 and December 31, 2021, respectively.
For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. The Company includes the gain or loss on the hedged items in the same line item as the offsetting loss or gain on the related derivatives.
Non-designated hedges
Derivatives not designated as hedges are not speculative and consist of interest rate swaps with commercial banking clients that facilitate their respective risk management strategies. Interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the client swaps and the offsetting swaps are recognized directly in earnings. As of September 30, 2022, the Company had matched interest rate swap transactions with an aggregate notional amount of $397.0 million related to this program. As of December 31, 2021, the Company had matched interest rate swap transactions with an aggregate notional amount of $394.4 million.
As part of its mortgage banking activities, the Company enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the clients have locked into that interest rate. The Company then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs ("best efforts") or commits to deliver the locked loan in a binding ("mandatory") delivery program with an investor. Fair value changes of certain loans under interest rate lock commitments are hedged with forward sales contracts of MBS. Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in non-interest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Company determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying assets. The fair value of the underlying assets is impacted by current interest rates, remaining origination fees, costs of production to be incurred and the probability that the interest rate lock commitments will close or will be funded.
Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Company does not expect any counterparty to any MBS contract to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Company fails to deliver the loans subject to interest rate risk lock commitments, it will still be obligated to “pair off” MBS to the counterparty. Should this be required, the Company could incur significant costs in acquiring replacement loans and such costs could have an adverse effect on the consolidated financial statements.
The fair value of the mortgage banking derivative is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.
The Company had interest rate lock commitments with a notional value of $46.9 million and forward contracts with a notional value of $54.5 million at September 30, 2022. At December 31, 2021, the Company had interest rate lock commitments with a notional value of $110.0 million and forward contracts with a notional value of $198.3 million.
Effect of derivative instruments on the consolidated statements of operations and accumulated other comprehensive income
The tables below present the effect of the Company’s derivative financial instruments in the consolidated statements of operations for the three and nine months ended September 30, 2022 and 2021:
Location of gain (loss)
Amount of gain recognized in income on derivatives
Derivatives in fair value
recognized in income on
hedging relationships
derivatives
20,795
9,057
13,893
1,829
Amount of loss recognized in income on hedged items
Hedged items
hedged items
(22,016)
(8,321)
(14,589)
(3,164)
Derivatives not designated
as hedging instruments
(1,936)
(861)
(2,780)
(5,962)
2,179
1,229
2,095
3,613
292
376
(680)
(2,331)
The table below presents the effect of fair value cash flow hedge accounting on AOCI as of the dates presented. The Company did not utilize cash flow hedges until the third quarter of 2022.
For the three and nine months ended September 30, 2022
Loss recognized in OCI on derivative
Loss recognized in OCI included component
Loss recognized in OCI excluded component
Location of Loss recognized from AOCI into income
Loss reclassified from AOCI into income
Loss reclassified from AOCI into income included component
Loss reclassified from AOCI into income excluded component
Derivatives in cash flow hedging relationships:
(2,355)
(1,827)
(528)
Interest income
(14)
Credit-risk-related contingent features
The Company has agreements with its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness for reasons other than an error or omission of an administrative or operational nature, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.
The Company also has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well/adequately capitalized institution, then the counterparty has the right to terminate the derivative positions and the Company would be required to settle its obligations under the agreements.
As of September 30, 2022, the termination value of derivatives in a net liability position related to these agreements was $42.7 million, which includes accrued interest but excludes any adjustment for nonperformance risk. The Company has minimum collateral posting thresholds with certain of its derivative counterparties and, as of September 30, 2022, the Company had met these thresholds. If the Company had breached any of these provisions at September 30, 2022, it could have been required to settle its obligations under the agreements at the termination value.
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Note 17 Commitments and Contingencies
In the normal course of business, the Company enters into various off-balance sheet commitments to help meet the financing needs of clients. These financial instruments include commitments to extend credit, commercial and consumer lines of credit and standby letters of credit. The same credit policies are applied to these commitments as the loans in the consolidated statements of financial condition; however, these commitments involve varying degrees of credit risk in excess of the amount recognized in the consolidated statements of financial condition. The total amounts of unused commitments do not necessarily represent future credit exposure or cash requirements, as commitments often expire without being drawn upon. However, the contractual amount of these commitments, offset by any additional collateral pledged, represents the Company’s potential credit loss exposure.
Total unfunded commitments at September 30, 2022 and December 31, 2021 were as follows:
Commitments to fund loans
684,800
462,151
Unfunded commitments under lines of credit
682,240
530,397
Commercial and standby letters of credit
6,245
7,321
Total unfunded commitments
1,373,285
999,869
Commitments to fund loans—Commitments to fund loans are legally binding agreements to lend to clients in accordance with predetermined contractual provisions providing there have been no violations of any conditions specified in the contract. These commitments are generally at variable interest rates and are for specific periods or contain termination clauses and may require the payment of a fee. The total amounts of unused commitments are not necessarily representative of future credit exposure or cash requirements, as commitments often expire without being drawn upon.
Unfunded commitments under lines of credit—In the ordinary course of business, the Company extends revolving credit to its clients. These arrangements may require the payment of a fee.
Commercial and standby letters of credit—As a provider of financial services, the Company routinely issues commercial and standby letters of credit, which may be financial standby letters of credit or performance standby letters of credit. These are various forms of “back-up” commitments to guarantee the performance of a client to a third party. While these arrangements represent a potential cash outlay for the Company, the majority of these letters of credit will expire without being drawn upon. Letters of credit are subject to the same underwriting and credit approval process as traditional loans, and as such, many of them have various forms of collateral securing the commitment, which may include real estate, personal property, receivables or marketable securities.
Contingencies
Mortgage loans sold to investors may be subject to repurchase or indemnification in the event of specific default by the borrower or subsequent discovery that underwriting standards were not met. The Company established a reserve liability for expected losses related to these representations and warranties based upon management’s evaluation of actual and historic loss history, delinquency trends in the portfolio and economic conditions. Charges against the reserve during the three and nine months ended September 30, 2022 totaling $74 thousand and $218 thousand, respectively, were primarily driven by early payoffs and repurchases. Charges against the reserve during the three and nine months ended September 30, 2021 totaling $150 thousand and $392 thousand, respectively, were primarily driven by early payoffs and repurchases. The repurchase reserve is included in other liabilities in the consolidated statements of financial condition.
The following table summarizes mortgage repurchase reserve activity for the periods presented:
1,878
2,398
2,102
2,741
Provision charged to (released from) operating expense, net
39
(45)
(62)
(74)
(150)
(218)
(392)
1,839
2,287
In the ordinary course of business, the Company and the Bank may be subject to litigation. Based upon the available information and advice from the Company’s legal counsel, management does not believe that any potential, threatened or pending litigation to which it is a party will have a material adverse effect on the Company’s liquidity, financial condition or results of operations.
Note 18 Fair Value Measurements
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to disclose the fair value of its financial instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For disclosure purposes, the Company groups its financial and non-financial assets and liabilities into three different levels based on the nature of the instrument and the availability and reliability of the information that is used to determine fair value. The three levels are defined as follows:
Level 1 inputs are considered to be the most transparent and reliable and level 3 inputs are considered to be the least transparent and reliable. The Company assumes the use of the principal market to conduct a transaction of each particular asset or liability being measured and then considers the assumptions that market participants would use when pricing the asset or liability. Whenever possible, the Company first looks for quoted prices for identical assets or liabilities in active markets (level 1 inputs) to value each asset or liability. However, when inputs from identical assets or liabilities on active markets are not available, the Company utilizes market observable data for similar assets and liabilities. The Company maximizes the use of observable inputs and limits the use of unobservable inputs to occasions when observable inputs are not available. The need to use unobservable inputs generally results from the lack of market liquidity of the actual financial instrument or of the underlying collateral. While third-party price indications may be available in those cases, limited trading activity can challenge the observability of those inputs.
Changes in the valuation inputs used for measuring the fair value of financial instruments may occur due to changes in current market conditions or other factors. Such changes may necessitate a transfer of the financial instruments to another level in the hierarchy based on the new inputs used. The Company recognizes these transfers at the end of the reporting period that the transfer occurs. During the nine months ended September 30, 2022 and 2021, there were no transfers of financial instruments between the hierarchy levels.
The following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of each instrument under the valuation hierarchy:
Fair Value of Financial Instruments Measured on a Recurring Basis
Investment securities available-for-sale—Investment securities available-for-sale are carried at fair value on a recurring basis. To the extent possible, observable quoted prices in an active market are used to determine fair value and, as such, these securities are classified as level 1. When quoted market prices in active markets for identical assets or liabilities are not available, quoted prices of securities with similar characteristics, discounted cash flows or other pricing characteristics are used to estimate fair values and the securities are then classified as level 2.
Loans held for sale—The Company has elected to record loans originated and intended for sale in the secondary market at estimated fair value. The portfolio consists primarily of fixed rate residential mortgage loans that are sold within 45 days. The Company estimates fair value based on quoted market prices for similar loans in the secondary market and are classified as level 2.
Interest rate swap derivatives—The Company's derivative instruments are limited to interest rate swaps that may be accounted for as fair value hedges or non-designated hedges. The fair values of the swaps incorporate credit valuation adjustments in order to appropriately reflect nonperformance risk in the fair value measurements. The credit valuation adjustment is the dollar amount of the
fair value adjustment related to credit risk and utilizes a probability weighted calculation to quantify the potential loss over the life of the trade. The credit valuation adjustments are calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying the respective counterparties’ credit spreads to the exposure offset by marketable collateral posted, if any. Certain derivative transactions are executed with counterparties who are large financial institutions ("dealers"). International Swaps and Derivative Association Master Agreements ("ISDA") and Credit Support Annexes ("CSA") are employed for all contracts with dealers. These contracts contain bilateral collateral arrangements. The fair value inputs of these financial instruments are determined using discounted cash flow analysis through the use of third-party models whose significant inputs are readily observable market parameters, primarily yield curves, with appropriate adjustments for liquidity and credit risk, and are classified as level 2.
Mortgage banking derivatives—The Company relies on a third-party pricing service to value its mortgage banking derivative financial assets and liabilities, which the Company classifies as a level 3 valuation. The external valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale includes grouping the interest rate lock commitments by interest rate and terms, applying an average 79.6% estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms and rate lock expiration dates of the loan commitment groups. The Company also relies on an external valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing.
The tables below present the financial instruments measured at fair value on a recurring basis as of September 30, 2022 and December 31, 2021 in the consolidated statements of financial condition utilizing the hierarchy structure described above:
Level 1
Level 2
Level 3
Investment securities available-for-sale:
U.S. Treasuries
Interest rate swap derivatives
44,852
Mortgage banking derivatives
2,133
Total assets at fair value
736,710
809,939
11,925
786
Total liabilities at fair value
12,711
839,318
841,201
20,550
463
21,013
The table below details the changes in level 3 financial instruments during the nine months ended September 30, 2022:
Mortgage banking
derivatives, net
Balance at December 31, 2021
1,420
Loss included in earnings, net
Fees and costs included in earnings, net
714
Balance at September 30, 2022
1,347
Fair Value of Financial Instruments Measured on a Non-recurring Basis
Certain assets may be recorded at fair value on a non-recurring basis as conditions warrant. These non-recurring fair value measurements typically result from the application of lower of cost or fair value accounting or a write-down occurring during the period.
Individually evaluated loans—The Company records individually evaluated loans based on the fair value of the collateral when it is probable that the Company will be unable to collect all contractual amounts due in accordance with the terms of the loan agreement. The Company relies on third-party appraisals and internal assessments, utilizing a discount rate in the range of 5% - 17% with a weighted average discount rate of 9.9%, in determining the estimated fair values of these loans. The inputs used to determine the fair values of loans are considered level 3 inputs in the fair value hierarchy. At September 30, 2022, the Company recorded a specific reserve of $2.9 million related to nine loans with a carrying value of $7.2 million. At September 30, 2021, the Company recorded a specific reserve of $1.2 million related to five loans with a carrying balance of $4.7 million.
