Atlantic Union Bankshares Corp (AUB) FY 2022 MD&A

ITEM 7. - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company and its subsidiaries. This discussion and analysis should be read in conjunction with the “Consolidated Financial Statements” and the “Notes to the Consolidated Financial Statements,” which include the Company’s significant accounting policies, presented in Item 8 “Financial Statements and Supplementary Data” contained in this Form 10-K. Amounts are rounded for presentation purposes; however, some of the percentages presented are computed based on unrounded amounts.

In management’s discussion and analysis, the Company provides certain financial information determined by methods other than in accordance with GAAP. These non-GAAP financial measures are a supplement to GAAP, which is used to prepare the Company’s financial statements, and should not be considered in isolation or as a substitute for comparable measures calculated in accordance with GAAP. In addition, the Company’s non-GAAP financial measures may not be comparable to non-GAAP financial measures of other companies. The Company uses the non-GAAP financial measures discussed herein in its analysis of the Company’s performance. The Company’s management believes that these non-GAAP financial measures provide additional understanding of ongoing operations, enhance comparability of results of operations with prior periods and show the effects of significant gains and charges in the periods presented without the impact of items or events that may obscure trends in the Company’s underlying performance. Non-GAAP financial measures may be identified with the symbol (+) and may be labeled as adjusted. Refer to the “Non-GAAP Financial Measures” section within this Item 7 for more information about these non-GAAP financial measures, including a reconciliation of these measures to the most directly comparable financial measures in accordance with GAAP.

CRITICAL ACCOUNTING ESTIMATES

The Company’s consolidated financial statements are prepared based on the application of accounting and reporting policies in accordance with GAAP and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, which require the use of estimates, assumptions, and judgments, which may prove inaccurate or are subject to variations. Changes in underlying factors, estimates, assumptions or judgements could result in material changes in the Company’s consolidated financial position and/or results of operations.

Certain accounting policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. The Company has identified the allowance for loan and lease losses and fair value measurements as accounting policies that require the most difficult, subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change. Therefore, the Company evaluates these accounting policies and related critical accounting estimates on an ongoing basis and updates them as needed. Management has discussed these accounting policies and critical accounting estimates summarized below with the Audit Committee of the Board of Directors.

The Company’s significant accounting policies are discussed in detail in Note 1 “Summary of Significant Accounting Policies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.

Allowance for Loan and Lease Losses - The ALLL represents the estimated balance that management considers adequate to absorb expected credit losses over the expected contractual life of the loan portfolio. We estimate the ALLL using a loan-level probability of default, loss given default method for all loans with the exception of our overdraft, auto, and third-party consumer lending portfolios. For auto and third-party consumer lending portfolios, the Company has elected to pool those loans based on similar risk characteristics to determine the ALLL using vintage and loss rate methods.

Determining the appropriateness of the ALLL is complex and requires judgment by management about the effect of matters that are inherently uncertain.  Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods. There are both internal factors (i.e. loan balances, credit quality, and the contractual lives of loans) and external factors (i.e. economic conditions such as trends in housing prices, interest rates, GDP, inflation, unemployment, and energy prices) that can impact the ALLL estimate.

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For instance, the Company considers a number of external economic variables in developing the ALLL, the most significant of which is the Virginia unemployment rate. The quantitative ALLL estimate is sensitive to changes in the Virginia unemployment rate forecast over a two-year reasonable and supportable period, with the commercial loan portfolio being the most sensitive to fluctuations in unemployment. To forecast Virginia unemployment, the Company uses Moody’s economic forecasts. At December 31, 2022, the baseline scenario used in this two-year forecast had Virginia’s unemployment rate at an average of 3.1%, compared to an average of 2.6% at December 31, 2021. Because current economic conditions and forecasts can change and future events are inherently difficult to predict, the anticipated amount of estimated credit losses on loans and therefore the appropriateness of the ALLL, could change significantly. It is difficult to estimate how potential changes in any one economic factor or input might affect the overall ALLL because the Company uses a wide variety of factors and inputs in estimating the ALLL and changes in those factors and inputs may not occur at the same rate and may not be consistent across all loan types. Additionally, changes in factors and inputs may be directionally inconsistent, such that improvement in one factor may offset deterioration in others.

The Company reviews its ALLL estimation process regularly for appropriateness as the economic and internal environment are constantly changing. While the ALLL estimate represents management’s current estimate of expected credit losses, due to uncertainty surrounding internal and external factors, there is potential that the estimate may not be adequate over time to cover credit losses in the portfolio. While management uses available information to estimate expected losses on loans, future changes in the ALLL may be necessary based on changes in portfolio composition, portfolio credit quality, economic conditions and/or other factors. See Note 1, “Summary of Significant Accounting Policies” and Note 3, “Loans and Allowance for Loan and Lease Losses” in this Form 10-K for more information on the Company’s ALLL.

Fair Value Measurements - Certain assets and liabilities are measured at fair value on a recurring basis, including securities and derivative instruments. Assets and liabilities carried at fair value inherently include subjectivity and may require the use of significant assumptions, adjustments, and judgment including, among others, discount rates, rates of return on assets, cash flows, default rates, loss rates, terminal values and liquidation values. A significant change in assumptions may result in a significant change in fair value, which in turn, may result in a higher degree of financial statement volatility and could result in significant impact on our results of operations, financial condition or disclosures of fair value information.

Under ASC 820, Fair Value Measurements, there is a three-level fair value hierarchy that requires the use of inputs that are observable or unobservable, when observable inputs are not available. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. As such, fair value measurements, particularly in level 2 and level 3 of the hierarchy, may require us to use significant assumptions that are subject to change. A change in one assumption could have a significant impact on the fair value estimate and certain assumptions may have offsetting impacts to one another. Management prepares a supportable estimate in accordance with ASC 820 but changes in significant assumptions could have a significant impact on the Company’s Balance Sheet, Statement of Income, and/or fair value disclosures. For more information of the Company’s financial instruments and fair value assessment, refer to Note 1 “Summary of Significant Accounting Policies” and Note 13 “Fair Value Measurements” in this Form 10-K.

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RECENT ACCOUNTING PRONOUNCEMENTS (ISSUED BUT NOT FULLY ADOPTED)

In March 2022, the FASB issued ASU No. 2022-01 Derivatives and Hedging (Topic 815): Fair Value Hedging- Portfolio Layer Method to allow nonprepayable financial assets to be included in a closed portfolio hedge using the portfolio layer method and to allow multiple hedged layers to be designated for a single closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company evaluated the impact of ASU No. 2022-01 and concluded that it will not have material implications on its consolidated financial statements.

In March 2022, the FASB issued ASU No. 2022-02 Financial Instruments- Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This guidance eliminates the accounting guidance for TDRs by creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. In addition, for public business entities, the amendments require disclosure of current period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of ASC 326-20, Financial Instruments – Credit Losses, Measured at Amortized Cost. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company plans to adopt ASU No. 2022-02 on January 1, 2023 and concluded it will not have material implications on its consolidated financial statements.

