ServisFirst Bancshares, Inc. (SFBS) FY 2023 MD&A

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

This section of the Form 10-K generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 that are not included in this Form 10-K can be found in “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide a reader of the Company’s financial statements with a narrative from the perspective of management on the Company’s financial condition, results of operations, liquidity and certain other factors that may affect future results. In certain instances, parenthetical references are made to relevant sections of the Notes to Consolidated Financial Statements to direct the reader to a further detailed discussion. This section should be read in conjunction with the Consolidated Financial Statements included in this Form 10-K.

Overview

The Company

We are a bank holding company within the meaning of the BHC Act headquartered in Birmingham, Alabama. Through our wholly-owned subsidiary bank, we operate full service banking offices located in Alabama, Florida, Georgia, North Carolina, South Carolina, Tennessee, and Virginia. We also operate loan production offices in Florida. Our principal business is to accept deposits from the public and to make loans and other investments. Our principal source of funds for loans and investments are demand, time, savings, and other deposits and the amortization and prepayment of loans and borrowings. Our principal sources of income are interest and fees collected on loans, interest and dividends collected on other investments and service charges. Our principal expenses are interest paid on savings and other deposits, interest paid on our other borrowings, employee compensation, office expenses, and other overhead expenses.

41

2023 Highlights

Results of Operations

The following discussion and analysis presents the more significant factors that affected our financial condition as of December 31, 2023 and 2022 and results of operations for each of the years then ended. Refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K filed with the SEC on February 25, 2023 (2022 FORM 10-K) for a discussion and analysis of the more significant factors that affected periods prior to 2022.

Net Income Available to Common Stockholders

Net income available to common stockholders was $206.8 million for the year ended December 31, 2023, compared to $251.4 million for the year ended December 31, 2022.  As discussed herein, this decrease in net income was primarily attributable to a decrease in net interest income, and an increase in noninterest expense, partially offset by a decrease in provision for credit losses.  Basic and diluted net income per common share were $3.80 and $3.79, respectively, for the year ended December 31, 2023, compared to $4.63 and $4.61, respectively, for the year ended December 31, 2022.  Return on average assets was 1.37% in 2023, compared to 1.71% in 2022, and return on average common stockholders’ equity was 15.13% in 2023, compared to 20.73% in 2022.

The following tables present a summary of our statements of income, including the percent change in each category, for the years ended December 31, 2023 compared to 2022, and for the years ended December 31, 2022 compared to 2021, respectively.

42

Performance Ratios

The following table presents selected ratios of our results of operations for the years ended December 31, 2023, 2022 and 2021.

Net Interest Income

Net interest income is the difference between the income earned on interest-earning assets and interest paid on interest-bearing liabilities used to support such assets. Net interest income is the single largest component of operating revenues. Management seeks to optimize this revenue while balancing interest rate, credit, and liquidity risks.  The major factors that affect net interest income are changes in volumes, the yield on interest-earning assets and the cost of interest-bearing liabilities.  Our management’s ability to respond to changes in interest rates by effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of our primary source of earnings.

Net interest income decreased 12.7% for the year ended December 31, 2023 from the year ended December 31, 2022. The decrease in net interest income was mostly attributable to the increase in both the average balance and rates paid on interest-bearing liabilities. Total average interest-bearing liabilities increased 19.7% year-over-year, while total interest expense increased by 355.0% year-over-year. As demonstrated in the discussion of net interest margin below, average interest rate yields on average earning assets had a lesser impact on our interest income.

Average earning assets increased 3.1% in 2023 from 2022, which was primarily driven by an increase of $1.04 billion in average loans. A majority of our regional markets grew loans during 2023.

Average interest-bearing liabilities increased 19.7% in 2023 from 2022. The increase in interest-bearing deposits was mostly attributable to the organic growth of our deposit base.

Net Interest Margin Analysis

The banking industry uses two key ratios to measure relative profitability of net interest revenue, which are the net interest spread and the net interest margin. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. The net interest spread eliminates the effect of noninterest-earning assets as well as noninterest-bearing deposits and other noninterest-bearing funding sources and gives a direct perspective on the effect of market interest rate movements. The net interest margin is an indication of the profitability of a company’s balance sheet and is defined as net interest revenue as a percentage of total average interest-earning assets, which includes the positive effect of funding a portion of interest-earning assets with noninterest-bearing deposits and stockholders’ equity.

43

The net interest margin is impacted by the average volumes of interest-sensitive assets and interest-sensitive liabilities and by the difference between the yield on interest-sensitive assets and the cost of interest-sensitive liabilities (spread). Loan fees collected at origination represent an additional adjustment to the yield on loans. Net interest spread can be affected by economic conditions, the competitive environment, loan demand, and deposit flows. The net yield on earning assets is an indicator of effectiveness of our ability to manage the net interest margin by managing the overall yield on assets and cost of funding those assets.