OREO—OREO is recorded at the fair value of the collateral less estimated selling costs using a range of 6% to 10% with a weighted average discount rate of 6.3%. The estimated fair values of OREO are updated periodically and further write-downs may be taken to reflect a new basis. The Company recognized $452 thousand and $799 thousand of OREO impairment during the nine months ended September 30, 2022 and 2021, respectively. During the nine months ended September 30, 2022, impairments included $227 thousand recorded within problem asset workout in the consolidated statements of operations and $225 thousand included within other liabilities in the statements of financial condition to reduce the payable for an SBA redemption agreement. The fair values of OREO are derived from third-party price opinions or appraisals that generally use an income approach or a market value approach. If reasonable comparable appraisals are not available, the Company may use internally developed models to determine fair values. The inputs used to determine the fair value of OREO properties are considered level 3 inputs in the fair value hierarchy.
Mortgage servicing rights—MSRs represent the value associated with servicing residential real estate loans that have been sold to outside investors with servicing retained. The fair value for servicing assets is determined through discounted cash flow analysis and
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utilizes a discount rate and weighted average rate of 9.5% at September 30, 2022 and prepayment speed assumption ranges of 7.6% to 7.8% with a weighted average rate of 7.6% at September 30, 2022. The weighted average MSRs are subject to impairment testing. The carrying values of these MSRs are reviewed quarterly for impairment based upon the calculation of fair value. For purposes of measuring impairment, the MSRs are stratified into certain risk characteristics including note type and note term. If the valuation model reflects a value less than the carrying value, MSRs are adjusted to fair value through a valuation allowance and the adjustment is included in mortgage banking income in the consolidated statements of operations. During the nine months ended September 30, 2022, the Company recorded impairment totaling $6 thousand. There was $0.7 million of recovery during the nine months ended September 30, 2021. The inputs used to determine the fair values of MSRs are considered level 3 inputs in the fair value hierarchy.
SBA servicing rights— SBA loan servicing assets represent the value associated with servicing small business real estate loans that have been sold to outside investors with servicing retained. The fair value for servicing assets is determined through a discounted cash flow analysis and utilizes a weighted average discount rate of 11.7% and a weighted average lifetime constant prepayment rate of 12.1%. SBA loan servicing assets are amortized over the period of the estimated future net servicing life of the underlying assets. SBA loan servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the SBA loan servicing asset. The Company recorded no impairment for the nine months ended September 30, 2022.
Premises and equipment—During the first quarter of 2021, the Company approved plans to consolidate seven banking centers. Premises and equipment held-for-sale are written down to estimated fair value less costs to sell in the period in which the held-for-sale criteria are met. Fair value is estimated in a process that considers current local commercial real estate market conditions, the judgment of the sales agent and often involves obtaining third-party appraisals from certified real estate appraisers. These fair value measurements are classified as level 3. Unobservable inputs to these measurements, which include estimates and judgments often used in conjunction with appraisals, are not readily quantifiable. For the nine months ended September 30, 2021, the Company recognized $1.6 million of impairment in its consolidated statements of operations related to premises and equipment classified as held-for-sale totaling $6.0 million as of September 30, 2021.
The Company may be required to record fair value adjustments on other available-for-sale and municipal securities valued at par on a non-recurring basis.
The tables below provide information regarding losses from assets recorded at fair value on a non-recurring basis during the nine months ended September 30, 2022 and 2021:
Losses from fair value changes
Individually evaluated loans
20,504
1,338
452
33,332
1,796
19,406
6,032
29,763
3,899
The Company did not record any liabilities measured at fair value on a non-recurring basis during the nine months ended September 30, 2022.
Note 19 Fair Value of Financial Instruments
The fair value of a financial instrument is the amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is determined based upon quoted market prices to the extent possible; however, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques that may be significantly impacted by the assumptions
42
used, including the discount rate and estimates of future cash flows. Changes in any of these assumptions could significantly affect the fair value estimates. The fair value of the financial instruments listed below does not reflect a premium or discount that could result from offering all of the Company’s holdings of financial instruments at one time, nor does it reflect the underlying value of the Company, as ASC Topic 825 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies and are based on the exit price concept within ASC Topic 825 and applied to this disclosure on a prospective basis. Considerable judgment is required to interpret market data in order to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange.
The fair value of financial instruments at September 30, 2022 and December 31, 2021 are set forth below:
Level in fair value
measurement
Carrying
Estimated
hierarchy
fair value
U.S. Treasury securities - AFS
U.S. Treasury securities - HTM
Mortgage-backed securities—residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises available-for-sale
Mortgage-backed securities—other residential mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored enterprises available-for-sale
Municipal securities available-for-sale
Other available-for-sale securities
Mortgage-backed securities—residential mortgage pass-through securities issued or guaranteed by U.S. Government agencies or sponsored enterprises held-to-maturity
Mortgage-backed securities—other residential mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored enterprises held-to-maturity
15,513
14,533
Loans receivable
5,434,105
4,540,847
Accrued interest receivable
30,125
17,848
LIABILITIES
Deposit transaction accounts
5,964,722
5,394,257
814,466
833,163
40,000
37,728
Accrued interest payable
3,318
3,944
Note 20 Subsequent Events
On October 1, 2022, the Company completed its acquisition of Bancshares of Jackson Hole Incorporated, the holding company for Bank of Jackson Hole with operations in Wyoming and Idaho. The acquisition added 12 banking centers and expanded the Company’s footprint into Wyoming and Idaho. The combined holding company will operate under the National Bank Holdings Corporation name. Pursuant to the merger agreement executed in March 2022, the Company paid $51.0 million of cash consideration and issued 4,391,964 shares of the Company’s Class A common stock in exchange for all of the outstanding common stock of BOJH. The cash paid is included in cash and due from banks in the Company’s consolidated statements of financial condition at September 30, 2022. The transaction had a value of $213.4 million in the aggregate, based on the Company’s closing price of $36.99 on September 30,
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2022. BOJH acquisition-related costs of $3.3 million and $3.9 million were included in the Company’s consolidated statements of operations for the three and nine months ended September 30, 2022, respectively.
With the completion of the BOJH and RCB acquisitions, the Company has approximately $9.4 billion in pro-forma assets, including $6.9 billion in total loans, $8.2 billion in total deposits and $0.8 billion in assets under management as of September 30, 2022.
Item 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management's discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes as of and for the three and nine months ended September 30, 2022, and with our annual report on Form 10-K (file number 001-35654), which includes our audited consolidated financial statements and related notes as of and for the years ended December 31, 2021, 2020 and 2019. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions that may cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in the section entitled “Cautionary Note Regarding Forward-Looking Statements” located elsewhere in this quarterly report and in Item 1A“Risk Factors” in the annual report on Form 10-K, referenced above, and should be read herewith.
All amounts are in thousands, except share and per share data, or as otherwise noted.
Overview
Our focus is on building relationships by creating a win-win scenario for our clients and our Company. We believe in providing solutions and services to our clients that are based on fairness and simplicity. We have established a solid financial services franchise with a sizable presence for deposit gathering and building client relationships necessary for growth. We are executing on strategic acquisition opportunities to expand our presence in attractive markets and to diversify our revenue streams. Additionally, we are innovating and building strategic fintech partnerships with the goal of delivering a comprehensive digital financial ecosystem for our clients. We are focused on providing small and medium-sized businesses with alternative digital access to address borrowing, depository and cash management needs, while also providing information management and access to blockchain payment tools, under the safety of a regulated bank. We believe that our established presence in our core markets of Colorado, the greater Kansas City region, Utah, Wyoming, Texas, New Mexico and Idaho, as well as our ongoing investment in digital and blockchain solutions and strategic acquisitions position us well for growth opportunities. As of September 30, 2022, we had $7.9 billion in assets, $5.7 billion in loans, $6.8 billion in deposits and $0.9 billion in equity.
Operating Highlights and Key Challenges
On September 1, 2022, the Company completed its acquisition of Community Bancorporation, the holding company for Rock Canyon Bank, headquartered in Provo, Utah. At the close of the acquisition, the Company acquired seven banking centers in the greater Salt Lake City region. The acquisition added approximately $832.2 million in total assets, $537.7 million in loans and $734.5 million in deposits. The merger consideration totaled $140.4 million and consisted of $124.3 million in Company stock and $16.1 million in cash. All core operating systems were converted in October.
On October 1, 2022, the Company completed its acquisition of Bancshares of Jackson Hole Incorporated, the holding company for Bank of Jackson Hole, with operations in Jackson Hole, Wyoming and Idaho. At the close of the acquisition, the Company acquired 12 banking centers. The acquisition added approximately $1.5 billion in total assets, $1.2 billion in loans and $1.4 billion in deposits and an attractive Wyoming-based trust and wealth management business with $0.8 billion in assets under management. The merger consideration totaled $213.4 million and consisted of $162.5 million in Company stock and $51.0 million in cash. All core operating systems will be converted during the fourth quarter of 2022.
Profitability and returns
●
Net income totaled $54.6 million, or $1.77 per diluted share, for the nine months ended September 30, 2022, compared to net income of $70.8 million, or $2.27 per diluted share, for the same period in the prior year. Adjusting for $13.6 million of non-recurring expenses related to the previously announced acquisitions of Bank of Jackson Hole and Rock Canyon Bank, including $5.4 million for a CECL Day 1 provision expense, net income totaled $65.0 million, or $2.11 per diluted share, for the nine months ended September 30, 2022.
The return on average tangible assets was 1.03% for the nine months ended September 30, 2022, compared to 1.39% for the same period in the prior year. Adjusting for non-recurring acquisition-related expenses, the return on average tangible assets for the nine months ended September 30, 2022 was 1.23%.
The return on average tangible common equity was 10.17% for the nine months ended September 30, 2022, compared to 13.04% for the same period in the prior year. Adjusting for non-recurring acquisition-related expenses, the return on average tangible common equity for the nine months ended September 30, 2022 was 12.10%.
Strategic execution
Completed the acquisition of Community Bancorporation, the holding company for RCB, on September 1, 2022, further expanding our presence in the Salt Lake City region. Additionally, the Company became the #1 SBA lender by loan volume in the state of Utah.
On October 1, 2022, the acquisition of BOJH, located in the fast-growing Wyoming and Boise markets, was closed. BOJH had $1.5 billion in assets, $1.2 billion in loans, $1.4 billion in deposits and a favorable Wyoming-domiciled trust business with $0.8 billion in assets under management at the acquisition date.
With the completion of these exclusively negotiated transactions, NBHC has approximately $9.4 billion in pro forma assets, $6.9 billion in total loans, $8.2 billion in total deposits and $0.8 billion in assets under management measured as of September 30, 2022.
Continued to invest in digital solutions for our clients through our financial eco-system, 2UniFiSM, for small and medium-sized businesses that we believe will increase access to financial services while reducing the costs of banking services.
Maintained a conservatively structured loan portfolio represented by diverse industries and concentrations with most industry sector concentrations at 5% or less of total loans, and all concentration levels remain well below our self-imposed limits.
Loan portfolio
Generated record organic loan growth of 30.2% annualized fueled by record year-to-date loan fundings.
New loan fundings over the trailing 12 months totaled a record $2.0 billion, led by commercial loan fundings of $1.3 billion. The RCB acquisition added loans totaling $537.7 million on September 1, 2022.
Total loans ended the quarter at $5.7 billion increasing $1.2 billion, or 35.8% annualized, since December 31, 2021.
Credit quality
Allowance for credit losses totaled 1.15% of total loans at September 30, 2022, compared to 1.10% at December 31, 2021.
The Company recorded an increase in the allowance for credit losses of $17.0 million for the nine months ended September 30, 2022, which included a Day 1 CECL allowance reserve of $5.2 million for the acquired RCB loan portfolio and a $2.5 million credit allowance for Day 1 PCD loans. The remainder of the provision expense was driven by record loan growth and higher reserve requirements from changes in the CECL model’s underlying macro-economic forecast. For the nine months ended September 30, 2021, the Company recorded an allowance for credit loss release of $9.4 million.
Net charge-offs to average total loans for the nine months ended September 30, 2022 totaled 0.03%, annualized, compared to 0.03% for the full year ended December 31, 2021.
Credit quality remained strong, as non-performing loans (comprised of non-accrual loans and non-accrual TDRs) totaled 0.26% of loans, compared to 0.24% at December 31, 2021. Non-performing assets to total loans and OREO improved to 0.32% at September 30, 2022, compared to 0.39% at December 31, 2021.