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RESULTS OF OPERATIONS

SIGNIFICANT ACTIVITIES

Recent Events

The Company is continually monitoring the impact of various global and national events on the Company’s results of operations and financial condition, including inflation and rising interest rates, the ongoing impact of COVID-19, and geopolitical conflicts (such as the ongoing conflict between Russia and Ukraine). Inflation has risen as a result of growth in economic activity and demand for goods and services, as well as labor shortages and supply chain issues. As a result, market interest rates began to rise during 2022 after an extended period at historical lows. On March 16, 2022, the FOMC began to increase its Federal Funds target rates to a range of 0.25% to 0.50%, which was the first increase since December 2018. The FOMC further increased the target rates throughout 2022 and early 2023 to its current range of 4.50% to 4.75%. The FOMC also foreshadowed potential further increases to the target rates throughout 2023 and also confirmed the continued reduction to the Federal Reserve’s holdings of U.S. Treasury securities and agency debt and agency MBS. These actions have impacted the Company’s asset-sensitive position throughout 2022 and resulted in an expansion of net interest margin, as well as an increase in unrealized losses in AFS securities, and a decline in purchases of mortgages. The timing and impact of inflation and rising interest rates on the Company's interest rate sensitivity, businesses, and results of operations will depend on future developments, which are highly uncertain and difficult to predict. The Company will continue to deploy various asset liability management strategies to seek to manage the Company's risk related to interest rate fluctuations. Refer to “Quantitative and Qualitative Disclosures about Market Risk” in Part II, Item 7A of this Form 10-K for additional information about the Company’s interest rate sensitivity.

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Strategic Initiatives

The Company has been taking certain actions to reduce expenses in light of the current and expected operating environment, which included the closure of the Company’s operations center and the consolidation of certain branches. These closures and consolidations totaled 16 branches for the year ended December 31, 2022, five branches for the year ended December 31, 2021, and 15 branches for the year ended December 31, 2020. These actions resulted in restructuring expenses primarily related to real estate, lease and other asset write downs, and severance costs of $5.5 million, $17.4 million, and $6.8 million for the years ended December 31, 2022, 2021, and 2020, respectively.

Effective June 30, 2022, the Company transferred its ownership interest in DHFB, which was formerly a subsidiary of the Bank, to Cary Street Partners Financial LLC in exchange for a minority ownership interest in Cary Street Partners Financial LLC, resulting in a $9.1 million pre-tax gain for the year ended December 31, 2022.

During 2021, the Company sold shares of Visa, Inc. Class B common stock and recorded a pre-tax gain in other income of $5.1 million for the year ended December 30, 2021.

Share Repurchase Program

On December 10, 2021, the Company’s Board of Directors approved a share repurchase program that authorized the purchase of up to $100.0 million of the Company’s common stock through December 9, 2022 in open market transactions or privately negotiated transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and/or Rule 10b-18 under the Exchange Act. The Company repurchased an aggregate of approximately 1.3 million shares (or approximately $48.2 million) through this repurchase program. At December 31, 2022, there were no active share repurchase programs, as the prior repurchase programs have expired or been fully utilized.

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SUMMARY OF 2022 FINANCIAL RESULTS

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Executive Overview

Net Income & Performance Metrics

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Balance Sheet

December 31, 2021. Average deposits during the year ended December 31, 2022 were $16.5 billion, a decrease of $89.6 million or 0.5% from the year ended December 31, 2021.

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Net Income

2022 compared to 2021

Net income available to common shareholders for the year ended December 31, 2022 was $222.6 million, a decrease of $29.4 million or 11.7% and represented diluted EPS of $2.97, compared to $252.0 million and $3.26, respectively, for the year ended December 31, 2021. The decrease was primarily driven by a $79.9 million increase in the provision for credit losses to $19.0 million for the year ended December 31, 2022, compared to a negative provision of $60.9 million for the prior year, reflecting the impact of a higher ACL due to changes in the macroeconomic forecast and loan growth, and a $7.3 million decrease in noninterest income. These changes were partially offset by a $33.0 million increase in net interest income, a $15.4 million decrease in noninterest expenses, and a $9.4 million decrease in income tax expense. Adjusted operating earnings available to common shareholders(+) totaled $219.0 million for the year ended December 31, 2022, compared to $273.3 million for the year ended December 31, 2021, and diluted adjusted operating EPS(+) was $2.92 for the year ended December 31, 2022, compared to $3.53 for the year ended December 31, 2021.

Net interest income for the year ended December 31, 2022 totaled $584.3 million, an increase of $33.0 million or 6.0% compared to the prior year, primarily due to an increase in overall earning asset yields of 39 bps for the year ended December 31, 2022, driven by the impact of rising market interest rates on loans and taxable investment securities yields, and growth in average loans and average investment securities. This increase was partially offset by an increase in cost of funds of 19 bps for the year ended December 31, 2022, driven by higher deposit and borrowing costs.

Noninterest income decreased $7.3 million or 5.8% to $118.5 million for the year ended December 31, 2022, from $125.8 million for the year ended December 31, 2021, primarily due to decreases in mortgage banking income as mortgage loan origination volumes and gain on sale margins declined, and fiduciary and asset management fees as assets under management decreased due to the sale of DHFB. Partially offsetting these decreases in noninterest income were increases in loan-related interest rate swap fees due to higher transaction volumes, and other operating income primarily driven by the gain on sale of DHFB, and an increase in loan syndication, SBA 7a, and foreign exchange revenues, partially offset by a decline in equity method investment income and the impact of the gain in 2021 on the sale of Visa, Inc. Class B common stock.

Noninterest expense decreased $15.4 million or 3.7% to $403.8 million for the year ended December 31, 2022, from $419.2 million for the year ended December 31, 2021, primarily due to decreases in loss on debt extinguishment and in other expenses, primarily driven by a decrease in branch closing and facility consolidation costs and a gain related to the sale and leaseback of an office building, as well as decreases in amortization of intangible assets, occupancy expenses, furniture and equipment expenses, professional services, and marketing and advertising expense. These decreases in noninterest expense were partially offset by increases in salaries and benefits, technology and data processing, and FDIC assessment premiums and other insurance.

2021 compared to 2020

Net income available to common shareholders for the year ended December 31, 2021 increased $99.5 million or 65.2% to $252.0 million for the year ended December 31, 2021 and represented diluted EPS of $3.26, compared to $152.6 million and $1.93 for the year ended December 31, 2020. The increase primarily reflects the decrease in the provision for credit losses, by $148.0 million from the year ended December 31, 2020 to a negative $60.9 million for the year ended December 31, 2021, primarily due to decreases to the Company’s ACL estimates driven by ongoing economic improvements, benign credit quality metrics since the COVID-19 pandemic began and a positive macroeconomic outlook. This increase was partially offset by higher income tax expense, higher noninterest expenses, and lower net interest income and noninterest income. Adjusted operating earnings available to common shareholders(+) totaled $273.3 million for the year ended December 31, 2021, compared to $174.2 million for the year ended December 31, 2020, and diluted adjusted operating EPS(+) were $3.53 for the year ended December 31, 2021, compared to $2.21 for the year ended December 31, 2020.