The following table shows, for the years ended December 31, 2023, 2022 and 2021, the average balances of each principal category of our assets, liabilities and stockholders’ equity, and an analysis of net interest revenue, and the change in interest income and interest expense segregated into amounts attributable to changes in volume and changes in rates. This table is presented on a taxable equivalent basis, if applicable.

44

The following table reflects changes in our net interest margin as a result of changes in the volume and rate of our interest-bearing assets and liabilities.

* The rate/volume variance is allocated on a pro rata basis between the volume variance and the rate variance in the table above.

In the table above, changes in net interest income are attributable to (a) changes in average balances (volume variance), (b) changes in rates (rate variance), or (c) changes in rate and average balances (rate/volume variance). The volume variance is calculated as the change in average balances times the previous period average balance. The rate variance is calculated as the change in rates times the previous period average balance. The rate/volume variance is calculated as the change in rates times the change in average balances.

From 2022 to 2023, our volume component was favorable as asset volumes increased primarily as a result of the growth in loan balances as well as an increase in taxable debt securities, while the volume change from our liabilities was primarily driven by growth in money market balances. The rate component was unfavorable as average rates paid on interest-bearing liabilities increased 275 basis points while yields on average earning assets increased 162 basis points.

45

The two primary factors that make up the spread are the interest rates received on loans and the interest rates paid on deposits. Our net interest spread and net interest margin were 1.83% and 2.81%, respectively, for the year ended December 31, 2023, compared to 2.96% and 3.32%, respectively, for the year ended December 31, 2022. The decrease in net interest spread and net interest margin was primarily attributable to increases in average interest-bearing liabilities, which increased $1.77 billion in 2023.

Our average interest-earning assets for the year ended December 31, 2023 increased $434.6 million, or 3.1%, to $14.62 billion from $14.19 billion for the year ended December 31, 2022. Average loans grew $1.04 billion, or 9.8%, average debt securities grew $164.4 million, or 9.6%, and average federal funds sold and interest-bearing balances with banks decreased $771.0 million, or 40.8%.

Our average interest-bearing liabilities increased $1.77 billion, or 19.7%, to $10.78 billion for the year ended December 31, 2023 from $9.01 billion for the year ended December 31, 2022. The ratio of our average interest-earning assets to average interest-bearing liabilities decreased from 157.5% for the year ended December 31, 2022 to 135.6% for the year ended December 31, 2023, as average noninterest-bearing deposits and stockholders’ equity decreased by a combined $1.4 billion, or 24.9%, from 2022 to 2023.

Our average interest-earning assets produced a taxable equivalent yield of 5.56% for the year ended December 31, 2023, compared to 3.94% for the year ended December 31, 2022. The average rate paid on interest-bearing liabilities was 3.73% for the year ended December 31, 2023, compared to 0.98% for the year ended December 31, 2022.

Provision for Credit Losses

The provision for credit losses represents the amount determined by management to be necessary to maintain the allowance for credit losses (“ACL”) at a level capable of absorbing expected credit losses over the contractual life of loans in the loan portfolio. See the section captioned “Allowance for Credit Losses” located elsewhere in this item for additional discussion related to provision for credit losses.

The provision expense for credit losses decreased 50.2% for the year ended December 31, 2023 when compared to the year-ended December 31, 2022. The decrease in provision expense was primarily the result of lower loan growth during 2023 compared to 2022. Nonperforming loans increased to $21.5 million, or 0.18% of total loans, at December 31, 2023 from $17.8 million, or 0.15% of total loans, at December 31, 2022. During 2023, we had net charged-off loans totaling $11.7 million, compared to net charged-off loans of $7.6 million for 2022. 52% of the $7.6 million net charge-off in 2022 was represented by three loans. In 2023, 62% of the $11.7 million net charge-off was represented by four loans. The ratio of net charged-off loans to average loans was 0.10% for 2023 compared to 0.08% for 2022. The ACL at December 31, 2023 totaled $153.3 million, or 1.32% of loans, net of unearned income. The ACL totaled $146.3 million, or 1.25% of loans, net of unearned income, at December 31, 2022.

Noninterest Income

Noninterest income for the years ended December 31, 2023 and 2022 were as follows.