Client deposit funded balance sheet
Average transaction deposits for the nine months ended September 30, 2022 increased 8.2% to $5.5 billion, compared to $5.1 billion for the same period in the prior year.
Average total deposits totaled $6.3 billion during the nine months ended September 30, 2022, increasing 4.7%, compared to $6.0 billion for the same period in the prior year.
The mix of transaction deposits to total deposits improved 120 basis points to 87.7% at September 30, 2022, compared to 86.5% at December 31, 2021. The Rock Canyon Bank acquisition added $734.5 million of total deposits, including $653.0 million of transaction deposits and $81.5 million of time deposits on September 1, 2022.
Cost of deposits totaled 0.17% during the nine months ended September 30, 2022, compared to 0.24% for the same period in the prior year.
46
Revenues
Fully taxable equivalent (“FTE”) net interest income totaled $175.8 million during the nine months ended September 30, 2022, increasing $34.3 million, or 24.2%, compared to the same period in the prior year.
The FTE net interest margin widened 52 basis points to 3.44% for the nine months ended September 30, 2022, as compared to the same period in the prior year. The yield on earning assets increased 48 basis points, led by the remix of assets into higher-yielding loan balances and multiple increases in the federal funds rate since March 2022. The cost of funds decreased five basis points to 0.19% for the nine months ended September 30, 2022, compared to the same period in the prior year.
Non-interest income totaled $53.2 million during the nine months ended September 30, 2022, compared to $87.1 million for the same period in 2021, primarily due to lower mortgage banking income from reduced refinance activity and tighter gain on sale margins for mortgage loans sold in the secondary market.
Expenses
Non-interest expense totaled $143.6 million during the nine months ended September 30, 2022, representing a decrease of $3.8 million, or 2.5%, compared to the nine months ended September 30, 2021, primarily due to lower salaries and benefits from lower mortgage banking-related compensation.
Included in the first nine months of 2022 were $13.6 million of non-recurring acquisition-related expenses, including $5.4 million of CECL Day 1 provision expense for credit losses, $5.6 million of professional fees, $0.8 million of salaries and benefits, $0.6 million of telecommunications and data processing expense, $0.5 million of occupancy and equipment expense and $0.7 million in other non-interest expense in the consolidated statements of operations.
The FTE efficiency ratio during the nine months ended September 30, 2022 totaled 62.69%, compared to 64.43% during the nine months ended September 30, 2021. Adjusting for CDI asset amortization and non-recurring acquisition-related expenses, the FTE efficiency ratio improved 538 basis points to 58.66% during the nine months ended September 30, 2022, compared to the same period in the prior year.
Income tax expense totaled $12.0 million during the nine months ended September 30, 2022, compared to $16.1 million during the nine months ended September 30, 2021. The effective tax rate for the nine months ended September 30, 2022 was 18.0%, compared to 18.5% for the nine months ended September 30, 2021.
Strong capital position
Capital ratios continue to be strong and in excess of federal bank regulatory agency “well capitalized” thresholds. As of September 30, 2022, our consolidated tier 1 leverage ratio was 10.45%, and our common equity tier 1 and consolidated tier 1 risk based capital ratio was 12.75%.
At September 30, 2022, common book value per share was $27.70. The tangible common book value per share decreased $1.93 to $22.40 at September 30, 2022 compared to December 31, 2021 as earnings, net of dividends paid, were outpaced by a $2.48 increase in accumulated other comprehensive loss and the issuance of shares for the RCB acquisition. Excluding accumulated other comprehensive loss, the tangible book value per share increased $0.54 to $25.10 at September 30, 2022.
Key Challenges
There are a number of significant challenges confronting us and our industry. We face continual challenges implementing our business strategy. These include growing our assets, particularly loans, and deposits amidst intense competition, changing interest rates, adhering to changes in the regulatory environment and identifying and consummating disciplined acquisition and other expansionary opportunities in a very competitive and inflationary environment.
The COVID-19 pandemic has caused disruption to the U.S. labor market, supply chain, consumer spending and business operations. The prolonged economic impacts from the pandemic, including inflationary pressures and demand for labor, are likely to continue to present challenges to our business and to our clients.
We are focused on growing our loan portfolio while adhering to our established underwriting standards and self-imposed concentration limits. A significant portion of our loan portfolio is secured by real estate and any deterioration in real estate values or credit quality or elevated levels of non-performing assets would ultimately have a negative impact on the quality of our loan portfolio.
The agriculture industry continues to be impacted by elevated and volatile commodity prices and intermittent disruptions in supply chains. Our food and agribusiness portfolio is only 5.9% of total loans and is well-diversified across food production, crop and livestock types. Crop and livestock loans represent 1.8% of total loans. We have maintained relationships with food and agribusiness clients that generally possess low leverage and, correspondingly, low bank debt to assets, minimizing any potential credit losses in the future.
Future growth in our interest income will ultimately be dependent on our ability to originate high-quality loans and other high-quality earning assets such as investment securities. Cash balances total $0.3 billion as of September 30, 2022 and have decreased $589.5 million from December 31, 2021 and $551.2 million from September 30, 2021. Investment securities totaled $1.3 billion as of September 30, 2022 and increased $36.2 million, or 2.8%, compared to December 31, 2021. As of September 30, 2022, our loans outstanding totaled $5.7 billion, increasing $1.2 billion, or 26.8%, compared to December 31, 2021. During 2022, our weighted average rate on new loans funded at the time of origination was 4.80%, compared to the weighted average yield of our originated loan portfolio of 4.30% (FTE). During the nine months ended September 30, 2022, the Federal Reserve increased prevailing interest rates by a total of 300 basis points. Our future earnings will be impacted by the Federal Reserve’s future interest rate policy decisions.
Continued regulation, impending new liquidity and capital constraints, and a continual need to bolster cybersecurity are adding costs and uncertainty to all U.S. banks and could affect profitability. Also, nontraditional participants in the market may offer increased competition as non-bank payment businesses, including fintechs, are expanding into traditional banking products. While certain external factors are out of our control and may provide obstacles to our business strategy, we are prepared to deal with these challenges and expand our offerings in digital technology, including by partnering with and investing in fintechs where appropriate. We seek to remain flexible, yet methodical and proactive, in our strategic decision making so that we can quickly respond to market changes and the inherent challenges and opportunities that accompany such changes.
Performance Overview
In evaluating our consolidated statements of financial condition and results of operations financial statement line items, we evaluate and manage our performance based on key earnings indicators, balance sheet ratios, asset quality metrics and regulatory capital ratios, among others. The table below presents some of the primary performance indicators that we use to analyze our business on a regular basis for the periods indicated:
Key Metrics(1)
As of and for the three months ended
As of and for the nine months ended
Return on average assets
0.84%
1.26%
1.11%
1.00%
1.36%
Return on average tangible assets(2)
0.87%
1.30%
1.14%
1.03%
1.39%
Return on average tangible assets, adjusted(2)(10)
1.23%
Return on average equity
7.22%
10.64%
9.15%
8.64%
11.20%
Return on average tangible common equity(2)
8.66%
12.37%
10.65%
10.17%
13.04%
Return on average tangible common equity, adjusted(2)(10)
13.76%
12.10%
Loan to deposit ratio (end of period)
84.10%
72.47%
72.08%
Non-interest bearing deposits to total deposits (end of period)
40.21%
40.24%
39.89%
Net interest margin(3)
3.93%
2.95%
2.85%
3.36%
2.84%
Net interest margin FTE(2)(3)(4)
4.01%
3.03%
2.93%
3.44%
2.92%
Interest rate spread FTE(4)(5)
3.86%
2.89%
2.78%
3.31%
2.75%
Yield on earning assets(6)
4.11%
3.13%
3.04%
3.54%
3.07%
Yield on earning assets FTE(2)(4)(6)
4.19%
3.21%
3.12%
3.62%
Cost of interest bearing liabilities
0.33%
0.32%
0.34%
0.31%
0.39%
Cost of deposits
0.18%
0.21%
0.17%
0.24%
Non-interest income to total revenue FTE(4)
19.76%
31.37%
36.85%
23.22%
38.11%
Non-interest expense to average assets
2.87%
2.47%
2.86%
2.63%
2.82%
Efficiency ratio
62.39%
61.22%
67.44%
63.83%
65.53%
Efficiency ratio FTE(2)(4)
61.39%
60.14%
66.29%
62.69%
64.43%
Efficiency ratio FTE, adjusted(2)(4)(10)
52.99%
59.74%
65.91%
58.66%
64.04%
Pre-provision net revenue
32,511
28,196
81,371
77,482
Pre-provision net revenue FTE(2)
33,920
29,495
26,092
85,429
81,344
Pre-provision net revenue FTE adjusted for acquisition-related expense(2)(10)
40,916
93,685
Total Loans Asset Quality Data(7)(8)(9)
Non-performing loans to total loans
0.26%
0.29%
Non-performing assets to total loans and OREO
Allowance for credit losses to total loans
1.15%
1.10%
Allowance for credit losses to non-performing loans
447.72%
458.77%
382.59%
Net charge-offs to average loans
0.01%
0.02%
0.03%
Ratios are annualized.
Ratio represents non-GAAP financial measure. See non-GAAP reconciliations below.
Net interest margin represents net interest income, including accretion income on interest earning assets, as a percentage of average interest earning assets.
Presented on an FTE basis using the statutory rate of 21% for all periods presented. The taxable equivalent adjustments included above are $1,409, $1,299 and $1,315 for the three months ended September 30, 2022, December 31, 2021 and September 30, 2021, respectively. The taxable equivalent adjustments included above are $4,058 and $3,862 for the nine months ended September 30, 2022 and September 30, 2021, respectively.
Interest rate spread represents the difference between the weighted average yield on interest earning assets and the weighted average cost of interest bearing liabilities.
Interest earning assets include assets that earn interest/accretion or dividends. Any market value adjustments on investment securities are excluded from interest earning assets.
(7)
Non-performing loans consist of non-accruing loans and restructured loans on non-accrual.
(8)
Non-performing assets include non-performing loans and OREO.
(9)
Total loans are net of unearned discounts and fees.
(10)
Ratios are adjusted for acquisition-related expenses. See non-GAAP reconciliation below.
About Non-GAAP Financial Measures
Certain of the financial measures and ratios we present, including “tangible assets,” “average tangible assets,” “return on average tangible assets,” “tangible common equity,” “tangible common equity to tangible assets,” “return on average tangible common equity,” “tangible common book value,” “tangible common book value per share,” “tangible common equity to tangible assets,” “tangible common book value, excluding accumulated other comprehensive loss, net of tax,” “tangible common book value per share, excluding accumulated other comprehensive loss, net of tax,” “adjusted non-interest expense,” “non-interest expense to average assets, adjusted,” “adjusted net income,” “adjusted net income excluding core deposit intangible amortization expense, after tax,” “adjusted earnings per share - diluted,” “adjusted return on average tangible assets,” “adjusted return on average tangible common equity,” “non-interest expense adjusted for CDI asset amortization and acquisition-related expenses,” “non-interest expense adjusted for acquisition-related expenses,” “efficiency ratio adjusted for CDI and acquisition-related expenses,” “pre-provision net revenue,” “pre-provision net revenue adjusted for acquisition-related expenses,” “tangible common book value, excluding accumulated other comprehensive loss (income), net of tax,” “tangible common book value per share, excluding accumulated other comprehensive loss (income), net of tax,” “adjusted net income excluding CDI amortization expense, after tax” and “fully taxable equivalent” metrics, are supplemental measures that are not required by, or are not presented in accordance with, U.S. generally accepted accounting principles (GAAP). We refer to these financial measures and ratios as “non-GAAP financial measures.” We consider the use of select non-GAAP financial measures and ratios to be useful for financial and operational decision making and useful in evaluating period-to-period comparisons. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding certain expenses or assets that we believe are not indicative of our primary business operating results or by presenting certain metrics on an FTE basis. We believe that management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, analyzing and comparing past, present and future periods.
These non-GAAP financial measures should not be considered a substitute for financial information presented in accordance with GAAP and you should not rely on non-GAAP financial measures alone as measures of our performance. The non-GAAP financial measures we present may differ from non-GAAP financial measures used by our peers or other companies. We compensate for these limitations by providing the equivalent GAAP measures whenever we present the non-GAAP financial measures and by including a reconciliation of the impact of the components adjusted for in the non-GAAP financial measure so that both measures and the individual components may be considered when analyzing our performance.