Net interest income for the year ended December 31, 2021 totaled $551.3 million, which was a decrease of $4.0 million or 0.7% compared to the prior year, primarily reflecting the impact of a decline in overall earning asset yields of 52 bps

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for the year ended December 31, 2021, offset by a decline in cost of funds of 35 bps for the year ended December 31, 2021 and increased loan accretion recognized on PPP loans.

Noninterest income decreased $5.7 million or 4.3% from $131.5 million for the year ended December 31, 2020 to $125.8 million for the year ended December 31, 2021 as declines in gains on securities transactions, loan swap fees reflecting lower transaction volumes in the current year, and mortgage banking income reflecting lower mortgage loan origination volumes in the current year, were partially offset by increases in unrealized gains on equity method investments, the gain on sale of Visa, Inc. Class B common stock, fiduciary and asset management fees primarily reflecting higher assets under management, income on bank owned life insurance, interchange fees, service charges on deposits, and also the impact of prior year benefitting from a balance sheet repositioning gain.

Noninterest expense increased $5.8 million or 1.4% from $413.3 million for the year ended December 31, 2020 to $419.2 million for the year ended December 31, 2021. The increase was primarily driven by an increase in branch closing and facility consolidation costs, as well as the impact of higher salaries and benefit costs, professional services costs, and technology and data processing expenses for the year ended December 31, 2021, partially offset by declines in losses related to balance sheet repositioning, core deposit intangibles amortization costs, loan-related expenses, and other business continuity expenses associated with the Company’s response to COVID-19.

Net Interest Income

Net interest income, which represents the principal source of revenue for the Company, is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of average earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income, the net interest margin, and net income.

The following tables show interest income on earning assets and related average yields, as well as interest expense on interest-bearing liabilities and related average rates paid for the periods indicated (dollars in thousands):

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For the year ended December 31, 2022, net interest income was $584.3 million, an increase of $33.0 million from the year ended December 31, 2021. For the year ended December 31, 2022, net interest income (FTE) (+) was $599.1 million, an increase of $35.3 million from the prior year. The increases in net interest income and net interest income (FTE) (+) were primarily driven by higher loan yields on the Company’s variable rate loans due to rising market interest rates and loan growth and increases in investment income primarily due to higher yields on taxable securities driven by rising market interest rates and growth in the average balance of the investment portfolio. These increases were partially offset by an increase in interest expense due to increased deposit and borrowing costs as a result of higher short-term interest rates and additional borrowings related to the 2031 Notes and increased FHLB advances. For the year ended December 31, 2022, net interest margin increased 19 bps and net interest margin (FTE) (+) increased 21 bps, compared to the year ended December 31, 2021 (dollars in thousands).

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For the year ended December 31, 2021, net interest income was $551.3 million, a decrease of $4.0 million from the year ended December 31, 2020. For the year ended December 31, 2021, net interest income (FTE) (+) was $563.9 million, a decrease of $3.0 million from the prior year. The decreases in both net interest income and net interest income (FTE) (+) were primarily the result of a decline in overall loan and securities yields partially offset by a decline in cost of funds and increased loan accretion recognized on PPP loans. For the year ended December 31, 2021, PPP loan accretion totaled $39.3 million, an increase of $6.8 million from $32.5 in the prior year. For the year ended December 31, 2021, net interest margin decreased 18 bps and net interest margin (FTE) (+) decreased 17 bps, compared to the year ended December 31, 2020. The net decline in net interest margin and net interest margin (FTE) (+) measures were primarily driven by a decrease in the yield on interest-earning assets, partially offset by a decrease in cost of funds and an increase in loan accretion on PPP loans. The decline in the Company’s earning asset yields was primarily driven by declines in loan and securities yields, as a result of the decrease in market interest rates. The cost of funds decline was driven by lower deposit costs and wholesale borrowing costs driven by lower market interest rates and a favorable funding mix.

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The following table shows interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the years indicated (dollars in thousands):

AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES (TAXABLE EQUIVALENT BASIS)

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The Volume Rate Analysis table below presents changes in interest income (FTE)(+) and interest expense and distinguishes between the changes related to increases or decreases in average outstanding balances of interest-earning assets and interest-bearing liabilities (volume), and the changes related to increases or decreases in average interest rates on such assets and liabilities (rate). Changes attributable to both volume and rate have been allocated proportionally. Results, on a taxable equivalent basis, are as follows for the years ended December 31, (dollars in thousands):

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The impact of net accretion related to acquisition accounting fair value adjustments for the years ended December 31, 2022, 2021, and 2020 are reflected in the following table (dollars in thousands):

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Noninterest Income

(1) The 2021 information presented includes a reclassification of gains on securities transactions, which is now included as a component of other operating income.

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For the year ended December 31, 2022, noninterest income decreased $7.3 million or 5.8% to $118.5 million from $125.8 million for the year ended December 31, 2021. Excluding, as applicable, the gain on sale of DHFB ($9.1 million in 2022 compared to $0 in 2021), the gain on sale of Visa, Inc. Class B common stock ($0 in 2022 compared to $5.1 million in 2021), and gains and losses on sale of securities (losses of $3,000 in 2022 compared to gains of $87,000 in 2021), adjusted operating noninterest income(+) for the year ended December 31, 2022 declined by $11.1 million or 9.2% from the prior year, which was driven primarily by a $13.9 million decrease in mortgage banking income as mortgage loan origination volumes and gain on sale margins each declined due to the rapid rise in market interest rates in 2022, a $5.1 million decrease in fiduciary and asset management fees as assets under management decreased due to the sale of DHFB, and a $2.6 million decrease in other operating income primarily driven by a decline in equity method investment income, partially offset by an increase in loan syndication, SBA 7a, foreign exchange revenues and by a $6.6 million increase in loan-related interest rate swap fees due to higher transaction volumes.

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(1) The 2021 and 2020 information presented includes a reclassification of gains on securities transactions, which is now included as a component of other operating income.

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For the year ended December 31, 2021, noninterest income decreased $5.7 million or 4.3% to $125.8 million from $131.5 million for the year ended December 31, 2020. Excluding the gain from the sale of Visa, Inc. Class B common stock ($5.1 million in 2021 compared to $0 in 2020), gains on securities transactions ($87,000 in 2021 compared to $12.3 million in 2020), and losses related to balance sheet repositioning ($0 in 2021 compared to gains of $1.8 million in 2020), adjusted operating noninterest income(+) for the year ended December 31, 2021 declined by $379,000 or 0.31% from the prior year. The slight net decrease in adjusted operating noninterest income(+) from the prior year was driven by a decline of $9.7 million in loan-related interest rate swap fees due to lower transaction volumes and a decline of $4.8 million in mortgage banking income due to lower mortgage origination volumes; largely offset by increases of $5.8 million in unrealized gains on equity method investments, an increase of $3.9 million in fiduciary and asset management fees due to market driven increases in assets under management, higher BOLI of $1.9 million primarily due to life insurance proceeds received in 2021, increases of $1.9 million in service charges on deposit accounts, and $1.1 million in interchange fees due to higher transaction volumes.