46

Noninterest income decreased $2.9 million, or 8.8%, to $30.4 million in 2023 from $33.4 million in 2022. The decrease in noninterest income is primarily the result of a decrease in other operating income, due to the maturity of an interest rate cap which was partially offset by the losses on sale of securities in 2022. Service charges on deposit accounts increased $387,000, or 4.8%, to $8.4 million in 2023 compared to $8.0 million 2022. Credit card income decreased $1.3 million, or 13.0%, to $8.6 million in 2023 compared to $9.9 million in 2022. Mortgage banking income increased $317,000, or 13.0%, to $2.8 million in 2023 compared to $2.4 million in 2022. The increase in cash surrender value of bank-owned life insurance contracts increased $1.1 million, or 16.9%, to $7.6 million in 2023 compared to $6.5 million 2022. Other operating income decreased 76.0% in 2023 compared to 2022, driven by a decrease in our interest rate cap. The income recognized from our interest rate cap derivative decreased from $7.0 million for the year ended December 31, 2022, to $32,000 for the year ended December 31, 2023, as a result of the interest rate cap maturing during the second quarter of 2023. Merchant service revenue increased $449,000, or 25.45%, to $2.2 million in 2023 compared to 2022.

Noninterest Expense

Noninterest expense for the years ended December 31, 2023 and 2022 were as follows.

Noninterest expenses increased $20.2 million, or 12.8%, to $178.1 million in 2023 compared to $157.8 million in 2022. Increased salaries and employee benefits expenses as well as increases in FDIC assessments were the primary drivers of the increase in noninterest expense. Salary and employee benefits expenses increased $3.0 million, or 3.9%, to $81.0 million in 2023 compared to $78.0 million in 2022. We had 591 full-time equivalent employees in 2023 compared to 571 in 2022. Equipment and occupancy expense increased $2.0 million, or 16.0%, to $14.30 million in 2023 compared to $12.30 million in 2022. Third party processing and other services increased $539,000, or 2.0%, to $27.9 million in 2023 compared to $27.3 million in 2022. Professional services expense increased $1.6 million, or 38.3%, to $5.9 million in 2023 compared to $4.3 million in 2022. FDIC assessments increased $11.0 million, or 242.0%, to $15.6 million in 2023 compared to $4.6 million in 2022. The FDIC implemented a special assessment to recapitalize the Deposit Insurance Fund resulting in an expense of $7.2 million during 2023. Expenses on other real estate owned decreased $248,000, or 84.1%, to $47,000 in 2023 compared to $295,000 in 2022. Other operating expenses increased $2.3 million, or 7.3%, to $33.3 million in 2023 compared to $31.1 million in 2022. Changes in other operating expenses from 2022 to 2023 are detailed in Note 15 - “Other Operating Income and Expenses,” to the Consolidated Financial Statements.

Income Tax Expense

Income tax expense was $37.7 million for the year ended December 31, 2023 compared to $57.3 million in 2022. Our effective tax rates for 2023 and 2022 were 15.4% and 18.6%, respectively. We recognized $17.7 million in credits related to new investments in Federal New Market Tax Credits during 2023 and $12.6 million during 2022. We also recognized excess tax benefits as an income tax credit to our income tax expense from the exercise and vesting of stock options and restricted stock during 2023 of $1.5 million, compared to $1.3 million during 2022. Our primary permanent differences are related to tax exempt income on debt securities, state income tax benefit on real estate investment trust dividends, various qualifying tax credits and change in cash surrender value of bank-owned life insurance.

We have invested $292.8 million in bank-owned life insurance for certain officers of the Bank. The periodic increases in cash surrender value of those policies are tax exempt and therefore contribute to a larger permanent difference between book income and taxable income.

We own real estate investment trusts for the purpose of holding and managing participations in residential mortgages and commercial real estate loans originated by the Bank. The trusts are majority-owned subsidiaries of a trust holding company, which in turn is an indirect, wholly-owned subsidiary of the Bank. The trusts earn interest income on the loans they hold and incur operating expenses related to their activities. They pay their net earnings, in the form of dividends, to the Bank, which receives a deduction for state income taxes.

47

Financial Condition

Assets

Total assets as of December 31, 2023, were $16.13 billion, an increase of $1.53 billion, or 10.5%, from total assets of $14.60 billion as of December 31, 2022. Average assets for the year ended December 31, 2023 were $15.07 billion, an increase of $363.7 million, or 2.5%, over average assets of $14.70 billion for the year ended December 31, 2022. Growth in loans and debt securities, offset by decreases in interest-bearing balances with banks, and federal funds sold were the primary reasons for the increase in ending and average total assets. Year-end 2023 loans, were $11.66 billion, a decrease of $29.1 million, or 0.2% compared to $1.53 billion, over year-end 2022 total loans of $11.69 billion.

