FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This section reviews the financial condition and results of operations of the Company and its subsidiaries as of and for the three months endingJune 30, 2022 . Some tables may include additional periods to comply with disclosure requirements or to illustrate trends. When reading this discussion, also refer to the Consolidated Financial Statements and related notes in this report. Page locations and specific sections and notes that are referred to in this discussion are listed in the table of contents.
Additionally, a comprehensive list of the acronyms and abbreviations used throughout this discussion is included in Note 1 to the Consolidated Financial Statements.
GENERAL
The Company was formed in
Over the past twenty-nine years, the Company has grown to include four banking subsidiaries and a number of nonbanking subsidiaries. As ofJune 30, 2022 , the Company had$7.4 billion in consolidated assets, including$5.7 billion in net loans/leases, and$5.8 billion in deposits. The financial results of acquired/merged entities for the periods since their acquisition/merger are included in this report. Further information related to acquired/merged entities has been presented in the annual reports previously filed with theSEC corresponding to the year of each acquisition/merger. OnApril 1, 2022 , the Company completed its acquisition of GFED and onApril 2, 2022 mergedGuaranty Bank , the banking subsidiary of GFED, into the Company's Springfield-based charter,Springfield First Community Bank . The combined bank changed its name toGuaranty Bank . IMPACT OF COVID-19 The progression of the COVID-19 pandemic inthe United States has had an impact on the Company's financial condition and results of operations as of and for the three and six months endedJune 30, 2022 and could continue to have a complex and significant adverse impact on the economy, the banking industry and the Company in future fiscal periods, all subject to a high degree of uncertainty.
Effects on the Company's Business
The extent to which COVID-19 will continue to affect business operations, financial condition, credit quality, and results of operations will depend on future developments that cannot be predicted, including the duration and scope of the pandemic. The direct or indirect impact on employees, customers, counterparties, and service providers, as well as other market participants, is likely to continue through 2022 as the world attempts to continue to gain control over the virus and emerging variants. The impact that the virus continues to have on global markets, the economy, the Company's market areas, business restrictions, and employment is ongoing as a projected return to pre-pandemic operating conditions is unknown. The Company currently expects that the economic impact from COVID-19 will continue for some time and could have a material and adverse impact on our business and result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the global economic impact of the COVID-19 pandemic, including the availability of credit, adverse impacts on liquidity, and any recession that has occurred or may as a global pandemic may have, nor are there historical indicators to rely on in terms of how markets will react, and as a result, the ultimate impact of the pandemic is highly uncertain and subject to change. 36 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
CRITICAL ACCOUNTING POLICIES AND CRITICAL ACCOUNTING ESTIMATES
The Company's financial statements are prepared in accordance with GAAP. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance, impairment of goodwill and the fair value of financial instruments.
Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified the following as critical accounting policies and estimates:
The Company records all assets and liabilities purchased in an acquisition, including intangibles, at fair value.Goodwill is not amortized but is subject, at a minimum, to annual tests for impairment. In certain situations, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A more detailed discussion of this critical accounting policy can be found in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 .
As of
ALLOWANCE FOR CREDIT LOSSES ON LOANS AND LEASES AND OFF-BALANCE SHEET EXPOSURES
OnJanuary 1, 2021 , the Company adopted ASU 2016-13, "Financial Instruments - Credit Losses (Topic326)," which replaces the incurred loss methodology with a current expected credit loss methodology, known as CECL. Additionally, CECL required an allowance for OBS exposures to be calculated using a current expected credit loss methodology. A more detailed discussion of this critical accounting policy can be found in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 .
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business. A framework has been established for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities. A more detailed discussion of this critical accounting estimate can be found in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 .
FAIR VALUE OF SECURITIES
The fair value of securities is determined monthly and the securities are stated at fair value. A more detailed discussion of this critical accounting estimate can be found in the Company's Annual Report on Form 10-K for the year ended
December 31, 2021 . 37 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
EXECUTIVE OVERVIEW
The Company reported net income of$15.2 million and diluted EPS of$0.87 for the quarter endedJune 30, 2022 . By comparison, for the quarter endedMarch 31, 2022 the Company reported net income of$23.6 million and diluted EPS of$1.49 . For the quarter endedJune 30, 2021 , the Company reported net income of$22.3 million , and diluted EPS of$1.39 . For the six months ended Juned 30, 2022, the Company reported net income of$38.9 million , and diluted EPS of$2.33 . By comparison, for the six months endedJune 30, 2021 , the Company reported net income of$40.3 million and diluted EPS of$2.52 .