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Noninterest Expense

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For the year ended December 31, 2022, noninterest expense decreased $15.4 million or 3.7% to $403.8 million from $419.2 million for the year ended December 31, 2021. Excluding amortization of intangible assets ($10.8 million in 2022 compared to $13.9 million in 2021), losses related to balance sheet repositioning ($0 in 2022 compared to $14.7 million in 2021), and branch closing and facility consolidation costs ($5.5 million in 2022 compared to $17.4 million in 2021), adjusted operating noninterest expense(+) for the year ended December 31, 2022 increased $14.3 million or 3.8%, compared to the year ended December 31, 2021, due to a $14.0 million increase in salaries and benefits primarily driven by higher salaries, wages, and variable incentive compensation, a $3.2 million increase in technology and data processing expenses, which includes the write-down of obsolete software, a $2.1 million increase in other expenses, primarily driven by increases in teammate travel and training costs and non-credit related losses on customer transactions, partially offset by a gain related to the sale and leaseback of an office building, and a $759,000 increase in FDIC assessment premiums and other insurance. The increases in noninterest expense were partially offset by a $2.7 million decrease in occupancy expenses and a $1.1 million decrease in furniture and equipment expenses, partially reflecting the impact of the Company’s consolidation of 16 branches that was completed in March 2022, a $1.1 million decrease in professional services expenses due to a decrease in legal and consulting fees associated with various strategic initiatives, and a $639,000 decrease in marketing and advertising expense.

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For the year ended December 31, 2021, noninterest expense increased $5.8 million or 1.4% to $419.2 million from $413.3 million for the year ended December 31, 2020. Excluding amortization of intangible assets ($13.9 million in 2021 compared to $16.6 million in 2020), losses related to balance sheet repositioning ($14.7 million in 2021 compared to $31.1 million in 2020), and branch closing and facility consolidation costs ($17.4 million in 2021 compared to $6.8 million in 2020), adjusted operating noninterest expense(+) for the year ended December 31, 2021 increased $14.3 million or 4.0%, compared to the year ended December 31, 2020, due to an increase of $8.3 million in salaries and benefits primarily driven by higher salaries, wages, and contract labor costs, $4.8 million in professional services costs due to an increase in legal and consulting fees associated with various strategic initiatives, $4.3 million in technology and data processing expenses primarily driven by higher software licensing and maintenance expenses, and contract termination costs of approximately $900,000. The increases were partially offset by a decline in loan-related expenses of approximately $2.5 million driven by lower third-party loan servicing costs compared to the prior year.

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Segment Results

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As discussed in Note 17 “Segment Reporting and Revenue” in the “Notes to Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K, effective as of the third quarter of 2022, the Company began segmenting its business into two primary reportable operating segments—Wholesale Banking and Consumer Banking — as these segments reflect how the chief operating decision makers are now evaluating the business, establishing the overall business strategy, allocating resources, and assessing business performance. Included below are the key metrics used by the chief operating decision makers in evaluating the Company’s reportable operating segments. The Company restated its segment information for the year ended December 31, 2021 under the new basis with two reportable operating segments; however, the Company determined that it is impracticable to restate segment information for the year ended December 31, 2020. Therefore, no such disclosures are presented for 2020, when the Company’s only reportable operating segment was the Bank.

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Wholesale Banking

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The Wholesale Banking segment provides loan and deposit services, as well as treasury management and capital market services to wholesale customers primarily throughout Virginia, Maryland, North Carolina, and South Carolina. These customers include commercial real estate and commercial and industrial customers. This segment also includes the Company’s public finance subsidiary and the equipment finance subsidiary, which has nationwide exposure.

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The following table presents operating results for the years ended December 31, 2022 and 2021 for the Wholesale Banking segment (dollars in thousands):

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Wholesale Banking income before income taxes decreased $50.4 million to $165.6 million for the year ended December 31, 2022, compared to $216.0 million for the year ended December 31, 2021. The decrease was primarily driven by an increase in the provision for credit losses of $45.7 million due to changes in the macroeconomic outlook and loan growth in 2022. In addition, noninterest expense increased by $12.8 million primarily due to an increase in salaries and wages, travel and entertainment, and non-credit related losses on customer transactions. These increases in the provision for credit losses and noninterest expense were partially offset by an increase in noninterest income of $10.1 million primarily due to increases in loan swap fees due to higher transaction volumes and increases in loan syndication fees. In addition, net interest income decreased $1.9 million from the year ended December 31, 2021 primarily due to a decrease in PPP related income of $20.4 million, partially offset by increased interest income primarily driven by higher loan balances.

The following table presents the key balance sheet metrics as of December 31, 2022 and 2021 for the Wholesale Banking segment (dollars in thousands):

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LHFI, net of deferred fees and costs, for the Wholesale Banking segment increased $1.1 billion or 10.7% to $11.3 billion at December 31, 2022 compared to December 31, 2021; growth occurred in the construction and land development, commercial real estate – non-owner occupied, and commercial and industrial loan portfolios.

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Wholesale Banking deposits decreased $244.0 million or 4.0% to $5.9 billion at December 31, 2022 compared to December 31, 2021, primarily driven by a decrease in demand deposits, partially offset by an increase in interest-bearing transaction deposits, which was primarily due to the impact of customer behavior in response to inflation and higher market interest rates.

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Consumer Banking

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The Consumer Banking segment provides loan and deposit services to consumers and small businesses throughout Virginia, Maryland, and North Carolina. Consumer Banking includes the home loan division and the wealth management division, which consists of private banking, trust, and investment management and advisory services.

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The following table presents operating results for the years ended December 31, 2022 and 2021 for the Consumer Banking segment (dollars in thousands):

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Consumer Banking income before income taxes decreased $47.4 million to $52.3 million for the year ended December 31, 2022 compared to $99.7 million for the year ended December 31, 2021. The decrease was primarily driven by an increase in the provision for credit losses of $34.1 million due to changes in the macroeconomic outlook and loan growth in 2022. In addition, noninterest income decreased by $15.6 million, primarily driven by a decrease in mortgage banking income due to a decline in mortgage origination volumes, and a decrease in fiduciary and asset management fees primarily due to the sale of DHFB. Net interest income increased $2.9 million from 2021 primarily due to a favorable mix of low-cost deposits throughout the year ended 2022, partially offset by a decrease in PPP related income of $18.8 million.

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The following table presents the key balance sheet metrics as of December 31, 2022 and 2021 for the Consumer Banking segment (dollars in thousands):

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LHFI, net of deferred fees and costs, for the Consumer Banking segment increased $150.4 million or 5.1% to $3.1 billion at December 31, 2022 compared to December 31, 2021; growth occurred in the residential 1-4 family consumer and auto loan portfolios.