Earning assets include loans, securities, short-term investments and bank-owned life insurance contracts. We maintain a higher level of earning assets in our business model than do our peers because we allocate fewer of our resources to facilities, ATMs, and cash and due-from-bank accounts used for transaction processing. Earning assets as of December 31, 2023 were $15.85 billion, or 98.2% of total assets of $16.13 billion. Earning assets as of December 31, 2022 were $14.37 billion, or 98.4% of total assets of $14.60 billion. We believe this ratio is expected to generally continue at these levels, although it may be affected by economic factors beyond our control.

Investment Portfolio

We view the investment portfolio as a source of income and liquidity. Our investment strategy is to accept a lower immediate yield in the investment portfolio by targeting shorter term investments. At December 31, 2023, mortgage-backed securities represented 34.9% of the investment portfolio, corporate debt represented 18.5% of the investment portfolio, state and municipal securities represented 1.0% of the investment portfolio, and U.S. Treasury securities represented 45.7% of the investment portfolio.

All of our investments in mortgage-backed securities are pass-through mortgage-backed securities. We generally do not hold, and did not have at December 31, 2023, any structured investment vehicles or any private-label mortgage-backed securities. The amortized cost of securities in our portfolio totaled $1.95 billion at December 31, 2023, compared to $1.74 billion at December 31, 2022.

The following table presents the book value and weighted average yield of our securities as of December 31, 2023 by their stated maturities (this maturity schedule excludes security prepayment and call features).

48

As of December 31, 2023, we had $100.6 million in federal funds sold, compared with $1.5 million at December 31, 2022.  At year-end 2023, there were no holdings of securities of any issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.

During the first two quarters of 2022, the bank added $100 million per month, net of paydowns and maturities, of U.S. Treasury Securities.

The objective of our investment policy is to invest funds not otherwise needed to meet our loan demand to earn the maximum return, yet still maintain sufficient liquidity to meet fluctuations in our loan demand and deposit structure. In doing so, we balance the market and credit risks against the potential investment return, make investments compatible with the pledge requirements of any deposits of public funds, maintain compliance with regulatory investment requirements, and assist certain public entities with their financial needs. The investment committee has full authority over the investment portfolio and makes decisions on purchases and sales of securities. The entire portfolio, along with all investment transactions occurring since the previous board of directors meeting, is reviewed by the board at each monthly meeting. The investment policy allows portfolio holdings to include short-term securities purchased to provide us with needed liquidity and longer-term securities purchased to generate level income for us over periods of interest rate fluctuations.

Loan Portfolio

The following is a condensed overview of changes in our loan portfolio. Please see Note 3 - “Loans” in the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data elsewhere in this report for a more detailed analysis of our loan portfolio by type of loan.

Section 1102 of the CARES Act created the Paycheck Protection Program, a program administered by the SBA to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. Our bank participated in the PPP as a lender. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments will also be deferred for the first six months of the loan term. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. No collateral or personal guarantees were required from borrowers and neither the government nor lenders were permitted to charge the recipients any fees.

On December 27, 2020, President Trump signed into law the Consolidated Appropriations Act (“CAA”). The CAA, among other things, extended the life of the PPP, effectively creating a second round of PPP loans for eligible businesses. Effective May 28, 2021, the PPP was closed to new applications. Additionally, section 541 of the CAA extended the relief provided by the CARES Act for financial institutions to suspend the GAAP accounting treatment for troubled debt restructuring to January 1, 2022.

We funded approximately 7,400 loans for a total amount of $1.5 billion for clients under the PPP since April 2020. To the extent the PPP loans are forgiven, this represents outside funds to our borrowers; and, especially with respect to vulnerable industries, we believe these capital injections have been instrumental in assisting our borrowers in navigating through the pandemic. This capital injection, along with the level of capital each borrower had immediately prior to the beginning of the COVID-19 pandemic, are critical factors in determining the continued business viability of our borrowers. As of December 31, 2023, we have received payment from the SBA on almost all of our loans totaling $1.5 billion.

We had total loans of approximately $11.66 billion at December 31, 2023.  A large majority of our loan customers are located within our market MSAs, as is the collateral for their loans. With our loan portfolio concentrated in a limited number of markets, there is a risk that our borrowers’ ability to repay their loans from us could be affected by changes in local and regional economic conditions.

49

The following table details our loans at December 31, 2023, 2022 and 2021:

The following table details the percentage composition of our loan portfolio by type at December 31, 2023, 2022 and 2021:

The following table details maturities and sensitivity to interest rate changes for our loan portfolio at December 31, 2023:

50

Asset Quality

The following table presents a summary of the allowance for credit losses, net charge-offs and certain credit ratios for the years ended December 31, 2023, 2022 and 2021.