The second quarter of 2022 was also highlighted by the following results and events:
? Completed the acquisition of GFED adding approximately
? Reported net income of
? Adjusted net income (non-GAAP) of
? Acquisition/Post-acquisition related expenses and the CECL Day 2 provision
totaled
? NIM of 3.53% and Adjusted
from the prior quarter by 23 and 24 basis points, respectively;
? Capital markets revenue from swap fees of
quarter of 2022
Annualized loan and lease growth (non-GAAP) of 14.0% for the quarter, excluding
? initial loan balances acquired from the GFED transaction and SBA PPP loans
(non-GAAP); and
? Repurchased 602,500 shares at an average price of
Following is a table that represents various net income measurements for the Company. For the three months ended For the six months ended June 30, 2022 March 31, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (dollars in thousands) Net income$ 15,242 $ 23,624$ 22,349 $ 38,866 $ 40,331 Diluted earnings per common share $ 0.87 $ 1.49 $
1.39 $ 2.33 $ 2.52
Weighted average common and common equivalent shares outstanding 17,549,107 15,852,256
16,045,239 16,700,682 16,035,394
The Company reported adjusted net income (non-GAAP) of
Adjusted net income for the three months ended excludes a number of non-recurring items, after-tax, most significantly$1.9 million of acquisition costs,$3.8 million of post-acquisition compensation, transition and integration costs and$12.4 million of CECL Day 2 provision. The Company reported adjusted net income (non-GAAP) of$54.8 million , with adjusted diluted EPS of$3.28 for the six months endedJune 30, 2022 . Adjusted net income for the six months ended excludes a number of non-recurring items, after-tax, most significantly$3.4 million of acquisition costs,$3.8 million of post-acquisition compensation, transition and integration costs and$12.4 million of CECL Day 2 provision. 38 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Following is a table that represents the major income and expense categories for the Company: For the three months ended For the six months ended June 30, 2022 March 31, 2022 June 30, 2021 June 30, 2022 June 30, 2021
(dollars in thousands)
Net interest income$ 59,400 $ 45,733$ 43,516 $ 105,133 $ 85,491 Provision for credit losses 11,200 (2,916)
- 8,284 6,713 Noninterest income 22,782 15,633 19,296 38,415 42,785 Noninterest expense 54,248 38,325 35,675 92,573 72,903 Federal and state income tax expense 1,492 2,333 4,788 3,825 8,329 Net income$ 15,242 $ 23,624$ 22,349 $ 38,866 $ 40,331
Following are some noteworthy changes in the Company's financial results:
Net interest income in the second quarter of 2022 increased 30% compared to the
first quarter of 2022. Net interest income increased 37% when comparing to the
? second quarter of 2021 and 23% when comparing the first six months of 2022 to
the same period of the prior year. The increase was due to an increase in
average earning assets, primarily attributable to the GFED transaction, but
also due to increased average loan growth.
Provision expense in the second quarter of 2022 increased
? compared to the first quarter of 2022. Provision expense increased
million when comparing the first six months of 2022 to the same period in the
prior year. The increase was primarily due to the GFED acquisition.
Noninterest income in the second quarter of 2022 increased
compared to the first quarter of 2022. Noninterest income increased
million or 18% compared to the second quarter of 2021. The increase was
primarily due to a
? fees as well as the GFED acquisition. Noninterest income decreased
million or 10% when comparing the first six months of 2022 to the same period
of the prior year. The decrease was primarily due to lower capital markets
revenue from swap fee income despite the strong second quarter increases due to
client project delays caused by ongoing supply chain disruptions and inflationary pressures.
Noninterest expense increased
2022 compared to the first quarter of 2022. This increase was primarily due to
acquisition costs and post-acquisition compensation, transition and integration
costs of
? compared to the second quarter of 2021 and increased
comparing the first six months of 2022 to the same period in the prior year.