50
A reconciliation of our GAAP financial measures to the comparable non-GAAP financial measures is as follows:
Tangible Common Book Value Ratios
Less: goodwill and CDI assets, net
(186,608)
(121,392)
(121,688)
Add: deferred tax liability related to goodwill
10,755
10,070
9,841
Tangible common equity (non-GAAP)
743,573
728,784
732,869
7,100,991
Tangible assets (non-GAAP)
7,747,068
7,102,689
6,989,144
Tangible common equity to tangible assets calculations:
Total shareholders' equity to total assets
11.60%
11.65%
11.90%
Less: impact of goodwill and CDI assets, net
(2.00)%
(1.39)%
(1.41)%
Tangible common equity to tangible assets (non-GAAP)
9.60%
10.26%
10.49%
Tangible common book value per share calculations:
Divided by: ending shares outstanding
33,189,253
29,958,764
30,288,131
Tangible common book value per share (non-GAAP)
22.40
24.33
24.20
Tangible common book value per share, excluding accumulated other comprehensive loss calculations:
89,339
6,963
1,397
Tangible common book value, excluding accumulated other comprehensive loss, net of tax (non-GAAP)
832,912
735,747
734,266
Tangible common book value per share, excluding accumulated other comprehensive loss, net of tax (non-GAAP)
25.10
24.56
24.24
51
Return on Average Tangible Assets and Return on Average Tangible Equity
22,769
Add: impact of CDI amortization expense, after tax
751
682
Net income excluding the impact of CDI amortization expense, after tax
16,134
22,996
20,052
55,304
71,519
Net income excluding impact of CDI amortization expense, after tax
Add: acquisition-related adjustments, after tax (non-GAAP)(1)
9,510
10,480
Net income excluding impact of CDI amortization expense adjusted, after tax (non-GAAP)(1)
25,644
65,784
Average assets
7,449,066
7,146,571
7,116,141
7,285,934
6,977,494
Less: average goodwill and CDI asset, net of deferred tax liability related to goodwill
(131,490)
(111,508)
(112,026)
(117,485)
(112,320)
Average tangible assets (non-GAAP)
7,317,576
7,035,063
7,004,115
7,168,449
6,865,174
Average shareholders' equity
870,849
848,803
859,245
844,241
845,776
Average tangible common equity (non-GAAP)
739,359
737,295
747,219
726,756
733,456
Return on average assets (non-GAAP)
Return on average tangible assets (non-GAAP)
Adjusted return on average tangible assets (non-GAAP)
Return on average equity (non-GAAP)
Return on average tangible common equity (non-GAAP)
Adjusted return on average tangible common equity (non-GAAP)
(1) Acquisition-related adjustments:
Provision expense adjustments:
CECL day 1 provision expense (non-GAAP)
5,358
Non-interest expense adjustments:
Acquisition-related expenses (non-GAAP)
6,996
8,256
Acquisition-related adjustments before tax (non-GAAP)
12,354
13,614
Tax expense impact
(2,844)
(3,134)
Acquisition-related adjustments, after tax (non-GAAP)
52
Fully Taxable Equivalent Yield on Earning Assets and Net Interest Margin
52,501
Add: impact of taxable equivalent adjustment
1,299
1,315
4,058
3,862
Interest income FTE (non-GAAP)
73,778
53,800
52,116
184,788
152,326
Net interest income
49,486
Net interest income FTE (non-GAAP)
70,500
50,785
48,884
175,827
141,520
Average earning assets
6,982,048
6,655,918
6,624,047
6,829,975
6,475,934
Yield on earning assets
Yield on earning assets FTE (non-GAAP)
Net interest margin
Net interest margin FTE (non-GAAP)
Efficiency Ratio and Pre-Provision Net Revenue
As of and for the six months ended
Net interest income, FTE (non-GAAP)
23,215
44,505
Less: CDI asset amortization
(296)
(295)
(975)
(887)
Less: Acquisition-related expenses
(6,996)
(8,256)
Non-interest expense adjusted for CDI asset amortization and acquisition-related expenses (non-GAAP)
46,559
44,209
51,019
134,341
146,438
Non-interest expense adjusted for acquisition-related expenses (non-GAAP)
46,942
135,316
Efficiency ratio FTE (non-GAAP)
Efficiency ratio FTE adjusted for CDI asset amortization and acquisition-related expenses (non-GAAP)
Pre-provision net revenue (non-GAAP)
Pre-provision net revenue, FTE (non-GAAP)
Pre-provision net revenue, FTE adjusted for acquisition-related expenses (non-GAAP)
53
Adjusted Net Income and Earnings Per Share
Adjustments to net income:
Add: Acquisition-related adjustments, after tax (non-GAAP)
Adjusted net income (non-GAAP)
25,349
65,033
Adjustments to earnings per share:
Earnings per share - diluted
0.75
0.30
0.34
Adjusted earnings per share - diluted (non-GAAP)
0.80
2.11
Application of Critical Accounting Policies and Significant Estimates
We use accounting principles and methods that conform to GAAP and general banking practices. We are required to apply significant judgment and make material estimates in the preparation of our financial statements and with regard to various accounting, reporting and disclosure matters. Assumptions and estimates are required to apply these principles where actual measurement is not possible or practical. The most significant of these estimates relate to the determination of the ACL. See additional discussion of our ACL policy in note 2 – Summary of Significant Accounting Policies in our audited consolidated financial statements in our 2021 Annual Report on Form 10-K.
Accounting for Acquired Loans
ASC Topic 805, Business Combinations, all acquired loans are recorded at fair value at the date of acquisition. The fair value for acquired loans at the time of acquisition is based on a variety of factors including discounted expected cash flows, adjusted for estimated prepayments and credit losses. In accordance with ASC 326, the fair value adjustment is recorded as premium or discount to the unpaid principal balance of each acquired loan. Loans that have been identified as having experienced a more-than-insignificant deterioration in credit quality since origination are PCD loans. The net premium or discount on PCD loans is adjusted by our allowance for credit losses recorded at the time of acquisition. The remaining net premium or discount is accreted or amortized into interest income over the remaining life of the loan using the level yield method. The net premium or discount on non-PCD loans, that includes credit quality and interest rate considerations, is accreted or amortized into interest income over the remaining life of the loan using the level yield method. The Company then records the necessary allowance for credit losses on the non-PCD loans through provision for credit losses expense.
Future Accounting Pronouncements
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 was effective upon issuance and can be adopted during any interim period through December 31, 2022. It provides optional expedients and guidance for applying generally accepted accounting principles to contract modifications and hedging relationships, if certain criteria are met, that reference LIBOR or any other reference rate that is expected to be discontinued. To address reference rate reform, the Company established a LIBOR transition subcommittee in January of 2020 to identify exposure to reference rates within loan and derivative contracts. The Company had no exposure to LIBOR tenors that were discontinued as of January 1, 2022. For tenors expiring on future dates the Company is working to ensure all documentation includes contingency terms, if necessary, that may be utilized at such time when the LIBOR is discontinued. Beginning January 1, 2022, the Company no longer originates loans using LIBOR as a reference rate. The Company has assessed, and will continue to evaluate, the impact from ASU 2020-04 and does not expect the adoption of ASU 2020-04, or any updates issued to date, to have a material impact on its financial statements.
In March 2022, the FASB issued ASU 2022-02, Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, which eliminates the accounting guidance on TDRs and requires disclosure of current-period gross write-offs by year of origination. The guidance also updates the requirements related to accounting for credit losses under ASC Topic 326 and adds
enhanced disclosures for creditors with respect to loan refinancing and restructuring for borrowers experiencing financial difficulty. The guidance will be effective for fiscal years, and interim periods, beginning after December 15, 2022 for entities that have adopted ASU 2016-13. The Company is reviewing ASU 2022-02 and does not expect the adoption of that pronouncement to have a material impact on its financial statements.
In March 2022, the FASB issued ASU 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. The purpose of this updated guidance is to further align risk management objectives with hedge accounting results on the application of the last-of-layer method, which was first introduced in ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. ASU 2022-01 is effective for public business entities for fiscal years beginning after December 15, 2022. The Company is reviewing ASU 2022-01 and does not expect the adoption of that pronouncement to have a material impact on its financial statements.
Financial Condition
Total assets increased $708.9 million to $7.9 billion from December 31, 2021 to September 30, 2022 primarily due to the acquisition of RCB. Cash and cash equivalents decreased $589.5 million, or 69.7%, from December 31, 2021 as excess cash liquidity was deployed into higher earning investment securities and loans. Investment securities decreased $36.2 million, or 2.8%, and loans increased $1.2 billion, or 26.8%, compared to December 31, 2021. The allowance for credit losses increased $15.9 million to $65.6 million at September 30, 2022, compared to December 31, 2021.
During the nine months ended September 30, 2022, lower cost demand, savings, and money market deposits ("transaction deposits") increased $570.5 million, or 14.1% annualized, compared to December 31, 2021, largely due to the acquisition of RCB, in addition to continued development of full banking relationships with our clients. In addition to providing excess cash liquidity, the increase in transaction deposits provided low-cost funding utilized to fund loan growth.
Investment securities
Total investment securities available-for-sale increased 5.6% during the nine months ended September 30, 2022 to $0.7 billion. Purchases of available-for-sale securities during the nine months ended September 30, 2022 and 2021 totaled $260.2 million and $196.3 million, respectively. Paydowns and maturities totaled $116.0 million and $185.0 million during the nine months ended September 30, 2022 and 2021, respectively.
Our available-for-sale investment securities portfolio is summarized in the following table as of the dates indicated. The weighted average yield was calculated based on amortized cost. Yields on tax exempt securities have not been adjusted for tax exempt status.
Percent of
portfolio
yield
Treasury securities
9.7%
31.4%
1.73%
32.9%
1.38%
58.5%
1.68%
66.7%
1.47%
0.0%
5.80%
0.1%
0.00%
1.78%
1.46%
As of September 30, 2022 and December 31, 2021, nearly all the available-for-sale investment portfolio was backed by mortgages. The residential mortgage pass-through securities portfolio is comprised of both fixed rate and adjustable rate FHLMC, FNMA and GNMA securities. The other mortgage-backed securities are comprised of securities backed by FHLMC, FNMA and GNMA securities.
Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average life of the available-for-sale mortgage-backed securities portfolio was 5.6 years and 4.2 years at September 30, 2022 and December 31, 2021, respectively. This estimate is based on assumptions and actual results may differ. At September 30, 2022 and December 31, 2021, the duration of the total available-for-sale investment portfolio was 4.6 years and 3.8 years, respectively.
At September 30, 2022 and December 31, 2021, adjustable rate securities comprised 11.1% and 1.7%, respectively, of the available-for-sale MBS portfolio. The remainder of the portfolio was comprised of fixed rate amortizing securities with 10 to 30 year contractual maturities, with a weighted average coupon of 1.75% per annum and 1.70% per annum at September 30, 2022 and December 31, 2021, respectively.
The available-for-sale investment portfolio included $115.3 million of unrealized losses and $12 thousand of unrealized gains at September 30, 2022 and $13.3 million of unrealized losses and $3.4 million of unrealized gains at December 31, 2021. We believe any unrealized losses are a result of prevailing interest rates, and as such, we do not believe that any of the securities with unrealized losses were impaired. Management believes that default of the available-for-sale securities is highly unlikely. FHLMC, FNMA and GNMA guaranteed mortgage-backed securities and U.S. Treasury securities have a long history of zero credit losses, an explicit guarantee by the U.S. government (although limited for FNMA and FHLMC securities) and yields that generally trade based on market views of prepayment and liquidity risk rather than credit risk.
Held-to-maturity investment securities decreased 0.5% during the nine months ended September 30, 2022 to $0.6 billion. Purchases during the nine months ended September 30, 2022 and 2021 totaled $91.6 million and $377.7 million, respectively. Paydowns and maturities totaled $93.2 million and $109.0 million during the nine months ended September 30, 2022 and 2021, respectively.
8.1%
48.0%
1.75%
51.4%
1.56%
43.9%
1.54%
48.6%
1.25%
1.77%
1.41%
The residential mortgage pass-through and other residential MBS held-to-maturity investment portfolios are comprised of fixed rate FHLMC, FNMA and GNMA securities.