51

As described below under Recently Adopted Accounting Pronouncements, the Company adopted ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“CECL”) Accounting Standard Codification (“ASC”) 326 effective January 1, 2020.  The ACL for December 31, 2023 and 2022 was calculated under the CECL methodology and totaled $153.3 million and $146.3 million, or 1.32% and 1.25% of loans, net of unearned income, respectively. The increase in the ACL as a percent of total loans at December 31, 2023 from December 31, 2022 was largely the result of adjustments to qualitative factors in our construction land development and commercial real estate pools. Net credit charge-offs to average loans were 0.10% for the year ended December 31, 2023, compared to 0.08% and 0.03% for the years ended December 31, 2022 and 2021, respectively. Nonaccrual loans increased to $19.3 million, or 0.17% of total loans, at December 31, 2023 from $12.5 million, or 0.11% of total loans, at December 31, 2022, and were $6.8 million, or 0.07% of total loans, at December 31, 2021. At December 31, 2023, the nonaccrual balance increase was attributable to three owner-occupied loans representing a balance of $3.8 million, and a net increase of $2.9 million in 1-4 family mortgage nonaccruals. At December 31, 2022, the nonaccrual increase was driven by one commercial and industrial (C&I) relationship and oneowner-occupied commercial relationship.

We maintain an ACL on unfunded commercial lending commitments and letters of credit to provide for the risk of loss inherent in these arrangements. The allowance is computed using a similar methodology to the one used to determine the ACL, modified to account for the probability of a drawdown on the commitment. The ACL on unfunded loan commitments is classified as a liability account on the balance sheet within other liabilities, while the corresponding provision for these credit losses is recorded as a component of other expense. The allowance for credit losses on unfunded commitments was $575,000 as of December 31, 2023 and December 31, 2022.

The following table presents the allocation of the allowance for loan losses for each respective loan category with the corresponding percent of loans in each category to total loans.

The Company assesses the adequacy of its ACL at the end of each calendar quarter. The level of ACL is based on the Company’s evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay a loan, the estimated value of any underlying collateral, composition of the loan portfolio and other relevant factors. The ACL is increased by a provision for credit losses, which is charged to expense, and reduced by charge-offs, net of recoveries. The ACL is believed adequate to absorb all expected future losses to be recognized over the contractual life of the loans in the portfolio. At December 31, 2023, we forecasted a slightly lower national unemployment rate and moderately higher national GDP compared to December 31, 2022. At December 31, 2022, we forecasted a moderately higher national unemployment rate and significantly lower national GDP compared to December 31, 2021.

52

Loans with similar risk characteristics are evaluated in pools and, depending on the nature of each identified pool, the Company utilizes a discounted cash flow (“DCF”), probability of default / loss given default (“PD/LGD”) or remaining life method. For all loans utilizing the DCF method, the historical loss experience estimate by pool is then adjusted by forecast factors that are quantitatively related to the Company’s historical credit loss experience, such as national unemployment rates and gross domestic product. Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. The reasonable and supportable period and reversion period are re-evaluated each quarter by the Company and are dependent on the current economic environment among other factors.

The expected credit losses for each loan pool are then adjusted for changes in qualitative factors not inherently considered in the quantitative analyses. The qualitative adjustments either increase or decrease the quantitative model estimation. The Company considers factors that are relevant within the qualitative framework, which include the following: lending policy, changes in nature and volume of loans, staff experience, changes in volume and trends of problem loans, concentration risk, trends in underlying collateral values, external factors, quality of loan review system; and other economic conditions and new markets.

Expected credit losses for loans that no longer share similar risk characteristics with the collectively evaluated pools are excluded from the collective evaluation and estimated on an individual basis. Individual evaluations are performed for nonaccrual loans, loans rated substandard, and modified loans classified as TDRs. Specific allocations of the ACL for credit losses are estimated on one of several methods, including the estimated fair value of the underlying collateral, observable market value of similar debt or the present value of expected cash flows.

PPP loans outstanding totaled $56,000 and $2.0 million as of December 31, 2023 and 2022, respectively, and are included within the commercial, financial and agricultural loan category.

The Bank has procedures and processes in place intended to ensure that losses do not exceed the potential amounts documented in the Bank’s analysis of loans individually evaluated and reduce potential losses in the remaining performing loans within our real estate construction portfolio. These include the following:

53

Nonperforming Assets

The table below summarizes our nonperforming assets at December 31, 2023, 2022 and 2021:

The accrual of interest on loans is discontinued when there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or the principal or interest is more than 90 days past due, unless the loan is both well-collateralized and in the process of collection. Interest previously accrued but uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. Interest income on nonaccrual loans is recognized only as received. If we believe that a loan will not be collected in full, we will increase the ACL to reflect management’s estimate of any potential exposure or loss. Generally, payments received on nonaccrual loans are applied directly to principal. There are not any loans, outside of those included in the table above, that cause management to have serious doubts as to the ability of borrowers to comply with present repayment terms.