The increase was primarily due to acquisition costs and post-acquisition
compensation, transition and integration costs of
the acquisition of GFED. See Note 2 of the Consolidated Financial Statements
for further discussion. STRATEGIC FINANCIAL METRICS The Company has established certain strategic financial metrics by which it manages its business and measures its performance. The goals are periodically updated to reflect changes in business developments. While the Company is determined to work prudently to achieve these metrics, there is no assurance that they will be met. Moreover, the Company's ability to achieve these metrics will be affected by the factors discussed under "Forward Looking Statements" as well as the factors detailed in the "Risk Factors" section included under Item 1A. of Part I of the Company's Annual 39 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
Report on Form 10-K for the year ended
? Generate loan and lease growth of 9% per year, funded by core deposits;
? Grow fee-based income by at least 6% per year; and
? Limit our annual operating expense growth to 5% per year.
The following table shows the evaluation of the Company's strategic financial metrics: Year to Date* Strategic Financial Metric* Key Metric Target June 30, 2022
Loan and lease growth organically Loans and leases ** growth > 9% annually 14.0 % 14.6 % 14.7 % Fee income Fee income growth growth*** > 6% annually (26.1) % (41.3) % (23.3) % Improve operational efficiencies and hold noninterest Noninterest expense growth*** expense growth < 5% annually 10.4 % (4.1) % (1.0) %
* Ratios and amounts provided for these measurements represent year-to-date actual amounts for the respective period that are then annualized for comparison. The calculations provided exclude non-core noninterest income and noninterest expense.
** Loan and lease growth excludes the initial loan balances from the GFED acquisition and PPP loans.
***Fee income growth and noninterest expense growth are both impacted by the GFED acquisition.
It should be noted that these initiatives are long-term targets.
STRATEGIC DEVELOPMENTS
The Company has taken the following actions during the second quarter of 2022 to support its corporate strategy:
The Company grew loans and leases in the second quarter of 2022 by 14.0% on an
? annualized basis, excluding the initial loan balances from the GFED acquisition
and PPP loans (non-GAAP), driven by both our specialty finance group and our
traditional commercial lending and leasing business.
Correspondent banking has continued to be a core line of business for the
Company. The Company is competitively positioned with experienced staff,
software systems and processes to continue growing in the four states currently
served -
correspondent bank for 189 downstream banks with average total noninterest
bearing deposits of
of
? acted as the correspondent bank for 186 downstream banks with average total
noninterest bearing deposits of
interest-bearing deposits of
line of business provides a strong source of noninterest bearing and interest
bearing deposits, fee income, high-quality loan participations and bank stock
loans. The Company also manages off-balance sheet liquidity held at the
30, 2022 as compared to the quarter ended
The Company is focused on executing interest rate swaps on select commercial
loans, including LIHTC permanent loans. The interest rate swaps allow
commercial borrowers to pay a fixed interest rate while the Company receives a
variable interest rate as well as an upfront nonrefundable fee dependent on the
? pricing. Management believes that these swaps help position the Company more
favorably for rising rate environments. The Company will continue to review
opportunities to execute these swaps at all of its subsidiary banks as
appropriate for the borrowers and the Company. Future levels of capital markets
revenue from swap fee income 40 Table of Contents
Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
are influenced by upon prevailing interest rates. Capital markets revenue from
swap fee income totaled
six months of 2022. Capital markets revenue from swap fees averaged
million per quarter for the year 2021 and
quarters. In recent years, the Company has been successful in expanding its wealth
management client base. Trust department fees continue to be a significant
contributor to noninterest income. Assets under management decreased by
million in the first six months of 2022 due to market value fluctuations.
There were 188 new relationships added in the first six months of 2022
? totaling
primarily from fees charged based on assets under administration for corporate
and personal trusts and for custodial services. The majority of the trust
department fees are determined based on the value of the investments within the
fully-managed trusts. The Company expects trust department fees to be
negatively impacted during periods of significantly lower market valuations and
positively impacted during periods of significantly higher market valuations.
Noninterest expense for the first six months of 2022 totaled
compared to
? to
transition and integration costs in 2022 related to the acquisition of GFED as
discussed in the Company's financial statements and the accompanying notes.