The fair value of the held-to-maturity investment portfolio included $97.3 million of unrealized losses at September 30, 2022. At December 31, 2021, the held-to-maturity investment portfolio included $11.9 million of unrealized losses and $2.2 million of unrealized gains.
The Company does not measure expected credit losses on a financial asset, or groups of financial assets, in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Management evaluated held-to-maturity securities noting they are backed by loans guaranteed by either U.S. government agencies or U.S. government sponsored entities, and management believes that default is highly unlikely given this governmental backing and long history without credit losses. Additionally, management notes that yields on which the portfolio generally trades are based upon market views of prepayment and liquidity risk and not credit risk. The Company has no intention to sell the securities and believes it will not be required to sell the securities before the recovery of their amortized cost.
Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average expected life of the held-to-
56
maturity mortgage-backed securities portfolio as of September 30, 2022 and December 31, 2021 was 6.3 years and 4.1 years, respectively. This estimate is based on assumptions and actual results may differ. The duration of the total held-to-maturity investment portfolio was 5.0 years and 3.8 years as of September 30, 2022 and December 31, 2021, respectively.
Non-marketable securities totaled $64.0 million and $50.7 million at September 30, 2022 and December 31, 2021, respectively, and included FRB stock, FHLB stock and other non-marketable securities. At September 30, 2022, other non-marketable securities totaled $48.5 million and consisted of equity method investments totaling $21.5 million and convertible preferred stock without readily determinable fair values totaling $27.0 million. At December 31, 2021, other non-marketable securities totaled $36.2 million and consisted of equity method investments totaling $14.2 million and convertible preferred stock without readily determinable fair values totaling $22.0 million. The Company continues to invest with fintech solution providers to support our digital ecosystem buildout, support our core bank products and offerings, and to leverage efficiencies and technological solutions in our shared services areas. Purchases of non-marketable securities totaled $11.5 million and $25.8 million during the nine months ended September 30, 2022 and 2021, respectively.
At September 30, 2022, the Company held $13.9 million of FRB stock and $1.6 million of FHLB stock for regulatory and debt facility purposes. At December 31, 2021, the Company held $13.9 million of FRB stock and $0.7 million of FHLB stock. These are restricted securities which, lacking a market, are carried at cost. The Company is not aware of any events or changes in circumstances that may have an adverse effect on the investments carried at cost.
Loans overview
At September 30, 2022, our loan portfolio was comprised of new loans that we have originated and loans that were acquired in connection with our seven acquisitions to date. The Company added $537.7 million of loans to the acquired loan portfolio on September 1, 2022 from the acquisition of RCB.
As discussed in note 3 to our consolidated financial statements, under ASC Topic 805, Business Combinations, all acquired loans are recorded at fair value at the date of acquisition. The fair value for acquired loans at the time of acquisition is based on a variety of factors including discounted expected cash flows, adjusted for estimated prepayments and credit losses. In accordance with ASC 326, the fair value adjustment is recorded as premium or discount to the unpaid principal balance of each acquired loan. Loans that have been identified as having experienced a more-than-insignificant deterioration in credit quality since origination are PCD loans. The net premium or discount on PCD loans is adjusted by our allowance for credit losses recorded at the time of acquisition. The remaining net premium or discount is accreted or amortized into interest income over the remaining life of the loan using a level yield method. The net premium or discount on non-PCD loans, that includes credit quality and interest rate considerations, is accreted or amortized into interest income over the remaining life of the loan using a level yield method. The Company then records the necessary allowance for credit losses on the non-PCD loans through provision for credit losses expense.
The table below shows the loan portfolio composition at the respective dates:
September 30, 2022 vs.
% Change
Originated:
1,724,469
1,479,895
16.5%
968,539
928,705
4.3%
631,783
503,663
25.4%
265,835
200,412
32.6%
3,590,626
3,112,675
15.4%
731,293
611,765
19.5%
750,669
616,135
21.8%
17,027
17,336
(1.8)%
Total originated
5,089,615
4,357,911
16.8%
Acquired:
82,324
16,252
>100%
326
(4.1)%
176,385
29,973
73,822
3,177
332,857
49,742
219,109
52,964
79,477
52,521
51.3%
927
245
Total acquired
632,370
155,472
26.8%
The Company maintains a granular and well-diversified loan portfolio with self-imposed concentration limits. The loan portfolio increased $1.2 billion, or 35.8% annualized, from December 31, 2021 to September 30, 2022. The increase was led by commercial loan growth of $761.1 million, or 32.2% annualized. Excluding loans totaling $537.7 million from the acquisition of RCB, loans increased $670.9 million led by originated commercial loan growth of $478.0 million, or 15.4%. Loan fundings during the nine months ended September 30, 2022 totaled a record $1.5 billion, led by commercial loan fundings of $977.4 million.
Our commercial and industrial loan portfolio is comprised of diverse industry segments. At September 30, 2022, these segments included finance and financial services, primarily lender finance loans, of $201.8 million, hospital/medical loans of $397.4 million, manufacturing-related loans of $206.9 million, and a variety of smaller subcategories of commercial and industrial loans. Food and agribusiness loans, which are well-diversified across food production, crop and livestock types, totaled $339.7 million and were 36.6% of the Company’s risk based capital. Crop and livestock loans represent 1.8% of total loans.
Non-owner occupied CRE loans were 102.3% of the Company’s risk based capital, or 16.6% of total loans, and no specific property type comprised more than 5.0% of total loans. The Company maintains very little exposure to non-owner occupied CRE retail properties, comprising 1.4% of total loans. Multi-family loans totaled $69.8 million, or 1.2% of total loans as of September 30, 2022.
New loan origination is a direct result of our ability to recruit and retain top banking talent, connect with clients in our markets and provide needed services at competitive rates. Loan fundings totaled a record $2.0 billion over the past 12 months, led by commercial loan fundings of $1.3 billion. Fundings are defined as closed-end funded loans and revolving lines of credit advances, net of any current period paydowns. Management utilizes this more conservative definition of fundings to better approximate the impact of fundings on loans outstanding and ultimately net interest income.
The following table represents new loan fundings for the periods presented:
Third quarter
Second quarter
First quarter
Fourth quarter
201,106
152,550
169,168
229,529
196,289
20,845
81,428
49,906
101,450
43,516
65,125
78,905
67,597
28,914
53,445
76,293
(4,186)
18,620
11,016
8,442
363,369
308,697
305,291
370,909
301,692
166,739
88,612
63,416
46,128
55,392
99,951
93,220
49,040
55,873
1,505
1,989
1,904
2,524
1,810
631,564
492,518
419,651
475,434
413,336
Included in fundings are net fundings under revolving lines of credit totaling $124,834, $21,762, $66,430, $138,777 and $29,154 as of the third, second and first quarters of 2022 and the fourth and third quarters of 2021, respectively.
The tables below show the contractual maturities of our total loans for the dates indicated:
Due within
Due after 1 but
Due after 5 but
Due after
1 year
within 5 years
within 15 years
15 Years
184,939
1,337,644
273,871
10,339
2,396
151,005
510,341
305,123
65,345
221,255
418,251
103,317
70,477
205,556
42,466
21,158
323,157
1,915,460
1,244,929
439,937
227,394
484,706
221,477
16,825
30,029
40,215
191,432
568,470
4,250
11,324
2,379
584,830
2,451,705
1,660,217
1,025,233
143,152
1,119,195
226,793
7,007
23,827
112,022
559,493
233,703
40,510
160,853
266,664
65,609
79,507
107,799
11,193
5,090
286,996
1,499,869
1,064,143
311,409
200,042
316,473
147,783
431
12,605
30,233
201,918
423,900
3,504
11,507
2,570
503,147
1,858,082
1,416,414
735,740
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The stated interest rate (which excludes the effects of non-refundable loan origination and commitment fees, net of costs and the accretion of fair value marks) of total loans with maturities over one year is as follows at the dates indicated:
Fixed
Variable
Balance
average rate
646,710
4.40%
975,144
5.91%
1,621,854
5.31%
Municipal and non-profit(1)
973,811
3.45%
23,430
3.90%
997,241
3.46%
381,363
4.55%
361,460
5.59%
742,823
5.10%
51,110
5.23%
218,070
6.15%
269,180
5.98%
2,052,994
4.02%
1,578,104
5.84%
3,631,098
4.81%
264,778
4.63%
458,230
5.44%
723,008
5.14%
397,691
3.57%
402,426
4.76%
800,117
4.17%
11,055
4.78%
2,649
6.30%
13,704
5.07%
Total loans with > 1 year maturity
2,726,518
2,441,409
5,167,927
480,034
4.05%
872,961
3.41%
1,352,995
3.63%
881,339
3.37%
23,879
2.76%
905,218
3.35%
293,190
4.70%
199,936
3.75%
493,126
4.45%
49,303
5.21%
74,779
3.95%
124,082
1,703,866
3.88%
1,171,555
3.49%
2,875,421
3.72%
214,463
4.28%
250,224
3.51%
464,687
360,648
295,403
4.00%
656,051
3.70%
11,567
4.37%
2,510
3.52%
14,077
4.21%
2,290,544
3.85%
1,719,692
3.58%
4,010,236
3.74%
Included in municipal and non-profit fixed rate loans are loans totaling $331,708 and $343,089 that have been swapped to variable rates at current market pricing at September 30, 2022 and December 31, 2021, respectively. Included in the municipal and non-profit segment are tax exempt loans totaling $774,498 and $746,508 with an FTE weighted average rate of 4.03% and 3.97% at September 30, 2022 and December 31, 2021, respectively.
Asset quality
Asset quality is fundamental to our success and remains a strong point, driven by our disciplined adherence to our self-imposed concentration limits across industry sector and real estate property type. Accordingly, for the origination of loans, we have established a credit policy that allows for responsive, yet controlled lending with credit approval requirements that are scaled to loan size. Within the scope of the credit policy, each prospective loan is reviewed in order to determine the appropriateness and the adequacy of the loan characteristics and the security or collateral prior to making a loan. We have established underwriting standards and loan origination procedures that require appropriate documentation, including financial data and credit reports. For loans secured by real property, we require property appraisals, title insurance or a title opinion, hazard insurance and flood insurance, in each case where appropriate.
Additionally, we have implemented procedures to timely identify loans that may become problematic in order to ensure the most beneficial resolution for the Company. Asset quality is monitored by our credit risk management department and evaluated based on quantitative and subjective factors such as the timeliness of contractual payments received. Additional factors that are considered, particularly with commercial loans over $500,000, include the financial condition and liquidity of individual borrowers and guarantors, if any, and the value of our collateral. To facilitate the oversight of asset quality, loans are categorized based on the number of days past due and on an internal risk rating system, and both are discussed in more detail below.
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In the event of borrower default, we may seek recovery in compliance with state lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include modifying or restructuring a loan from its original terms, for economic or legal reasons, to provide a concession to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Such restructured loans are considered TDRs in accordance with ASC 310-40. Assets that have been foreclosed on or acquired through deed-in-lieu of foreclosure are classified as OREO until sold, and are carried at the fair value of the collateral less estimated costs to sell, with any initial valuation adjustments charged to the ACL and any subsequent declines in carrying value charged to impairments on OREO.
Non-performing assets and past due loans
Non-performing assets consist of non-accrual loans and OREO. Interest income that would have been recorded had non-accrual loans performed in accordance with their original contract terms during the three and nine months ended September 30, 2022 was $0.2 million and $0.4 million, respectively, and $0.2 million and $0.7 million during the three and nine months ended September 30, 2021, respectively.
Past due status is monitored as an indicator of credit deterioration. Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. Loans that are 90 days or more past due are put on non-accrual status unless the loan is well secured and in the process of collection.
The following table sets forth the non-performing assets and past due loans as of the dates presented:
Non-accrual loans:
Non-accrual loans, excluding restructured loans
10,232
8,466
Restructured loans on non-accrual
Non-performing loans
OREO
Total non-performing assets
18,352
17,837
Loans 30-89 days past due and still accruing interest
Loans 90 days or more past due and still accruing interest
Total past due and non-accrual loans
Accruing restructured loans
Total 90 days past due and still accruing interest and non-accrual loans to total loans
0.25%
Total non-performing assets to total loans and OREO
ACL to non-performing loans
During the nine months ended September 30, 2022, total non-performing loans increased $3.8 million from December 31, 2021 to $14.7 million. The increases in the non-performing loans was primarily driven by the inclusion of the Rock Canyon Bank portfolio. Total non-performing assets to total loans and OREO decreased seven basis points to 0.32% at September 30, 2022.