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Consumer Banking deposits decreased $383.5 million or 3.7% to $10.0 billion at December 31, 2022 compared to December 31, 2021. This decrease was primarily due to deposit balance declines in money market accounts, interest checking accounts, and demand deposits, partially offset by an increase in time deposit balances, which was primarily due to customer behavior in response to inflation and higher market interest rates.

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Income Taxes

The provision for income taxes is based upon the results of operations, adjusted for the effect of certain tax-exempt income and non-deductible expenses. In addition, certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.

The Company’s effective tax rate for the years ended December 31, 2022, 2021, and 2020 was 16.2%, 17.2% and 15.1%, respectively. The decrease in the effective rate for the year ended December 31, 2022 compared to the year ended December 31, 2021 is primarily due to the higher proportion of tax-exempt income to pre-tax income.

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BALANCE SHEET

Assets

At December 31, 2022, total assets were $20.5 billion, an increase of $396.3 million or 2.0% from December 31, 2021. The increase in assets was primarily a result of a $1.3 billion increase in total LHFI, net of deferred fees and costs, partially offset by a $520.1 million decrease in the net investment securities portfolio due to a decline in the fair value of the AFS portfolio due to market interest rate increases, partially offset by a $219.7 million increase in the HTM portfolio, and a $482.6 million decrease in cash and cash equivalents.

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LHFI, net of deferred fees and costs, were $14.4 billion, including $7.3 million in PPP loans, at December 31, 2022, an increase of $1.3 billion or 9.5% from December 31, 2021. Total adjusted loans, which excludes PPP loans (net of deferred fees and costs) (+), increased $1.4 billion or 10.7% at December 31, 2022 from December 31, 2021. Average loan balances increased $32.4 million or 0.2% at December 31, 2022, from December 31, 2021. Total adjusted average loans which excludes PPP loans (net of deferred fees and costs) (+), increased $855.3 million or 6.7% at December 31, 2022 from December 31, 2021. For additional information on the Company’s loan activity, please refer to the section “Loan Portfolio” included within this Item 7 and Note 3 “Loans and Allowance for Loan and Lease Losses” in the “Notes to Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.

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Liabilities and Stockholders’ Equity

At December 31, 2022, total liabilities were $18.1 billion, an increase of $733.7 million from December 31, 2021, primarily driven by an increase in short-term borrowings, offset by a decrease in total deposits.

Total deposits at December 31, 2022 were $15.9 billion, a decrease of $679.4 million or 4.1% from December 31, 2021. Average deposits at December 31, 2022 decreased $89.6 million or 0.5% from December 31, 2021. The decrease in total deposits was primarily due to the impact of inflation and the economy on customer behavior. For additional information on deposits, refer to the section “Deposits” included within this Item 7.

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Total short-term and long-term borrowings at December 31, 2022 were $1.7 billion, an increase of $1.2 billion or 237.3% compared to $506.6 million at December 31, 2021. The increase in borrowings was primarily due to an increase of $1.2 billion in short-term FHLB advances used by the Company to fund loan production. For additional information on the Company’s borrowing activity, please refer to Note 8 “Borrowings” in the “Notes to Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.

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At December 31, 2022, stockholders’ equity was $2.4 billion, a decrease of $337.3 million from December 31, 2021. The net decrease was primarily attributable to other comprehensive losses related to the decline in fair value of the AFS portfolio due to market rate increases, partially offset by the impact of earnings retained by the Company during 2022. The Company’s consolidated regulatory capital ratios continue to exceed the minimum capital requirements and are considered “well-capitalized” for regulatory purposes. The following table summarizes the Company’s consolidated capital ratios for the periods ended December 31, (dollars in thousands):

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At December 31, 2022, the Company’s common equity to total assets capital ratio and tangible common equity to tangible assets capital ratio decreased from the prior year primarily due to the unrealized losses on the AFS securities portfolio recorded in other comprehensive income due to market interest rate increases.

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During 2022, the Company declared and paid dividends on the outstanding shares of Series A Preferred Stock of $687.52 per share (equivalent to $1.72 per outstanding depositary share). During 2022, the Company also declared and paid cash dividends of $1.16 per common share, an increase of $0.07 per share, or 6.4%, over 2021.

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At December 31, 2022, the Company had no active share repurchase programs, as the repurchase program in effect in 2022 expired on December 9, 2022. Under that repurchase program, the Company repurchased an aggregate of approximately 1.3 million shares (or approximately $48.2 million) in 2022.

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Securities

At December 31, 2022, the Company had total investments of $3.7 billion or 18.1% of total assets, compared to $4.2 billion or 20.9% of total assets at December 31, 2021. This decrease was primarily due to a decline in the market value of the AFS securities portfolio, which was partially offset by growth in the HTM portfolio. The Company may experience further declines in the AFS portfolio in future periods if market interest rates continue to increase or the FOMC reduces the Federal Reserve’s balance sheet more quickly than anticipated. The Company seeks to diversify its investment portfolio to minimize risk, and it focuses on purchasing MBS for cash flow and reinvestment opportunities and securities issued by states and political subdivisions due to the tax benefits and the higher yield offered from these securities. The majority of the Company’s MBS are agency-backed securities, which have a government guarantee. For information regarding the hedge transaction related to AFS securities, see Note 10 “Derivatives” in “Notes to the Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.

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The table below sets forth a summary of the AFS securities, HTM securities, and restricted stock as of the dates indicated (dollars in thousands):

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The following table summarizes the weighted average yields(1) for AFS securities by contractual maturity date of the underlying securities as of December 31, 2022:

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(1) Yields on tax-exempt securities have been computed on a tax-equivalent basis.

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The following table summarizes the weighted average yields(1) for HTM securities by contractual maturity date of the underlying securities as of December 31, 2022:

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(1) Yields on tax-exempt securities have been computed on a tax-equivalent basis.

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Weighted average yield is calculated as the tax-equivalent yield on a pro rata basis for each security based on its relative amortized cost.

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As of December 31, 2022, the Company maintained a diversified municipal bond portfolio with approximately 65% of its holdings in general obligation issues and the majority of the remainder primarily backed by revenue bonds. Issuances within the State of Texas represented 19% of the total municipal portfolio; no other state had a concentration above 10%. Substantially all municipal holdings are considered investment grade. When purchasing municipal securities, the Company focuses on strong underlying ratings for general obligation issuers or bonds backed by essential service revenues.

Loan Portfolio

LHFI, net of deferred fees and costs, were $14.4 billion and $13.2 billion at December 31, 2022 and December 31, 2021, respectively. Commercial real estate and commercial and industrial loans represented the Company’s largest loan categories at both December 31, 2022 and December 31, 2021. Commercial and industrial loans included approximately $7.3 million and $145.3 million of PPP loans (net of deferred fees) at December 31, 2022 and December 31, 2021, respectively.