GAAP TO NON-GAAP RECONCILIATIONS
The following table presents certain non-GAAP financial measures related to the "TCE/TA ratio", "adjusted net income", "adjusted EPS", "adjusted ROAA", "NIM (TEY)", "adjusted NIM", "efficiency ratio" and "loan growth annualized excluding acquired and PPP loans". In compliance with applicable rules of theSEC , all non-GAAP measures are reconciled to the most directly comparable GAAP measure, as follows:
? TCE/TA ratio (non-GAAP) is reconciled to stockholders' equity and total assets;
? Adjusted net income, adjusted EPS and adjusted ROAA (all non-GAAP measures) are
reconciled to net income;
?
PPP income (TEY) (non-GAAP) are reconciled to NIM;
? Efficiency ratio (non-GAAP) is reconciled to noninterest expense, net interest
income and noninterest income; and
? Loan growth annualized excluding acquired and PPP loans is reconciled to total
loans and leases.
The TCE/TA non-GAAP ratio has been a focus for investors and management believes that this ratio may assist investors in analyzing the Company's capital position without regard to the effects of intangible assets. The following tables also include several "adjusted" non-GAAP measurements of financial performance. The Company's management believes that these measures are important to investors as they exclude non-recurring income and expense items; therefore, they provide a better comparison for analysis and may provide a better indicator of future performance.NIM (TEY) is a financial measure that the Company's management utilizes to take into account the tax benefit associated with certain tax-exempt loans and securities. It is standard industry practice to measure net interest margin using tax-equivalent measures. In addition, the Company calculates NIM without the impact of acquisition accounting net accretion (adjusted NIM), as accretion amounts can fluctuate widely, making comparisons difficult. The efficiency ratio is a ratio that management utilizes to compare the Company to its peers. It is a standard ratio used to calculate overhead as a percentage of revenue in the banking industry and is widely utilized by investors. 41 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Loan growth annualized, excluding acquired and PPP loans, is a ratio that management utilizes to compare the Company to its peers. The Company's management believes this financial measure is important to investors as total loans and leases for the quarter endedJune 30, 2022 were materially higher due to the addition of acquired loans and for the quarter endedJune 30, 2021 were materially higher due to the addition of PPP loans. By excluding the acquired and PPP loans, the investor is provided a better comparison to prior periods for analysis. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP. As of GAAP TO NON-GAAP June 30, March 31, June 30, RECONCILIATIONS 2022 2022 2021 (dollars in thousands, except per share data) TCE/TA RATIO Stockholders' equity (GAAP)$ 743,138 $ 667,924 $ 630,476 Less: Intangible assets 155,940 82,922 84,431 TCE (non-GAAP)$ 587,198 $ 585,002 $ 546,045 Total assets (GAAP)$ 7,392,941 $ 6,175,819 $ 5,827,412 Less: Intangible assets 155,940 82,922 84,431 TA (non-GAAP)$ 7,237,001 $ 6,092,897 $ 5,742,981 TCE/TA ratio (non-GAAP) 8.11 % 9.60 % 9.51 % 42 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued For the Quarter Ended For the Six Months Ended June 