Loans 30-89 days past due and still accruing interest were 0.03% and 0.04% of total loans at September 30, 2022 and December 31, 2021, respectively. Loans 90 days or more past due and still accruing interest were 0.01% of total loans at both September 30, 2022 and December 31, 2021.
The ACL represents the amount that we believe is necessary to absorb estimated lifetime credit losses inherent in the loan portfolio at the balance sheet date and involves a high degree of judgment and complexity. On January 1, 2020, the Company adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments which replaced the incurred loss methodology for recognizing credit losses with a CECL model. The Company utilizes a DCF model developed within a third-party software tool to establish expected
lifetime credit losses for the loan portfolio. The ACL is calculated as the difference between the amortized cost basis and the projections from the DCF analysis. The DCF model allows for individual life of loan cash flow modeling, excluding extensions and renewals, using loan-specific interest rates and repayment schedules including estimated prepayment rates and loss recovery timing delays. The model incorporates forecasts of certain national macro-economic factors, including unemployment rates, home price index (“HPI”), retail sales and gross domestic product (“GDP”), which drive correlated loss rates. The determination and application of the ACL accounting policy involves judgments, estimates and uncertainties that are subject to change. For periods beyond the reasonable and supportable forecast period, we revert to historical long-term average loss rates on a straight-line basis.
We measure expected credit losses for loans on a pooled basis when similar risk characteristics exist. We have identified four primary loan segments within the ACL model that are further stratified into 11 loan classes to provide more granularity in analyzing loss history and to allow for more definitive qualitative adjustments based upon specific risk factors affecting each loan class. Generally, the underlying risk of loss for each of these loan segments will follow certain norms/trends in various economic environments. Loans that do not share risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. Following are the loan classes within each of the four primary loan segments:
commercial real estate
Acquisition and development
Loans on non-accrual, in bankruptcy and TDRs with a balance greater than $250,000 are excluded from the pooled analysis and are evaluated individually. If management determines that foreclosure is probable, expected credit losses are evaluated based on the criteria listed below, adjusted for selling costs as appropriate. Typically, these loans consist of commercial, commercial real estate and agriculture loans and exclude homogeneous loans such as residential real estate and consumer loans. Specific allowances are determined by collectively analyzing:
the borrower's resources, ability, and willingness to repay in accordance with the terms of the loan agreement;
the likelihood of receiving financial support from any guarantors;
the adequacy and present value of future cash flows, less disposal costs, of any collateral; and
the impact current economic conditions may have on the borrower's financial condition and liquidity or the value of the collateral.
The collective resulting ACL for loans is calculated as the sum of the general reserves, specific reserves on individually evaluated loans, and qualitative factor adjustments. While these amounts are calculated by individual loan or on a pool basis by segment and class, the entire ACL is available for any loan that, in our judgment, should be charged-off. The determination and application of the ACL accounting policy involves judgments, estimates, and uncertainties that are subject to change. Changes in these assumptions, estimates or the conditions surrounding them may have a material impact on our financial condition, liquidity or results of operations.
Net charge-offs on loans during the three and nine months ended September 30, 2022 were $0.2 million and $1.1 million, respectively. The Company recorded an increase in the allowance for credit losses of $15.0 million during the three months ended September 30, 2022, which included a $5.2 million provision expense as a Day 1 allowance reserve for the RCB portfolio and a $2.5 million credit allowance for Day 1 PCD loans. The remainder of the provision expense during the quarter was driven by strong loan growth and higher reserve requirements from changes in the CECL model’s underlying macro-economic forecast. During the nine months ended September 30, 2022, the Company recorded an increase in the allowance for credit losses of $17.0 million. The provision expense was driven by record loan growth, higher reserve requirements from changes in the CECL model’s underlying macro-economic forecast and Day 1 reserve requirements for the acquired RCB portfolio. Specific reserves on loans totaled $2.9 million at September 30, 2022.
Net charge-offs on loans during the three and nine months ended September 30, 2021 were $0.2 million and $1.1 million, respectively. The Company recorded a net zero provision for credit losses for the three months ended September 30, 2021, as the provision expense of $0.3 million for funded loans was fully offset by a provision release of $0.3 million for unfunded loan commitments. During the nine months ended September 30, 2021, the Company recorded total provision release of $9.4 million, which included a provision release of $9.6 million for funded loans and a provision expense of $0.2 million for unfunded loan commitments. The provision
release was driven by strong asset quality and an improved outlook in the CECL model’s underlying economic forecast. Specific reserves on loans totaled $1.2 million at September 30, 2021.
The Company has elected to exclude AIR from the ACL calculation. When a loan is placed on non-accrual, any recorded AIR is reversed against interest income. As of September 30, 2022 and December 31, 2021, AIR from loans totaled $26.9 million and $15.7 million, respectively.
Total ACL
After considering the above mentioned factors, we believe that the ACL of $65.6 million is adequate to cover estimated lifetime losses inherent in the loan portfolio at September 30, 2022. However, it is likely that future adjustments to the ACL will be necessary. Any changes to the underlying assumptions, circumstances or estimates, including but not limited to changes in the underlying macro-economic forecast, used in determining the ACL, could negatively or positively affect the Company's results of operations, liquidity or financial condition.
The following schedules present, by class stratification, the changes in the ACL during the periods listed:
% NCOs(1)
Beginning allowance for credit losses
Charge-offs:
Total charge-offs
Net charge-offs
(187)
(221)
Ending allowance for credit losses
Average total loans outstanding during the period
5,114,044
4,352,557
(1,082)
(1,068)
Ratio of ACL to total loans outstanding at period end
Ratio of ACL to total non-performing loans at period end
4,421,760
4,784,064
4,314,330
12,848
Ratio of annualized net charge-offs to average total loans.
63
At the acquisition date, RCB had $2.1 million of previously charged off loans for which the Company continued to have contractual rights to the cash flows. In accordance with ASC Topic 326, PCD loan accounting is to be applied by the acquirer whereby an allowance for credit losses should be recorded for this subset of loans at the acquisition date, and if deemed non-collectible, the loans are to be fully charged off on the acquirer’s books. Such amounts were fully reserved for, charged off on the acquisition date and excluded from the table above.
The following tables present the allocation of the ACL and the percentage of the total amount of loans in each loan category listed as of the dates presented:
ACL as a %
% of total loans
Related ACL
of total ACL
58.2%
21.7%
19.6%
0.5%
62.9%
20.2%
16.2%
0.7%
Deposits
Deposits from banking clients serve as a primary funding source for our banking operations, and our ability to gather and manage deposit levels is critical to our success. Deposits not only provide a low-cost funding source for our loans, but also provide a foundation for the client relationships that are critical to future loan growth. The following table presents information regarding our deposit composition at September 30, 2022 and December 31, 2021:
Increase (decrease)
40.2%
229,567
8.8%
8.9%
41,634
7.5%
Savings accounts
817,724
12.0%
774,559
12.4%
43,165
5.6%
Money market accounts
1,814,131
26.7%
1,558,032
25.0%
256,099
16.4%
Total transaction deposits
87.7%
86.5%
570,465
10.6%
Time deposits < $250,000
672,267
9.9%
703,741
11.4%
(31,474)
(4.5)%
Time deposits > $250,000
166,563
2.4%
130,175
2.1%
36,388
28.0%
Total time deposits
12.3%
13.5%
4,914
0.6%
575,379
The following table shows uninsured time deposits by scheduled maturity as of September 30, 2022:
Three months or less
15,299
Over 3 months through 6 months
17,109
Over 6 months through 12 months
23,120
Thereafter
86,599
Total uninsured time deposits
142,127
At September 30, 2022 and December 31, 2021, time deposits that were scheduled to mature within 12 months totaled $521.7 million and $555.4 million, respectively. Of the time deposits scheduled to mature within 12 months at September 30, 2022, $72.9 million were in denominations of $250,000 or more, and $448.8 million were in denominations less than $250,000.
The note is subordinated, unsecured and matures on November 15, 2031. Payments consist of interest only. Interest expense on the note is payable semi-annually in arrears and will bear interest at 3.00% per annum until November 15, 2026 (or any earlier redemption date). From November 15, 2026 until November 15, 2031 (or any earlier redemption date) payments will be made quarterly in arrears, and the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month term SOFR plus 203 basis points. The Company is using the net proceeds from the sale of the note for general corporate purposes. Prior to November 5, 2026, the Company may redeem the note only under certain limited circumstances. Beginning on November 5, 2026 through maturity, the note may be redeemed, at the Company’s option, on any scheduled interest payment date. Any redemption by the Company would be at a redemption price equal to 100% of the principal amount of the note being redeemed, together with any accrued and unpaid interest on the note being redeemed up to but excluding the date of redemption. The note is not subject to redemption at the option of the holder.
Other borrowings
As of September 30, 2022 and December 31, 2021, the Bank sold securities under agreements to repurchase totaling $20.0 million and $22.8 million, respectively. In addition, as a member of the FHLB, the Bank has access to a line of credit and term financing from the FHLB with total available credit of $1.0 billion at September 30, 2022. The Bank may utilize its FHLB line of credit as a funding mechanism for originated loans and loans held for sale. At September 30, 2022 and December 31, 2021, the Bank had no outstanding borrowings with the FHLB. The Bank may pledge investment securities and loans as collateral for FHLB advances. There were no investment securities pledged at September 30, 2022 or December 31, 2021. Loans pledged were $1.7 billion and $1.3 billion at September 30, 2022 and December 31, 2021, respectively. The Company incurred no interest expense related to FHLB advances or other short-term borrowings for the three and nine months ended September 30, 2022 or 2021.
Results of Operations
Our net income depends largely on net interest income, which is the difference between interest income from interest earning assets and interest expense on interest bearing liabilities. Our results of operations are also affected by provisions for credit losses and non-interest income, such as service charges, bank card income, swap fee income, and gain on sale of mortgages. Our primary operating expenses, aside from interest expense, consist of salaries and benefits, occupancy costs, telecommunications data processing expense and intangible asset amortization. Any expenses related to the resolution of problem assets are also included in non-interest expense.
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Overview of results of operations
Net income totaled $15.8 million and $54.6 million, or $0.50 and $1.77 per diluted share, during the three and nine months ended September 30, 2022, respectively. Excluding $9.5 million of after-tax non-recurring acquisition-related expenses, net income totaled $25.3 million, or $0.80 per diluted share, during the three months ended September 30, 2022. Excluding $10.5 million of after-tax non-recurring acquisition-related expenses, net income totaled $65.0 million, or $2.11 per diluted share, during the nine months ended September 30, 2022. During the three and nine months ended September 30, 2021, net income totaled $19.8 million and $70.8 million, or $0.64 and $2.27 per diluted share, respectively. The rise in mortgage rates in 2022 has resulted in lower mortgage banking income during the first nine months of 2022. However, the increases in the Federal Reserve’s interest rates are driving higher loan yields resulting in increasing levels of net interest income.
We regularly review net interest income metrics to provide us with indicators of how the various components of net interest income are performing. We regularly review: (i) our loan mix and the yield on loans; (ii) the investment portfolio and the related yields; (iii) our deposit mix and the cost of deposits; and (iv) net interest income simulations for various forecast periods.
The effects of trade-date accounting of investment securities for which the cash had not settled are not considered interest earning assets and are excluded from this presentation for time frames prior to their cash settlement, as are the market value adjustments on the investment securities available-for-sale and loans.
The table below presents the components of net interest income on a FTE basis for the three months ended September 30, 2022 and 2021.