On December 27, 2020, the CAA was signed into law and extended the period established by Section 4013 of the CARES Act to the earlier of January 1, 2022 or the date that is 60 days after the date on which the national COVID-19 emergency terminates. In keeping with this guidance from regulators, the bank offered short-term modifications made in response to COVID-19 to borrowers who were current and otherwise not past due. Should eventual credit losses on these deferred payments emerge, the related loans would be placed on nonaccrual status and interest income accrued would be reversed. In such a scenario, interest income in future periods could be negatively impacted. As of December 31, 2023, we carry $2.1 million of accrued interest income on deferrals made to COVID-19 affected borrowers compared to $2.4 million at December 31, 2022. At this time, we are unable to project the materiality of such an impact on future deferrals to COVID-19 affected borrowers, but we recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.

54

Deposits

We rely on increasing our deposit base to fund loan and other asset growth. Each of our markets is highly competitive. We compete for local deposits by offering attractive products with competitive rates.  We expect to have a higher average cost of funds for local deposits than competitor banks due to our lack of an extensive branch network.  Our management’s strategy is to offset the higher cost of funding with a lower level of operating expense and firm pricing discipline for loan products.  We have promoted electronic banking services by providing them without charge and by offering in-bank customer training. The following table presents the average balance and average rate paid on each of the following deposit categories at the bank level for years ended December 31, 2023, 2022 and 2021:

At December 31, 2023 and December 31, 2022, we estimate that we had approximately $8.76 billion and $7.66 billion, respectively, in total uninsured deposits. Included in the total uninsured deposits we estimate that we had approximately $607.3 million and $400.9 million, respectively, in uninsured time deposits. These uninsured deposits represent the portion of deposit accounts that exceed FDIC insurance limits. Included in our uninsured deposits as of December 31, 2023 and December 31, 2022, we estimate that we had approximately $2.2 billion and $758 million, respectively, in public funds. While public fund balances that exceed FDIC limits are uninsured deposits, these deposits are collateralized by securities. The uninsured deposit data for 2023 and 2022 reflect the deposit insurance impact of “combined ownership segregation” of escrow and other accounts at an aggregate level but do not reflect an evaluation of all of the account styling distinctions that would determine the availability of deposit insurance to individual accounts based on FDIC regulations.

Borrowed Funds

We had $880.0 million in unused and available federal funds lines of credit with regional banks as of December 31, 2023, compared to $963.0 million as of December 31, 2022. These lines are subject to certain restrictions.

Federal funds purchased from correspondent banks averaged $1.29 billion, $1.53 billion, and $1.16 billion for 2023, 2022 and 2021, respectively. We paid average interest rates on these funds of 5.18%, 1.72%, and 0.21% for the same three years, respectively. The maximum amount outstanding at a month-end during 2023 and 2022 was $1.47 billion and $1.44 billion, respectively.

Stockholders’ Equity

Stockholders’ equity increased $142.5 million during 2023, to $1.44 billion as of December 31, 2023 from $1.30 billion as of December 31, 2022. The increase in stockholders’ equity resulted primarily from net income of $206.9 million during the year ended December 31, 2023, less dividends paid or declared on our common stock of $62.0 million during the year ended December 31, 2023.

Off-Balance Sheet Arrangements

In the normal course of business, we are a party to financial credit arrangements with off-balance sheet risk to meet the financing needs of our customers. These financial credit arrangements include commitments to extend credit beyond current fundings, credit card arrangements, standby letters of credit and financial guarantees. Those credit arrangements involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement we have in those particular financial credit arrangements. All such credit arrangements bear interest at variable rates and we have no such credit arrangements which bear interest at fixed rates.

55

Our exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, credit card arrangements and standby letters of credit is represented by the contractual or notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

The following table sets forth our credit arrangements and financial instruments whose contract amounts represent credit risk as of December 31, 2023, 2022 and 2021:

Commitments to extend credit beyond current fundings are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Such commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  We evaluate each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained if deemed necessary by us upon extension of credit is based on our management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions.  All letters of credit are due within one year or less of the original commitment date.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Derivatives

The Company periodically enters into derivative contracts to manage exposures to movements in interest rates. The Company purchased an interest rate cap in May of 2020 to limit exposures to increases in interest rates. The interest rate cap was not designated as a hedging instrument but rather as a stand-alone derivative. The interest rate cap had an original term of three years, a notional amount of $300 million and was tied to the one-month LIBOR rate with a strike rate of 0.50%. The fair value of the interest rate cap was carried on the Consolidated Balance Sheets in other assets and the change in fair value was recognized in noninterest income each quarter. The interest rate cap had a fair value of $4.2 million and remaining term of 0.3 years at December 31, 2022, and expired on May 4, 2023.