30, March 31, June 30, June 30, June 30, 2022 2022 2021 2022 2021 (dollars in thousands, except per share data) ADJUSTED NET INCOME Net income (GAAP)$ 15,242 $ 23,624 $ 22,349 $ 38,866 $ 40,331 Less non-core items (post-tax) (*): Income: Securities losses, net $ - $ -$ (69) $ -$ (69) Mark to market gains on unhedged derivatives, net 342 715 (58) 1,057 71 Total non-core income (non-GAAP)$ 342 $ 715 $ (127) $ 1,057 $ 2 Expense: Disposition costs $ - $ - $ - $ - $ 7 Acquisition costs 1,932 1,462 - 3,394 - Post-acquisition compensation, transition and integration costs 3,789 - - 3,789 - CECL Day 2 credit loss expense on acquired loans 8,651 - - 8,651 - CECL Day 2 credit loss expense on acquired OBS exposure 1,140 - - 1,140 - Separation agreement - - - - 734 Total non-core expense (non-GAAP)$ 15,512 $ 1,462 $ -$ 16,974 $ 741 Adjusted net income (non-GAAP)$ 30,412 $ 24,371 $ 22,476 $ 54,783 $ 41,070 ADJUSTED EPS Adjusted net income (non-GAAP) (from above)$ 30,412 $ 24,371 $ 22,476 $ 54,783 $ 41,070 Weighted average common shares outstanding 17,345,324 15,625,112 15,813,932 16,485,218 15,808,788 Weighted average common and common equivalent shares outstanding 17,549,107 15,852,256 16,045,239 16,700,682 16,035,394 Adjusted EPS (non-GAAP): Basic$ 1.75 $ 1.56 $ 1.42 $ 3.32 $ 2.60 Diluted$ 1.73 $ 1.54 $ 1.40 $ 3.28 $ 2.56 ADJUSTED ROAA Adjusted net income (non-GAAP) (from above)$ 30,412 $ 24,371 $ 22,476 $ 54,783 $ 41,070 Average Assets$ 7,324,470 $ 6,115,127 $ 5,739,067 $ 6,723,137 $ 5,704,151 Adjusted ROAA (non-GAAP) 1.66 % 1.59 % 1.57 % 1.63 % 1.44 % ADJUSTED NIM (TEY)* Net interest income (GAAP)$ 59,400 $ 45,733 $ 43,516 $ 105,133 $ 85,491 Plus: Tax equivalent adjustment 3,396 2,933 2,444 6,327 4,702 Net interest income - tax equivalent (non-GAAP)$ 62,796 $ 48,666 $ 45,960 $ 111,460 $ 90,193 Less: Acquisition accounting net accretion 1,695 118 291 1,813 795 Adjusted net interest income 61,101 48,548 45,669 109,647 89,398 Less: PPP income 125 530 1,658 655 3,921 Adjusted net interest income, excluding PPP income$ 60,976 $ 48,018 $ 44,011 $ 108,992 $ 85,477 Average earning assets$ 6,742,095 $ 5,625,813 $ 5,320,881 $ 6,187,038 $ 5,269,820 NIM (GAAP) 3.53 % 3.30 % 3.28 % 3.43 % 3.27 % NIM (TEY) (non-GAAP) 3.74 % 3.50 % 3.46 % 3.63 % 3.45 % Adjusted NIM (TEY) (non-GAAP) 3.64 % 3.50 % 3.44 % 3.57 % 3.42 % Adjusted NIM, excluding PPP income (TEY) (non-GAAP) 3.63 % 3.46 % 3.32 % 3.55 % 3.27 % EFFICIENCY RATIO Noninterest expense (GAAP)$ 54,248 $ 38,325 $ 35,675 $ 92,573 $ 72,903 Net interest income (GAAP)$ 59,400 $ 45,733 $ 43,516 $ 105,133 $ 85,491 Noninterest income (GAAP) 22,782 15,633 19,296 38,415 42,785 Total income$ 82,182 $ 61,366 $ 62,812 $ 143,548 $ 128,276 Efficiency ratio (noninterest expense/total income) (non-GAAP) 66.01 % 62.45 % 56.80 % 64.49 % 56.83 % LOAN GROWTH, EXCLUDING ACQUIRED AND PPP LOANS Total loans and leases$ 5,797,903 $ 4,827,868 $ 4,417,705 $ 5,797,903 $ 4,417,705 Less: Acquired loans 807,599 - - 807,599 - Less: PPP loans 79 6,340 147,506 79 147,506 Total loans and leases, excluding acquired and PPP loans$ 4,990,225 $ 4,821,528 $ 4,117,191 $ 4,990,225 $ 4,270,199 Loan growth, excluding acquired and PPP loans 14.00 % 14.58 % 14.87 % 14.54 % 12.90 % * Nonrecurring items (after-tax) are calculated using an estimated effective tax rate of 21% with the exception of acquisition costs which have an estimated effective tax rate of 11.26%.