The following table presents the remaining maturities, based on contractual maturity, by loan type and by rate type (variable or fixed), net of deferred fees and costs, as of December 31, 2022 (dollars in thousands):

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The Company remains committed to originating soundly underwritten loans to qualifying borrowers within its markets. The Company seeks to mitigate risks attributable to our most highly concentrated portfolios—commercial real estate, commercial and industrial, and construction and land development—through its credit underwriting and monitoring processes, including oversight by a centralized credit administration function and credit policy and risk management committee, as well as through its seasoned bankers that focus on lending to borrowers with proven track records in markets with which the Company is familiar.

Asset Quality

Overview

At December 31, 2022, the Company experienced decreases in NPAs and accruing past due loan levels as a

percentage of total LHFI compared to December 31, 2021. Net charge-offs remain low at 0.02% of total loans for the year ended December 31, 2022, a one bp increase from the prior year. The ACL at December 31, 20222 increased from the prior year due to increased uncertainty in the macroeconomic outlook and the impact of loan growth throughout 2022.

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The Company continued to experience historically low levels of NPAs in 2022, however, the economic environment in the Company’s footprint could be impacted as persistent inflation and the threat of a recession looms, which could increase NPAs in future periods. The Company continues to refrain from originating or purchasing loans from foreign entities. The Company selectively originates loans to higher risk borrowers. The Company’s loan portfolio generally does not include exposure to option adjustable rate mortgage products, high loan-to-value ratio mortgages, interest only mortgage loans, subprime mortgage loans or mortgage loans with initial teaser rates, which are all considered higher risk instruments.

Nonperforming Assets

At December 31, 2022, NPAs totaled $27.1 million, a decrease of $5.7 million or 17.3% from December 31, 2021. NPAs as a percentage of total outstanding loans at December 31, 2022 were 0.19%, a decrease of 6 bps from 0.25% at December 31, 2021.

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The following table shows a summary of asset quality balances and related ratios as of and for the years ended December 31, (dollars in thousands):

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NPAs include non-accrual loans, which totaled $27.0 million and $31.1 million at December 31, 2022 and December 31, 2021 respectively. The following table shows the activity in nonaccrual loans for the years ended December 31, (dollars in thousands):

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The following table presents the composition of nonaccrual loans and the coverage ratio, which is the ALLL expressed as a percentage of nonaccrual loans, at the years ended December 31, (dollars in thousands):

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Past Due Loans

At December 31, 2022 past due loans still accruing interest totaled $30.0 million or 0.21% of total LHFI, compared to $29.9 million or 0.23% of total LHFI at December 31, 2021. Of the total past due loans still accruing interest $7.5 million or 0.05% of total LHFI were loans past due 90 days or more at December 31, 2022, compared to $9.1 million or 0.07% of total LHFI at December 31, 2021.

Troubled Debt Restructurings

A modification of a loan’s terms constitutes a TDR if the creditor grants a concession that it would not otherwise consider to the borrower for economic or legal reasons related to the borrower’s financial difficulties. Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, extension of terms that are considered to be below market, conversion to interest only, principal forgiveness and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral.

The total recorded investment in TDRs at December 31, 2022 was $14.2 million, a decrease of $3.8 million or 21.0% from $18.0 million at December 31, 2021. Of the $14.2 million of TDRs at December 31, 2022, $9.3 million or 65.3% were considered performing while the remaining $4.9 million were considered nonperforming. Of the $18.0 million of TDRs at December 31, 2021, $10.3 million or 57.4% were considered performing while the remaining $7.6 million were considered nonperforming. Loans are removed from TDR status in accordance with the established policy described in Note 1 “Summary of Significant Accounting Policies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.

Net Charge-offs

For the year ended December 31, 2022, net charge-offs of loans were $2.3 million or 0.02% of total average loans, compared to $1.9 million or 0.01%, respectively, for the year ended December 31, 2021. The net charge-offs of loans for the years ended December 31, 2022 and 2021 remained low, driven by continued low levels of NPAs.

Provision for Credit Losses

The Company recorded a provision for credit losses of $19.0 million for the year ended December 31, 2022, an increase of $79.9 million or 131.2% from the prior year’s negative provision for credit losses of $60.9 million. The provision for credit losses for the year ended December 31, 2022 reflected $13.3 million in provision for loan losses and $5.7 million in provision for unfunded commitments. The increased provision for credit losses is due to changes in the macroeconomic forecast and the impact of loan growth during the year ended December 31, 2022.

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Allowance for Credit Losses

At December 31, 2022, the ACL was $124.4 million, comprised of ALLL of $110.8 million and a reserve for unfunded commitments of $13.7 million. At December 31, 2022, the Company increased the ACL $16.7 million from December 31, 2021, primarily as a result of both increases in loan growth and increasing uncertainty in the macroeconomic outlook. The ACL as a percentage of the total loan portfolio was 0.86% at December 31, 2022, compared to 0.82% at December 31, 2021.

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The following table summarizes the ACL as of December 31, (dollars in thousands):

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The following table summarizes the net charge-off activity by loan segment for the years ended December 31, (dollars in thousands):

(1) Annualized

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The following table summarizes the ACL activity by loan segment and the percentage of the loan portfolio that the related ACL covers for the years ended of December 31, (dollars in thousands):

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The increase in the ACL for both loan segments reflect the impact of changes in the macro-economic environment and increases in loan balances.

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Deposits

As of December 31, 2022, total deposits were $15.9 billion, a decrease of $679.4 million, or 4.1%, compared to December 31, 2021. Total interest-bearing deposits consist of NOW, money market, savings, and time deposit account balances. Total time deposit balances of $1.8 billion accounted for 16.4% of total interest-bearing deposits at December 31, 2022, compared to $1.9 billion and 16.3% at December 31, 2021.

The following table presents the deposit balances by major category as of December 31, (dollars in thousands):

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The Company may also borrow additional funds by purchasing certificates of deposit through a nationally recognized network of financial institutions. The Company utilizes this funding source as part of its overall liquidity management strategy. As of December 31, 2022 and 2021, there were $7.5 million and $0, respectively, purchased certificates of deposit included in certificates of deposit on the Company’s Consolidated Balance Sheets.

Maturities of time deposits in excess of FDIC insurance limits as of December 31, 2022 were as follows (dollars in thousands):

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Capital Resources

Capital resources represent funds, earned or obtained, over which financial institutions can exercise greater or longer control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders.

On May 4, 2021, the Company’s Board of Directors authorized a share repurchase program to purchase up to $125.0 million worth of the Company’s common stock through June 30, 2022 in open market transactions or privately negotiated transactions, which was fully utilized as of September 30, 2021.

On December 10, 2021, the Company’s Board of Directors authorized a share repurchase program to purchase up to $100.0 million of the Company’s common stock through December 9, 2022 in open market transactions or privately negotiated transactions. The Company repurchased an aggregate of approximately 1.3 million shares (or approximately $48.2 million) through this repurchase program in 2022.