The Bank has entered into agreements with secondary market investors to deliver loans on a “best efforts delivery” basis. When a rate is committed to a borrower, it is based on the best price that day and locked with our investor for our customer for a 30-day period. In the event the loan is not delivered to the investor, the Bank has no risk or exposure with the investor. The interest rate lock commitments to customers related to loans that are originated for later sale are classified as derivatives. The fair values of our agreements with investors and rate lock commitments to customers as of December 31, 2023 and 2022 were not material.

Asset and Liability Management

The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the dollar amount of rate-sensitive assets repricing during a period and the volume of rate-sensitive liabilities repricing during the same period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.

56

Our asset liability and investment committee is charged with monitoring our liquidity and funds position. The committee regularly reviews the rate sensitivity position on a three-month, six-month and one-year time horizon; loans-to-deposits ratios; and average maturities for certain categories of liabilities. The asset liability committee uses a model to analyze the maturities of rate-sensitive assets and liabilities. Gap is also expressed as the ratio of rate-sensitive assets divided by rate-sensitive liabilities. If the ratio is greater than “one,” then the dollar value of assets exceeds the dollar value of liabilities and the balance sheet is “asset sensitive.” Conversely, if the value of liabilities exceeds the dollar value of assets, then the ratio is less than one and the balance sheet is “liability sensitive.”  Our internal policy requires our management to maintain the gap such that net interest margins will not change more than 10% if interest rates change by 100 basis points or more than 15% if interest rates change by 200 basis points. As of December 31, 2023, our gap was within such ranges. See “—Quantitative and Qualitative Analysis of Market Risk” below in Item 7A for additional information.

Liquidity and Capital Adequacy

Sources and Uses of Funds

The following table illustrates, during the years presented, the mix of our funding sources and the assets in which those funds are invested as a percentage of our average total assets for the period indicated. Average assets totaled $15.07 billion in 2023, compared to $14.70 billion in 2022, and $13.56 billion in 2021.

Liquidity

Liquidity is defined as our ability to generate sufficient cash to fund current loan demand, deposit withdrawals, or other cash demands and disbursement needs, and otherwise to operate on an ongoing basis.

Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The management of liquidity at both levels is critical because the Company and the Bank have different funding needs and sources, and each are subject to regulatory guidelines and requirements. We are subject to general FDIC guidelines that require a minimum level of liquidity. Management believes our liquidity ratios meet or exceed these guidelines. Our management is not currently aware of any trends or demands that are reasonably likely to result in liquidity increasing or decreasing in any material manner.

57

The Bank’s main source of liquidity is customer interest-bearing and noninterest-bearing deposit accounts. Our regular sources of funding are from the growth of our deposit base, repayment of principal and interest on loans, the sale of loans and the renewal of time deposits. Liquidity is also available from funding sources consisting primarily of federal funds purchased, FHLB loan advances and available-for-sale securities. The retention of existing deposits and attraction of new deposit sources through new and existing customers is critical to our liquidity position. In the event of compression in liquidity due to a run-off in deposits, we have a liquidity policy and procedure that provides for certain actions under varying liquidity conditions. These actions include borrowing from existing correspondent banks, selling or participating loans and the curtailment of loan commitments and funding. As of December 31, 2023, our liquid assets, represented by cash and due from banks, federal funds sold and unpledged available-for-sale securities, totaled $2.51 billion. The Bank had loans pledged to both the FHLB and the Federal Reserve Bank of Atlanta which provided approximately $2.58 billion and $2.17 billion, respectively, in available funding. The Bank’s policy limits on brokered deposits would allow for up to $4.03 billion in available funding for brokered deposits. Additionally, the Bank had available to us approximately $888.0 million in unused federal funds lines of credit with regional banks, subject to certain restrictions and collateral requirements, to meet short term funding needs.

As a separate entity from the bank, we also have separate liquidity obligations. We are responsible for the payment of dividends to our stockholders and interest and principal on our outstanding indebtedness. As a source of internal liquidity, we have access to the capital markets. We also may continue periodic offerings of debt and equity securities. However, our ultimate source of liquidity consists of dividends from the Bank, which are limited by applicable law and regulations. In 2023 and 2022, the Bank paid dividends of $62.5 million and $57.5 million, respectively. For a detailed discussion on the regulatory limitation on Bank dividends, see “Supervision and Regulation - Payment of Dividends” in Item 1.