NET INTEREST INCOME - (TAX EQUIVALENT BASIS)
Net interest income, on a tax equivalent basis, increased 37% to$62.8 million for the quarter endedJune 30, 2022 compared to the same quarter of the prior year and increased 24% to$111.5 million for the six months endedJune 30, 2022 . Net interest income, on a GAAP basis, increased 37% for the quarter endedJune 30, 2022 compared to the same quarter of the prior year, and increased 23% for the six months endedJune 30, 2022 compared to the same period of the 43 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued prior year. Net interest income improved due to the GFED acquisition, but also due to increased average organic loan growth and NIM expansion with the rapidly rising interest rate environment. A comparison of yields, spread and margin on a tax equivalent and GAAP basis is as follows: Tax Equivalent Basis GAAP For the Quarter Ended For the Quarter Ended June 30, March 31, June 30, June 30, March 31, June 30, 2022 2022 2021 2022 2022 2021 Average Yield on Interest-Earning Assets 4.26 % 3.88 % 3.87 % 4.05 % 3.63 % 3.68 % Average Cost of Interest-Bearing Liabilities 0.74 % 0.56 % 0.60 % 0.74 % 0.55 % 0.60 % Net Interest Spread 3.52 % 3.32 % 3.27 % 3.31 % 3.08 % 3.08 % NIM (TEY) (Non-GAAP) 3.74 % 3.50 % 3.46 % 3.53 % 3.30 % 3.28 % NIM Excluding Acquisition Accounting Net Accretion 3.64 % 3.50 % 3.44 % 3.50 % 3.25 % 3.27 %
Acquisition accounting net accretion can fluctuate mostly depending on the payoff activity of the acquired loans. In evaluating net interest income and NIM, it's important to understand the impact of acquisition accounting net accretion when comparing periods. The above table reports NIM with and without the acquisition accounting net accretion to allow for more appropriate comparisons. A comparison of acquisition accounting net accretion included in NIM is as follows: For the Quarter Ended For the Six Months Ended June 30, March 31, June 30, June 30, June 30, 2022 2022 2021 2022 2021 (dollars in thousands) (dollars in thousands)
Acquisition Accounting Net Accretion in NIM 1,695
The Company's management closely monitors and manages NIM. From a profitability standpoint, an important challenge for the Company's subsidiary banks and leasing company is focusing on quality growth in conjunction with the improvement of their NIMs. Management continually addresses this issue with pricing and other balance sheet strategies which include better loan pricing, reducing reliance on very rate-sensitive funding, closely managing deposit rate changes and finding additional ways to manage cost of funds through derivatives. 44 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued The Company's average balances, interest income/expense, and rates earned/paid on major balance sheet categories, as well as the components of change in net interest income, are presented in the following tables: For the Three Months Ended June 30, 2022 2021 Interest Average Interest Average Average Earned Yield or Average Earned Yield or Balance or Paid Cost Balance or Paid Cost (dollars in thousands) ASSETS Interest earning assets: Federal funds sold$ 5,896 $ 12 0.83 %$ 1,817 $ 1 0.06 % Interest-bearing deposits at financial institutions 67,254 169 1.01 % 88,396 35 0.16 % Investment securities (1) 920,308 9,002 3.91 % 798,732 7,294 3.66 % Restricted investment securities 37,166 485 5.16 % 19,614 238 4.79 % Gross loans/leases receivable (1) (2) (3) 5,711,471 61,932 4.35 % 4,412,322 43,776 3.98 % Total interest earning assets 6,742,095 71,600
4.26 % 5,320,881 51,344 3.87 %
Noninterest-earning assets: Cash and due from banks 97,927 62,876 Premises and equipment 114,510 74,328 Less allowance (81,871) (80,603) Other 451,809 361,585 Total assets$ 7,324,470 $ 5,739,067 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing deposits$ 3,791,595 4,478 0.47 %$ 2,978,382 2,050 0.28 % Time deposits 529,675 1,047 0.79 % 440,599 1,184 1.08 % Short-term borrowings 1,404 3 0.78 % 10,883 1 0.05 % FHLB advances 286,484 780 1.08 % 21,802 15 0.28 % Subordinated notes 133,529 1,816 5.44 % 115,339 1,570 5.45 % Junior subordinated debentures 46,536 680
5.78 % 38,044 564 5.86 % Total interest-bearing liabilities 4,789,223 8,804 0.74 % 3,605,049 5,384 0.60 %
Noninterest-bearing demand deposits 1,546,174
1,290,751 Other noninterest-bearing liabilities 200,869 219,267 Total liabilities 6,536,266 5,115,067 Stockholders' equity 788,204 624,000 Total liabilities and stockholders' equity$ 7,324,470 $ 5,739,067 Net interest income$ 62,796 $ 45,960 Net interest spread 3.52 % 3.27 % Net interest margin 3.53 % 3.28 % Net interest margin (TEY)(Non-GAAP) 3.74 % 3.46 % Adjusted net interest margin (TEY)(Non-GAAP) 3.64 % 3.44 % Adjusted net interest margin, excluding PPP income(TEY)(Non-GAAP) 3.63 % 3.32 % Ratio of average interest-earning assets to average interest-bearing liabilities 140.78 % 147.60 %
(1) Interest earned and yields on nontaxable investment securities and nontaxable
loans are determined on a tax equivalent basis using a 21% tax rate.