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On January 27, 2023, the Company announced that its Board of Directors declared a quarterly dividend of $0.30 per share of common stock. The common stock dividend is payable on February 24, 2023 to common shareholders on record as of February 10, 2023. The Board also declared a quarterly dividend on the outstanding shares of its Series A preferred stock. The dividend of $171.88 per share (equivalent to $0.43 per outstanding depositary share) is payable on March 1, 2023 to preferred shareholders of record as of February 14, 2023.

The Federal Reserve requires the Company and the Bank to comply with the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of 7.0% of risk-weighted assets; (ii) a Tier 1 capital ratio of 8.5% of risk-weighted assets; (iii) a total capital ratio of 10.5% of risk-weighted assets; and (iv) a leverage ratio of 4.0% of total assets. These ratios, with the exception of the leverage ratio, include a 2.5% capital conservation buffer, which is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

On March 27, 2020, the banking agencies issued an interim final rule that allows the Company to phase in the impact of adopting the CECL methodology up to two years, with a three-year transition period to phase out the cumulative benefit to regulatory capital provided during the two-year delay.  The Company is allowed to include the impact of the CECL transition, which is defined as the CECL Day 1 impact to capital plus 25% of the Company’s provision for credit losses during 2020, in regulatory capital through 2021. The Company elected to phase in the regulatory capital impact as permitted under the aforementioned interim final rule. The CECL transition amount will be phased out of regulatory capital over a three-year period, beginning in 2022 and ending in 2024.

The table summarizes the Company’s regulatory capital and related ratios for the periods ended December 31, (dollars in thousands):

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(+) Refer to “Non-GAAP Financial Measures” within this Item 7 for more information about this non-GAAP financial measure, including a reconciliation of this measure to the most directly comparable financial measure calculated in accordance with GAAP.

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For more information about the Company’s off-balance sheet obligations and cash requirements refer to section “Liquidity” included within this Item 7.

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MARKET RISK

Interest Sensitivity

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, and equity prices. The Company’s market risk is composed primarily of interest rate risk. The Company’s asset liability committee is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to this risk. The Company’s Board of Directors reviews and approves the guidelines established by the asset liability committee.

The Company monitors interest rate risk through the use of three complementary modeling tools: static gap analysis, earnings simulation modeling, and economic value simulation (net present value estimation). Each of these models measures changes in a variety of interest rate scenarios. While each of the interest rate risk models has limitations, taken together, they represent a reasonably comprehensive view of the magnitude of the Company’s interest rate risk, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. The Company’s static gap analysis, which measures aggregate re-pricing values, is utilized less often because it does not effectively take into account the optionality embedded into many assets and liabilities and, therefore, the Company does not address it here. The Company uses earnings simulation and economic value simulation models on a regular basis, which more effectively measure the cash flow and optionality impacts, and these models are discussed below.

The Company determines the overall magnitude of interest sensitivity risk and then formulates policies and practices governing asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These decisions are based on management’s expectations regarding future interest rate movements, the states of the national, regional and local economies, and other financial and business risk factors. The Company uses simulation modeling to measure and monitor the effect of various interest rate scenarios and business strategies on net interest income. This modeling reflects interest rate changes and the related impact on net interest income and net income over specified time horizons.

Earnings Simulation Modeling

Management uses earnings simulation modeling to measure the sensitivity of net interest income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but the Company believes it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analyses, such as the static gap analysis noted above.

The Company derives the assumptions used in the model from historical trends and management’s outlook, including expected loan and deposit growth rates and projected yields and rates. These assumptions may not be realized and unanticipated events and circumstances may also occur that cause the assumptions to be inaccurate. The model also does not take into account any future actions of management to mitigate the impact of interest rate changes. The Company monitors the assumptions and periodically adjusts them as deemed appropriate. In the Company’s modeling, it is assumed that all maturities, calls, and prepayments in the securities portfolio are reinvested in like instruments, and the Company bases the MBS prepayment assumptions on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. The Company also uses different interest rate scenarios and yield curves to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and these differences are reflected in the different rate scenarios.

The Company uses its earnings simulation model to estimate earnings in rate environments where rates are instantaneously shocked up or down around a “most likely” rate scenario, based on implied forward rates and futures curves. The analysis assesses the impact on net interest income over a 12-month period after an immediate increase or “shock” in rates, of 100 bps up to 300 bps. The model, under all scenarios, does not drop the index below zero.

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The following table represents the interest rate sensitivity on net interest income for the Company across the rate shocks modeled for balances at the period ended December 31, 2022 and 2021 (dollars in thousands):

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If an institution is asset sensitive its assets reprice more quickly than its liabilities and net interest income would be expected to increase in a rising interest rate environment, and decrease in a falling interest rate environment. If an institution is liability sensitive its liabilities reprice more quickly than its assets and net interest income would be expected to decrease in a rising interest rate environment and increase in a falling interest rate environment.

From a net interest income perspective, the Company was less asset sensitive as of December 31, 2022 compared to its position as of December 31, 2021. This shift is primarily due to the composition of the Consolidated Balance Sheets, changes in the pricing characteristics and assumptions of certain deposits and also due to the implementation of interest rate derivative strategies. In an increasing interest rate environment, the Company would expect an increase in net interest income as interest-earning assets re-price at higher rates than interest-bearing deposits.

Economic Value Simulation Modeling

Economic value simulation modeling is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. The Company calculates the economic values based on discounted cash flow analysis. The net economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in net economic value over different rate environments is an indication of the longer-term earnings capability of the balance sheet. The Company uses the same assumptions in the economic value simulation model as in the earnings simulation model. The economic value simulation model uses instantaneous rate shocks to the balance sheet.

The following table reflects the estimated change in net economic value over different rate environments using economic value simulation for the balances at the period ended December 31, 2022 and 2021 (dollars in thousands):

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As of December 31, 2022, the Company’s economic value of equity is generally less asset sensitive in a rising interest rate environment compared to its position as of December 31, 2021 primarily due to the composition of the Consolidated Balance Sheets, changes in the pricing characteristics and assumptions of certain deposits and also due to the implementation of interest rate derivative strategies.

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Liquidity

Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, money market investments, federal funds sold, LHFS, and securities and loans maturing or re-pricing within one year. Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary through federal funds lines with several correspondent banks, a line of credit with the FHLB, the Federal Reserve Discount Window, the purchase of brokered certificates of deposit, corporate line of credit with a large correspondent bank, and debt and capital issuance. Management believes the Company’s current overall liquidity is sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

The Company closely monitors changes in the industry and market conditions that may impact the Company’s liquidity. Beginning in 2020 and in much of 2021, the Company saw increased liquidity due to higher customer deposit balances related to government stimulus programs in response to the COVID-19 pandemic, however, in 2022, as expected, the Company saw these elevated levels of customer deposits begin to decline. The Company will use other means of borrowings or other liquidity sources to fund any liquidity needs based on declines in deposit balances. The Company is also closely tracking the potential impacts on the Company’s liquidity of declines in fair value of the Company’s securities portfolio due to rising market interest rates.