We believe these sources of funding are adequate to meet both our immediate (within the next 12 months) and our longer term anticipated funding needs. Our management meets on a weekly basis to review sources and uses of funding to determine the appropriate strategy to ensure an appropriate level of liquidity, and we have increased our focus on the generation of core deposit funding to supplement our liquidity position. At the current time, our long-term liquidity needs primarily relate to funds required to support loan originations and commitments and deposit withdrawals.

Capital Adequacy

As of December 31, 2023, our most recent notification from the FDIC categorized us as well-capitalized under the regulatory framework for prompt corrective action.  To remain categorized as well-capitalized, we must maintain minimum common equity tier 1 risk-based, Tier 1 risk-based, total risk-based, and Tier 1 leverage ratios as disclosed in the table below.  Our management believes that we are well-capitalized under the prompt corrective action provisions as of December 31, 2023.  In addition, the Alabama Banking Department has required that the Bank maintain a leverage ratio of 8.00%.

The following table sets forth (i) the capital ratios of the Bank required by the FDIC to maintain “well-capitalized” status and (ii) our actual ratios of capital to total regulatory or risk-weighted assets, as of December 31, 2023.

For a description of capital ratios see Note 14 - “Regulatory Matters” to the Consolidated Financial Statements.

Critical Accounting Estimates

Our consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in the Notes to the Consolidated Financial Statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect our reported results and financial position for the current period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on our future financial condition and results of operations.

58

Allowance for Credit Losses

The Company assesses the adequacy of its allowance for credit losses at the end of each calendar quarter. The level of allowance is based on the Company’s evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay a loan, the estimated value of any underlying collateral, composition of the loan portfolio and other relevant factors. The allowance is increased by a provision for credit losses, which is charged to expense, and reduced by charge-offs, net of recoveries. The allowance for credit losses is believed adequate to absorb all expected future losses to be recognized over the contractual life of the loans in the portfolio. If our assumptions regarding the adequacy of our allowance for credit losses are not accurate, we may incur credit losses in excess of our current allowance for credit losses and be required to make material additions to our allowance. Such additional provision for credit losses could have a material adverse effect on our business and results of operations. Our regulators may disagree with our assumptions and could require us to materially increase our allowance for credit losses.

Loans with similar risk characteristics are evaluated in pools and, depending on the nature of each identified pool, the Company utilizes a discounted cash flow (“DCF”), probability of default / loss given default (“PD/LGD”) or remaining life method.  The historical loss experience estimate by pool is then adjusted by forecast factors that are quantitatively related to the Company’s historical credit loss experience, such as national unemployment rates and gross domestic product.  Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. The reasonable and supportable period and reversion period are re-evaluated each quarter by the Company and are dependent on the current economic environment among other factors.  See Note 1 – “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data elsewhere in this report.

The expected credit losses for each loan pool are then adjusted for changes in qualitative factors not inherently considered in the quantitative analyses. The qualitative adjustments either increase or decrease the quantitative model estimation. The Company considers factors that are relevant within the qualitative framework, which include the following: lending policy, changes in nature and volume of loans, staff experience, changes in volume and trends of problem loans, concentration risk, trends in underlying collateral values, external factors, quality of loan review system and other economic conditions.

Expected credit losses for loans that no longer share similar risk characteristics with the collectively evaluated pools are excluded from the collective evaluation and estimated on an individual basis.  Individual evaluations are performed for nonaccrual loans, loans rated substandard, and modified loans classified as troubled debt restructurings.  Specific allocations of the allowance for credit losses are estimated on one of several methods, including the estimated fair value of the underlying collateral, observable market value of similar debt or the present value of expected cash flows.

Income Taxes

Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

In accordance with GAAP, the Company established a single model to address accounting for uncertain tax positions. GAAP clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. GAAP also provides guidance on derecognition measurement classification interest and penalties, accounting in interim periods, disclosure, and transition. GAAP provides a two-step process in the evaluation of a tax position. The first step is recognition. A company determines whether it is more likely than not that a tax position will be sustained upon examination, including a resolution of any related appeals or litigation processes, based upon the technical merits of the position. The second step is measurement. A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Because of the uncertainty of estimates involved, the ultimate resolution may result in a payment that is different from the current estimate of the tax liabilities and can be significant to the Company’s consolidated financial position, results of operations or cash flows.

59

Adoption of Recent Accounting Pronouncements

New accounting standards are discussed in Note 1, “Summary of Significant Accounting Policies” to the Notes to Consolidated Financial Statements.