Loan/lease fees are not material and are included in interest income from (2) loans/leases receivable in accordance with accounting and regulatory
guidance.
Non-accrual loans/leases are included in the average balance for gross (3) loans/leases receivable in accordance with accounting and regulatory
guidance. 45 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Analysis of Changes of Interest Income/Interest Expense For the Three Months Ended June 30, 2022 Inc./(Dec.) Components from of Change (1) Prior Period (1) Rate Volume 2022 vs. 2021 (dollars in thousands) INTEREST INCOME Federal funds sold $ 11$ 10 $ 1 Interest-bearing deposits at financial institutions 134 193 (59) Investment securities (2) 1,708 525 1,183 Restricted investment securities 247 20 227 Gross loans/leases receivable (2) (3) 18,156 4,363 13,793 Total change in interest income 20,256
5,111 15,145 INTEREST EXPENSE Interest-bearing deposits 2,428 1,748 680 Time deposits (137) (1,171) 1,034 Short-term borrowings 2 11 (9)
Federal Home Loan Bank advances 765 148 617 Subordinated notes 246 - 246 Junior subordinated debentures 116 (50) 166 Total change in interest expense 3,420
686 2,734
Total change in net interest income $ 16,836
The column "Inc./(Dec.) from Prior Period" is segmented into the changes (1) attributable to variations in volume and the changes attributable to changes
in interest rates. The variations attributable to simultaneous volume and
rate changes have been proportionately allocated to rate and volume.
(2) Interest earned and yields on nontaxable investment securities and nontaxable
loans are determined on a tax equivalent basis using a 21% tax rate.
Loan/lease fees are not material and are included in interest income from (3) loans/leases receivable in accordance with accounting and regulatory
guidance. 46 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued For the Six Months Ended June 30, 2022 2021 Interest Average Interest Average Average Earned Yield or Average Earned Yield or Balance or Paid Cost Balance or Paid Cost (dollars in thousands) ASSETS Interest earning assets: Federal funds sold$ 5,234 $ 14 0.53 %$ 1,830 $ 1 0.05 % Interest-bearing deposits at financial institutions 68,285 204 0.60 % 102,343 71 0.14 % Investment securities (1) 861,610 16,683 3.87 % 804,364 14,344 3.57 % Restricted investment securities 29,716 766 5.13 % 18,843 456 4.81 % Gross loans/leases receivable (1) (2) (3) 5,222,193 107,927 4.17 % 4,342,440 86,299 4.01 % Total interest earning assets 6,187,038 125,594
4.09 % 5,269,820 101,171 3.87 %
Noninterest-earning assets: Cash and due from banks 75,928 64,741 Premises and equipment, net 97,103 73,752 Less allowance for estimated losses on loans/leases (80,393) (83,494) Other 443,461 379,332 Total assets$ 6,723,137 $ 5,704,151 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing demand deposits$ 3,511,396 6,816 0.39 %$ 2,979,835 4,036 0.27 % Time deposits 464,647 1,846 0.80 % 444,297 2,625 1.19 % Short-term borrowings 1,676 3 0.36 % 9,021 3 0.06 % Federal Home Loan Bank advances 186,685 863 0.92 % 17,464 25 0.28 % Subordinated notes 123,753 3,370 5.45 % 117,014 3,164 5.41 % Junior subordinated debentures 42,376 1,236
5.80 % 38,026 1,125 5.87 % Total interest-bearing liabilities 4,330,533 14,134 0.66 % 3,605,657 10,978 0.61 %
Noninterest-bearing demand deposits 1,412,019