Averagebalance
Interest
Averagerate
Interest earning assets:
Originated loans FTE(1)(2)(3)
4,834,206
58,153
4.77%
4,137,001
41,865
Acquired loans
295,893
6,581
8.82%
187,419
3,796
8.04%
39,532
551
5.53%
157,381
1,166
2.94%
865,875
4,247
1.96%
656,757
2,572
1.57%
Investment securities held-to-maturity
605,356
671,053
2,178
14,909
5.69%
5.73%
Interest earning deposits and securities purchased under agreements to resell
326,277
2.22%
799,779
0.16%
Total interest earning assets FTE(2)
81,112
77,498
440,516
463,553
(54,610)
(48,957)
Interest bearing liabilities:
Interest bearing demand, savings and money market deposits
3,058,463
2,803,071
799,759
1,116
0.55%
903,935
1,711
0.75%
22,183
0.13%
19,681
0.10%
39,543
3.27%
Total interest bearing liabilities
3,919,948
3,726,687
Demand deposits
2,557,286
2,422,976
100,983
107,233
6,578,217
6,256,896
Shareholders' equity
Total liabilities and shareholders' equity
Net interest income FTE(2)
Interest rate spread FTE(2)
Net interest earning assets
3,062,100
2,897,360
Net interest margin FTE(2)
Average transaction deposits
5,615,749
5,226,047
Average total deposits
6,415,508
6,129,982
Ratio of average interest earning assets to average interest bearing liabilities
178.12%
177.75%
Originated loans are net of deferred loan fees, less costs, which are included in interest income over the life of the loan.
Presented on an FTE basis using the statutory tax rate of 21% for all periods presented. The taxable equivalent adjustments included above are $1,409 and $1,315 for the three months ended September 30, 2022 and 2021, respectively.
Loan fees included in interest income totaled $2,205 and $4,514 for the three months ended September 30, 2022 and 2021, respectively.
Net interest income totaled $69.1 million and $47.6 million during the three months ended September 30, 2022 and 2021, respectively. Net interest income on an FTE basis totaled a record $70.5 million and $48.9 million during the three months ended September 30, 2022 and 2021, respectively. During the three months ended September 30, 2022, the FTE net interest margin widened 108 basis points to 4.01%, compared to the three months ended September 30, 2021. The yield on earning assets increased 107 basis points, primarily driven by increases in the federal funds rate since March 2022 as well as excess cash being deployed into higher-yielding
67
originated loans and investment securities. The cost of funds decreased one basis point to 0.20% during the three months ended September 30, 2022, compared to the three months ended September 30, 2021.
Average loans comprised $5.1 billion, or 73.5%, of total average interest earning assets during the three months ended September 30, 2022, compared to $4.3 billion, or 65.3%, during the three months ended September 30, 2021. The increase in average loan balances was driven by a $697.2 million increase in average originated loans. Average acquired loans increased $108.5 million primarily driven by the RCB acquisition.
Average investment securities comprised 21.1% and 20.0% of total interest earning assets during the three months ended September 30, 2022 and 2021, respectively. The increase in the investment portfolio was driven by strategic decisions to deploy a portion of the excess cash liquidity into higher-yielding investment securities.
Average balances of interest bearing liabilities increased $193.3 million during the three months ended September 30, 2022, compared to the three months ended September 30, 2021. The increase was driven by higher interest bearing demand, savings and money market deposits totaling $255.4 million, long-term debt totaling $39.5 million and securities sold under agreement to repurchase totaling $2.5 million. The increase was partially offset by a decrease in time deposits of $104.1 million.
The Rock Canyon Bank acquisition added $734.5 million of total deposits, including $653.0 million of transaction deposits and $81.5 million of time deposits on September 1, 2022.
The table below presents the components of net interest income on an FTE basis for the nine months ended September 30, 2022 and 2021:
4,598,705
148,025
4.30%
4,073,529
121,461
3.99%
191,089
13,552
9.48%
212,151
12,847
8.10%
70,384
2,188
4.16%
182,385
3,896
839,235
10,904
660,399
7,454
1.50%
585,023
6,291
1.43%
555,818
5,317
1.28%
14,698
15,180
5.52%
530,841
0.80%
776,472
0.12%
78,710
78,953
428,374
476,856
(51,125)
(54,249)
2,996,317
4,760
2,746,657
4,740
0.23%
804,110
3,201
0.53%
936,088
6,050
0.86%
22,236
20,310
0.11%
39,516
980
3.32%
3,862,179
3,703,055
2,487,522
2,320,160
91,992
108,503
6,441,693
6,131,718
2,967,796
2,772,879
5,483,839
5,066,817
6,287,949
6,002,905
176.84%
174.88%
Presented on a fully taxable equivalent basis using the statutory tax rate of 21% for all periods presented. The taxable equivalent adjustments included above are $4,058 and $3,862 for the nine months ended September 30, 2022 and 2021, respectively.
Loan fees included in interest income totaled $7,155 and $13,753 for the nine months ended September 30, 2022 and 2021, respectively.
Net interest income totaled $171.8 million and $137.7 million during the nine months ended September 30, 2022 and 2021, respectively. Net interest income on an FTE basis totaled $175.8 million and $141.5 million during the nine months ended September 30, 2022 and 2021, respectively. During the nine months ended September 30, 2022, the FTE net interest margin widened 52 basis points to 3.44%, compared to the nine months ended September 30, 2021. The yield on earnings assets increased 48 basis points, primarily driven by increases in the federal funds rate since March 2022, the RCB acquisition as well as excess cash being deployed into higher-yielding originated loans and investment securities. The cost of funds decreased five basis points to 0.19% during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021.
69
Average loans comprised $4.8 billion, or 70.1%, of total average interest earning assets during the nine months ended September 30, 2022, compared to $4.3 billion, or 66.2%, of total average interest earning assets during the nine months ended September 30, 2021. The increase in average loan balances was driven by a $525.2 million increase in average originated loans. Year-to-date loan fundings through September 30, 2022 totaled a record $1.5 billion.
Average investment securities comprised 20.9% and 18.8% of total interest earning assets during the nine months ended September 30, 2022 and 2021, respectively. The increase in the investment portfolio was driven by strategic decisions to deploy a portion of excess cash liquidity into higher-yielding investment securities.
Average balances of interest bearing liabilities increased $159.1 million during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. The increase was driven by higher interest bearing demand, savings and money market deposits totaling $249.7 million, long-term debt totaling $39.5 million and securities sold under agreements to repurchase totaling $1.9 million. The increase was partially offset by a decrease in time deposits of $132.0 million. The cost of deposits decreased seven basis points to 0.17% during the nine months ended September 30, 2022, compared to 0.24% during the nine months ended September 30, 2021.
70
The following table summarizes the changes in net interest income on an FTE basis by major category of interest earning assets and interest bearing liabilities, identifying changes related to volume and changes related to rates for the three and nine months ended September 30, 2022, compared to the three and nine months ended September 30, 2021:
compared to
Increase (decrease) due to
Volume
Rate
Interest income:
8,387
7,901
16,288
16,905
9,659
26,564
2,413
372
2,785
(1,494)
2,199
705
(1,643)
1,028
(615)
(3,482)
1,774
(1,708)
1,026
649
1,675
2,324
1,126
3,450
(240)
274
314
660
974
(21)
(2,644)
4,137
1,493
(1,479)
3,953
Total interest income
7,303
14,359
21,662
13,067
19,395
32,462
160
397
(377)
(145)
(450)
(595)
(525)
(2,324)
(2,849)
335
(289)
854
(2,699)
(1,845)
Net change in net interest income
6,968
21,616
12,213
22,094
34,307
Presented on an FTE basis using the statutory tax rate of 21% for all periods presented. The taxable equivalent adjustments included above are $1,409 and $1,315 for the three months ended September 30, 2022 and 2021, respectively. The taxable equivalent adjustments included above are $4,058 and $3,862 for the nine months ended September 30, 2022 and 2021, respectively.
Loan fees included in interest income totaled $2,205 and $4,514 for the three months ended September 30, 2022 and 2021, respectively. Loan fees included in interest income totaled $7,155 and $13,753 for the nine months ended September 30, 2022 and 2021, respectively.
Below is a breakdown of average deposits and the average rates paid during the periods indicated:
Average
rate
balance
paid
Non-interest bearing demand
Interest bearing demand
592,133
544,056
0.19%
589,918
548,906
1,674,240
1,535,361
1,619,744
1,491,591
0.27%
792,090
723,654
0.15%
786,655
706,160
Total average deposits
Provision for credit losses
The provision for credit losses represents the amount of expense that is necessary to bring the ACL to a level that we deem appropriate to absorb estimated lifetime losses inherent in the loan portfolio as of the balance sheet date. The determination of the ACL, and the resultant provision for credit losses, is subjective and involves significant estimates and assumptions. The allowance for credit losses totaled 1.15% of total loans at September 30, 2022, compared to the allowance for credit losses of 1.11% at September 30, 2021.
The Company recorded credit loss provision expense of $12.7 million during the three months ended September 30, 2022, which included a provision expense of $12.5 million for funded loans and a provision expense of $0.2 million for unfunded loan commitments. During the nine months ended September 30, 2022, the Company recorded credit loss provision expense of $14.9 million, which included a provision expense of $14.5 million for funded loans and a provision expense of $0.4 million for unfunded loan commitments. The provision expense was driven by record loan growth, higher reserve requirements from changes in the CECL model’s underlying macro-economic forecast and $5.4 million of Day 1 reserve requirements for the acquired RCB portfolio.
The Company recorded $0.3 million of provision expense for funded loans and $0.3 million of provision release for unfunded loan commitment reserves, during the three months ended September 30, 2021, as the impact of net loan growth was offset by strong asset quality and an improved outlook in the CECL model’s underlying economic forecast. The Company recorded total provision release of $9.4 million for the nine months ended September 30, 2021, which included a provision release of $9.6 million for funded loans and a provision expense of $0.2 million for unfunded loan commitments, driven by strong asset quality and an improved outlook in the CECL model’s underlying economic forecast.
The table below details the components of non-interest income for the periods presented:
Three months
Nine months
379
9.6 %
1,003
9.1 %
151
3.3 %
128
1.0 %
(12,141)
(73.1)%
(31,885)
(60.2)%
2.7 %
(0.8)%
2,527
1,708
3,554
4,705
48.0 %
(1,151)
(24.5)%
100.0 %
(29)
(82.9)%
Banking center consolidation-related income
776
1,164
1,544
3,571
(33.3)%
(2,027)
(56.8)%
(11,164)
(39.1)%
(33,975)
(39.0)%
Non-interest income totaled $17.4 million for the three months ended September 30, 2022, compared to $28.5 million for the three months ended September 30, 2021. The decrease in mortgage banking income was driven by lower mortgage activity due to higher interest rates on mortgage loans and competition driving tighter gain on sale margins. Service charges and bank card fees increased a combined $0.4 million during the three months ended September 30, 2022, compared to the three months ended September 30, 2021, due to changes in consumer behavior. Other non-interest income increased $0.8 million due to higher derivative fee income and unrealized gains on equity method investments, partially offset by market adjustments on company-owned life insurance.
Non-interest income totaled $53.2 million for the nine months ended September 30, 2022, compared to $87.1 million for the nine months ended September 30, 2021. The decrease in mortgage banking income was driven by lower mortgage activity due to higher interest rates on mortgage loans and competition driving tighter gain on sale margins. Other non-interest income decreased $1.2 million primarily due to market adjustments on company-owned life insurance and lower unrealized gains on equity method investments. Service charges and bank card fees increased a combined $1.1 million during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, due to changes in consumer behavior.
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The table below details the components of non-interest expense for the periods presented:
(2,016)
(6.2)%
(8,866)
(9.1)%
24.1 %
1,937
10.1 %
617
27.0 %
11.5 %
68.2 %
45.0 %
6.9 %
7.3 %
(48)
(3.3)%
144
3.7 %
2,559
78.7 %
3,468
74.7 %
719
25.4 %
1,612
21.1 %
(904)
(80.8)%
(1,329)
(71.8)%
(100.0)%
(840)
>(100.0)%
29.8 %
9.9 %
(1,589)
2,624
5.1 %
(3,753)
(2.5)%
During the three and nine months ended September 30, 2022, non-interest expense increased $2.6 million, or 5.1%, and decreased $3.8 million, or 2.5%, respectively, compared to the three and nine months ended September 30, 2021. Salaries and benefits decreased primarily due to lower mortgage banking-related compensation. The three months ended September 30, 2022 included $7.0 million of non-recurring acquisition-related expenses with $4.6 million included in professional fees, $0.8 million included in salaries and benefits, $0.6 million included in telecommunications and data processing, $0.5 million included in occupancy and equipment, $0.3 million included in other non-interest expense and $0.2 million included in marketing and business development. The nine months ended September 30, 2022 included $8.3 million of non-recurring acquisition-related expenses with $5.7 million included in professional fees, $0.8 million included in salaries and benefits, $0.6 million in telecommunications and data processing, $0.5 million in occupancy and equipment, $0.5 million included in other non-interest expense and $0.2 million in marketing and business development.