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As of December 31, 2022, liquid assets totaled $6.0 billion or 29.2% of total assets, and liquid earning assets totaled $5.8 billion or 31.5% of total earning assets. Asset liquidity is also provided by managing loan and securities maturities and cash flows. As of December 31, 2022, loan payments of approximately $5.3 billion or 37.0% of total loans are expected within one year based on contractual terms, adjusted for expected prepayments, and approximately $296.7 million or 8.0% of total securities are scheduled to be paid down within one year based on contractual terms, adjusted for expected prepayments.

For additional information and the available balances on various lines of credit, please refer to Note 8 “Borrowings” in the “Notes to the Consolidated Financial Statements” contained in Items 8 “Financial Statements and Supplementary Data” of this Form 10-K. In addition to lines of credit, the Bank may also borrow additional funds by purchasing certificates of deposit through a nationally recognized network of financial institutions. For additional information and outstanding balances on purchased certificates of deposits, please refer to “Deposits” within this Item 7. For additional information on cash requirements for known contractual and other obligations, please refer to “Capital Resources” within this Item 7.

Cash Requirements

The Company’s cash requirements outside of lending transactions relate primarily to borrowings, debt, and capital instruments which are used as part of the Company’s overall liquidity and capital management strategy.  Cash required to repay these obligations will be sourced from future debt and capital issuances and from other general liquidity sources as described above under “Liquidity” within this Item 7.

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The following table presents the Company’s contractual obligations related to its major cash requirements and the scheduled payments due at the various intervals over the next year and beyond as of December 31, 2022 (dollars in thousands):

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For more information pertaining to the previous table, refer to Note 6 “Leases” and Note 8 “Borrowings” in the “Notes to the Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.

Off-Balance Sheet Obligations

In the normal course of business, the Company is party to financial instruments with off-balance sheet risk to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the Company’s Consolidated Balance Sheets. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments. For more information on these commitments, refer to Note 9 “Commitments and Contingencies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support off-balance sheet financial instruments with credit risk.

The following table represents the Company’s other commitments with balance sheet or off-balance sheet risk as of December 31, (dollars in thousands):

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(1) Includes unfunded overdraft protection.

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The Company is also a lessor in sales-type and direct financing leases for equipment, as noted in Note 6 “Leases” in the “Notes of the Consolidated Financial Statements” contained in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K. The Company’s future commitments related to the aforementioned leases totaled $296 million and $217 million, respectively, at December 31, 2022 and 2021.

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Impact of Inflation and Changing Prices

The Company’s financial statements included in Item 8 “Financial Statements and Supplementary Data” of this Form 10-K below have been prepared in accordance with GAAP, which requires the financial position and operating results to be measured principally in terms of historic dollars without considering the change in the relative purchasing

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power of money over time due to inflation. Inflation affects the Company’s results of operations mainly through increased operating costs, but since nearly all of the Company’s assets and liabilities are monetary in nature, changes in interest rates generally affect the financial condition of the Company to a greater degree than changes in the rate of inflation. Although interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. The Company’s management reviews pricing of its products and services, in light of current and expected costs due to inflation, to mitigate the inflationary impact on financial performance.

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NON-GAAP FINANCIAL MEASURES

In this Form 10-K, the Company has provided supplemental performance measures on a tax-equivalent, tangible, operating, adjusted or pre-tax pre-provision basis. These non-GAAP financial measures are a supplement to GAAP, which is used to prepare the Company’s financial statements and should not be considered in isolation or as a substitute for comparable measures calculated in accordance with GAAP. In addition, the Company’s non-GAAP financial measures may not be comparable to non-GAAP financial measures of other companies. The Company uses the non-GAAP financial measures discussed herein in its analysis of the Company’s performance. The Company’s management believes that these non-GAAP financial measures provide additional understanding of ongoing operations, enhance comparability of results of operations with prior periods and show the effects of significant gains and charges in the periods presented without the impact of items or events that may obscure trends in the Company’s underlying performance.

Net interest income (FTE) and total revenue (FTE), which are used in computing net interest margin (FTE), provide valuable additional insight into the net interest margin by adjusting for differences in the tax treatment of interest income sources. The entire FTE adjustment is attributable to interest income on earning assets, which is used in computing the yield on earning assets. Interest expense and the related cost of interest-bearing liabilities and cost of funds ratios are not affected by the FTE components.

The following table reconciles non-GAAP financial measures from the most directly comparable GAAP financial measures for each of the periods presented (dollars in thousands):

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Tangible common equity and tangible assets are used in the calculation of certain profitability, capital, and per share ratios. The Company believes tangible common equity, tangible assets, and the related ratios are meaningful measures of capital adequacy because they provide a meaningful basis for period-to-period and company-to-company comparisons, which the Company believes will assist investors in assessing the capital of the Company and its ability to absorb potential losses. The Company believes tangible common equity is an important indication of its ability to grow organically and through business combinations as well as its ability to pay dividends and to engage in various capital management strategies.

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The following table reconciles non-GAAP financial measures from the most directly comparable GAAP financial measures for each of the periods presented (dollars in thousands):

Adjusted operating measures exclude the losses related to balance sheet repositioning (principally composed of losses on debt extinguishment), gains or losses on sale of securities, gains on the sale of Visa, Inc. Class B common stock, gain on the sale of DHFB, as well as strategic branch closure initiatives and related facility consolidation costs (principally composed of real estate, leases and other assets write downs, as well as severance and expense reduction initiatives. The Company believes these non-GAAP adjusted measures provide investors with important information about the continuing economic results of the organization’s operations. Prior periods in this Form 10-K reflect adjustments for previously announced strategic branch closure and expense reduction initiatives.

The following table reconciles non-GAAP financial measures from the most directly comparable GAAP financial measures for each of the periods presented (dollars in thousands, except per share amounts):

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Adjusted operating measures exclude the amortization of intangible assets, losses related to balance sheet repositioning (principally composed of losses on debt extinguishment), gains or losses on sale of securities, gains on the sale of Visa, Inc. Class B common stock, gain on the sale of DHFB, as well as strategic branch closure initiatives and related facility consolidation costs (principally composed of real estate, leases and other assets write downs, as well as severance and expense reduction initiatives). The Company believes these non-GAAP adjusted measures provide investors with important information about the continuing economic results of the organization’s operations. Prior periods reflect adjustments for previously announced strategic branch closures and expense reduction initiatives. Net interest income (FTE), which is used in computing net interest margin (FTE) provides valuable additional insight into the net interest margin by adjusting for differences in tax treatment of interest income sources. The entire FTE adjustment is attributable to interest income on earning assets, which is used in computing yield on earning assets. Interest expense is not affected by the FTE components.

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The following table reconciles non-GAAP financial measures from the most directly comparable GAAP financial measures for each of the periods presented (dollars in thousands):

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The Company believes LHFI, net of deferred fees and costs, excluding PPP is useful to investors as it provides more clarity on the Company’s organic growth. PPP loans excludes the unforgiven portion of PPP loans, net of deferred fees and costs.

The following table reconciles non-GAAP financial measures from the most directly comparable GAAP financial measures for each of the periods presented (dollars in thousands):

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