Income taxes
Income tax expense totaled $4.0 million and $12.0 million for the three and nine months ended September 30, 2022, respectively. Income tax expense for the three and nine months ended September 30, 2021 was $5.0 million and $16.1 million, respectively. The effective tax rate for the three and nine months ended September 30, 2022 was 20.1% and 18.0%, respectively, compared to 20.0% and 18.5% for the same periods in the prior year. The effective tax rate is lower than the federal statutory rate primarily due to interest income from tax-exempt lending, bank-owned life insurance income, and the relationship of these items to pre-tax income.
Additional information regarding income taxes can be found in note 19 of our audited consolidated financial statements in our 2021 Annual Report on Form 10-K.
Liquidity and Capital Resources
Liquidity
Liquidity is monitored and managed to ensure that sufficient funds are available to operate our business and pay our obligations to depositors and other creditors, while providing ample available funds for opportunistic and strategic investments. Management believes that the Company's excess cash, borrowing capacity and access to sufficient sources of capital are adequate to meet its short-term and long-term liquidity needs in the foreseeable future. Our primary sources of funds are deposits, securities sold under agreements to repurchase, prepayments and maturities of loans and investment securities, the sale of investment securities, and funds provided from operations. We anticipate having access to other third party funding sources, including the ability to raise funds through the issuance of shares of our common stock or other equity or equity-related securities, incurrence of debt, and federal funds purchased, that may also be a source of liquidity. We anticipate that these sources of liquidity will provide adequate funding and
liquidity for at least a 12-month period, and we may utilize any combination of these funding sources for long-term liquidity needs if deemed prudent.
On-balance sheet liquidity is represented by our cash and cash equivalents and unencumbered investment securities, and is detailed in the table below as of September 30, 2022 and December 31, 2021:
Unencumbered investment securities, at fair value
597,535
781,166
853,742
1,626,861
Total on-balance sheet liquidity decreased $773.1 million at September 30, 2022, compared to December 31, 2021. The decrease was due to $183.6 million lower unencumbered available-for-sale and held-to-maturity securities balances and lower cash and due from banks of $589.5 million.
At present, financing activities primarily consist of changes in deposits and repurchase agreements, in addition to the payment of dividends and the repurchase of our common stock. Maturing time deposits represent a potential use of funds. As of September 30, 2022, $521.7 million of time deposits were scheduled to mature within 12 months. Based on the current interest rate environment, market conditions, and our consumer banking strategy focusing on lower cost transaction accounts, our strategy is to replace a portion of those maturing time deposits with transaction deposits and market-rate time deposits. During 2021, the Company entered into a subordinated note purchase agreement maturing on November 15, 2031. The Company is using the net proceeds from the sale of the note for general corporate purposes. At September 30, 2022, the balance on the note, net of issuance costs totaling $0.4 million, totaled $39.6 million.
Through our relationship with the FHLB, the Bank may pledge qualifying loans and investment securities allowing us to obtain additional liquidity through FHLB advances and lines of credit. There were no investment securities pledged at September 30, 2022 or December 31, 2021. The Bank had loans pledged as collateral for FHLB advances of $1.7 billion at September 30, 2022 and $1.3 billion at December 31, 2021. FHLB advances, lines of credit and other short-term borrowing availability totaled $1.0 billion at September 30, 2022. The Bank can obtain additional liquidity through the FHLB facility, if required, and also has access to federal funds lines of credit with correspondent banks. Currently, the Company does not have any advances from the FHLB.
Our primary uses of funds are loan fundings, investment security purchases, withdrawals of deposits, settlement of repurchase agreements, capital expenditures, operating expenses, and share repurchases. For additional information regarding our operating, investing and financing cash flows, see our consolidated statements of cash flows in the accompanying consolidated financial statements.
Exclusive from the investing activities related to acquisitions, our primary investing activities are loan fundings and pay-offs and paydowns of loans and purchases and sales of investment securities. At September 30, 2022, pledgeable investment securities represented a significant source of liquidity. Our available-for-sale investment securities are carried at fair value and our held-to-maturity securities are carried at amortized cost. Our collective investment securities portfolio totaled $1.3 billion at September 30, 2022, inclusive of pre-tax net unrealized losses of $115.2 million on the available-for-sale securities portfolio. Additionally, our held-to-maturity securities portfolio had $97.3 million of pre-tax net unrealized losses at September 30, 2022. The gross unrealized gains and losses are detailed in note 4 of our consolidated financial statements. As of September 30, 2022, our investment securities portfolio consisted primarily of MBS, all of which were issued or guaranteed by U.S. Government agencies or sponsored enterprises. The anticipated repayments and marketability of these securities offer substantial resources and flexibility to meet new loan demand, reinvest in the investment securities portfolio, or provide optionality for reductions in our deposit funding base.
Capital
Under the Basel III requirements, at September 30, 2022, the Company and the Bank met all capital adequacy requirements and the Bank had regulatory capital ratios in excess of the levels established for well-capitalized institutions. For more information on regulatory capital, see note 10 in our consolidated financial statements.
74
Our shareholders' equity is impacted by earnings, changes in unrealized gains and losses on securities, net of tax, stock-based compensation activity, share repurchases, shares issued in connection with acquisitions and the payment of dividends.
The Board of Directors has from time to time authorized multiple programs to repurchase shares of the Company’s common stock either in open market or in privately negotiated transactions in accordance with applicable regulations of the SEC. On February 24, 2021, the Company’s Board of Directors authorized a program to repurchase up to $75.0 million of the Company’s stock. The remaining authorization under the program as of September 30, 2022 was $38.6 million.
On November 8, 2022, our Board of Directors declared a quarterly dividend of $0.25 per common share, payable on December 15, 2022 to shareholders of record at the close of business on November 25, 2022.
Asset/Liability Management and Interest Rate Risk
Management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit this exposure. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/replacement of asset and liability cash flows.
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 earnings and preserving adequate levels of liquidity and capital. The asset and liability management function is under the guidance of the Asset Liability Committee with direction from the Board of Directors. The Asset Liability Committee meets monthly to review, among other things, the sensitivity of the Company's assets and liabilities to interest rate changes, local and national market conditions and rates. The Asset Liability Committee also reviews the liquidity, capital, deposit mix, loan mix and investment positions of the Company.
Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and utilize various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.
We also analyze the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analyses on net interest income.
Our interest rate risk model indicated that the Company was asset sensitive in terms of interest rate sensitivity at September 30, 2022. At September 30, 2022, our asset sensitivity decreased for a rising rate environment as a result of the balance sheet mix. The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 100 and 200 basis point decrease in interest rates on net interest income based on the interest rate risk model at September 30, 2022 at the respective dates:
Hypothetical
shift in interest
% change in projected net interest income
rates (in bps)
200
5.40%
11.12%
2.79%
5.37%
(100)
(5.81)%
(200)
(12.96)%
Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that management may undertake to manage the risks in response to anticipated changes in interest rates and actual results may also differ due to any actions taken in response to the changing rates.
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As part of the asset/liability management strategy to manage primary market risk exposures expected to be in effect in future reporting periods, management has emphasized the origination of longer duration loans. The strategy with respect to liabilities has been to continue to emphasize transaction deposit growth, particularly non-interest or low interest bearing non-maturing deposit accounts while building long-term client relationships. Non-maturing deposit accounts totaled 87.7% of total deposits at September 30, 2022, compared to 86.5% at December 31, 2021. We currently have no brokered time deposits.
Impact of Inflation and Changing Prices
The primary impact of inflation on our operations is reflected in increasing operating costs and non-interest expense. Unlike most industrial companies, virtually all of our assets and liabilities are monetary in nature. As a result, changes in interest rates have a more significant impact on our performance than do changes in the general rate of inflation and changes in prices. Interest rate changes do not necessarily move in the same direction, nor have the same magnitude, as changes in the prices of goods and services. Although not as critical to the banking industry as many other industries, inflationary factors may have some impact on our ability to grow, total assets, earnings and capital levels. While we plan to continue our disciplined approach to expense management, an inflationary environment may cause wage pressures and general increases in our cost of doing business, which may increase our non-interest expense.
Off-Balance Sheet Activities
In the normal course of business, we are a party to various contractual obligations, commitments and other off-balance sheet activities that contain credit, market, and operational risk that are not required to be reflected in our consolidated financial statements. The most significant of these are the loan commitments that we enter into to meet the financing needs of clients, including commitments to extend credit, commercial and consumer lines of credit and standby letters of credit. As of September 30, 2022 and December 31, 2021, we had loan commitments totaling $1.4 billion and $992.5 million, respectively, and standby letters of credit that totaled $6.2 million and $7.3 million, respectively. Unused commitments do not necessarily represent future credit exposure or cash requirements, as commitments often expire without being drawn upon.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is provided under the caption Asset/Liability Management and Interest Rate Risk in Part I, Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations and is incorporated herein by reference.
Item 4. CONTROLS AND PROCEDURES
Our management, with the participation of our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as of September 30, 2022. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2022.
On September 1, 2022, the Company completed the acquisition of Rock Canyon Bank. The Company is in the process of incorporating RCB’s internal controls and procedures into its internal controls over financial reporting.
Other than mentioned above, there were no changes made in the Company's internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting, during the most recently completed fiscal quarter.
PART II: OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
From time to time, we are a party to various litigation matters incidental to the conduct of our business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, prospects, financial condition, liquidity, results of operation, cash flows or capital levels.
Item 1A. RISK FACTORS
There have been no material changes to the risk factors disclosed in Item 1A: Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2021 with the exception of the following:
The Company is expected to incur significant costs related to the mergers and integration of both Bancshares of Jackson Hole Inc. and Community Bancorporation.
The Company has incurred and is expected to continue to incur substantial costs in connection with the mergers, including legal, financial advisory, accounting, consulting and other advisory fees, severance/employee benefit-related costs, and other regulatory fees and related costs. There are a large number of processes, policies, procedures, operations, technologies, and systems that may need to be integrated, including purchasing, accounting and finance, payroll, compliance, treasury management, banking center operations, vendor management, risk management, lines of business, pricing, and benefits. While the Company has assumed that a certain level of costs will be incurred, there are many factors beyond our control that could affect the total amount or the timing of the integration costs. Moreover, many of the costs that will be incurred are, by their nature, difficult to estimate accurately. These integration costs may result in the Company taking charges against earnings following the completion of the mergers, the amount, and timing of which are uncertain at present.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Maximum
Total number of
approximate dollar
shares purchased
value of shares
as part of publicly
that may yet be
Total number
Average price
announced plans
purchased under the
Period
of shares purchased
paid per share
or programs
plans or programs (2)
July 1 - July 31, 2022(1)
38,618,179
August 1 - August 31, 2022(1)
September 1 - September 30, 2022(1)
Represents shares purchased other than through publicly announced plans purchased pursuant to the Company’s stock incentive plans at the then current market value in satisfaction of stock option exercise prices, settlements of restricted stock and tax withholdings.
On February 24, 2021, the Company’s Board of Directors authorized a program to repurchase up to $75.0 million of the Company’s stock from time to time in either the open market or through privately negotiated transactions. The remaining authorization under the program as of September 30, 2022 was $38.6 million.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS
3.1
Second Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.1 to our Form S-1 Registration Statement (Registration No. 333-177971), filed August 22, 2012)
3.2
Second Amended and Restated By-Laws (incorporated herein by reference to Exhibit 3.2 to our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2014, filed November 7, 2014)
31.1
Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certifications of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
XBRL Taxonomy Extension Schema
101.CAL
XBRL Taxonomy Extension Calculation
101.DEF
XBRL Taxonomy Extension Definition
101.LAB
XBRL Taxonomy Extension Labels
101.PRE
XBRL Taxonomy Extension Presentation
104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
National Bank Holdings Corporation
By
/s/ Aldis Birkans
Aldis Birkans
Chief Financial Officer
(principal financial officer)
Date: November 8, 2022
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