1,245,401 Other noninterest-bearing liabilities 244,133 239,032 Total liabilities 5,986,685 5,090,090 Stockholders' equity 736,452 614,061 Total liabilities and stockholders' equity$ 6,723,137 $ 5,704,151 Net interest income$ 111,460 $ 90,193 Net interest spread 3.43 % 3.26 % Net interest margin 3.43 % 3.27 % Net interest margin (TEY)(Non-GAAP) 3.63 % 3.45 % Adjusted net interest margin (TEY)(Non-GAAP) 3.57 % 3.42 % Adjusted net interest margin, excluding PPP income(TEY)(Non-GAAP) 3.55 % 3.27 % Ratio of average interest earning assets to average interest-bearing liabilities 142.87 % 146.15 % 47 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Analysis of Changes of Interest Income/Interest Expense For the six months ended June 30, 2022 Inc./(Dec.) Components from of Change (1) Prior Period (1) Rate Volume 2022 vs. 2021 (dollars in thousands) INTEREST INCOME Federal funds sold $ 13$ 11 $ 2 Interest-bearing deposits at other financial institutions 133 208 (75) Investment securities (2) 2,339 1,266 1,073 Restricted investment securities 310 32 278 Gross loans/leases receivable (2) (3) 21,628 3,559 18,069 Total change in interest income 24,423
5,076 19,347
INTEREST EXPENSE Interest-bearing demand deposits 2,780
1,984 796 Time deposits (779) (1,108) 329 Short-term borrowings - 7 (7)
Federal Home Loan Bank advances 838 160 678 Subordinated notes 206 - 206 Junior subordinated debentures 111 - 111 Total change in interest expense 3,156
1,043 2,113
Total change in net interest income $ 21,267 $
4,033
The column "Inc./(Dec.) from Prior Period" is segmented into the changes (1) attributable to variations in volume and the changes attributable to changes
in interest rates. The variations attributable to simultaneous volume and
rate changes have been proportionately allocated to rate and volume.
(2) Interest earned and yields on nontaxable investment securities and nontaxable
loans are determined on a tax equivalent basis using a 21% tax rate.
Loan/lease fees are not material and are included in interest income from (3) loans/leases receivable in accordance with accounting and regulatory
guidance.
The Company's operating results are also impacted by various sources of noninterest income, including trust department fees, investment advisory and management fees, deposit service fees, swap fee income, gains from the sales of residential real estate loans and government guaranteed loans, earnings on BOLI and other income. Offsetting these items, the Company incurs noninterest expenses, which include salaries and employee benefits, occupancy and equipment expense, professional and data processing fees,FDIC and other insurance expense, loan/lease expense and other administrative expenses. The Company's operating results are also affected by economic and competitive conditions, particularly changes in interest rates, income tax rates, government policies and actions of regulatory authorities.
RESULTS OF OPERATIONS
INTEREST INCOME
Interest income (tax equivalent) increased 39%, comparing the second quarter of 2022 to the same period of 2021 and increased 24% when comparing the first half of 2022 to the same period of 2021. This was primarily due the GFED acquisition, but also due to an increase in the yield of average securities and average loans/leases as well as an increased volume of average organic loans/leases.
The Company intends to continue to grow quality loans and leases as well as its private placement tax-exempt securities portfolio to maximize yield while minimizing credit and interest rate risk.
48 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
INTEREST EXPENSE
Interest expense (tax equivalent) for the second quarter of 2022 increased 64% from the second quarter of 2021 and increased 29% comparing the first half of 2022 to the same period of 2021. The increase is primarily due to the GFED acquisition, however the Company has grown organically at a significant pace over the past several years and core deposit growth has funded the larger majority of the growth. The cost of funds on the Company's average interest-bearing liabilities increased in conjunction with the rising rate environment. The Company's cost of funds was 0.74% for the quarter endedJune 30, 2022 , which was up from 0.60% for the quarter endedJune 30, 2021 . The Company's cost of funds was 0.66% for the six months endedJune 30, 2022 , which was up from 0.61% for the six months endedJune 30, 2021 .
PROVISION FOR CREDIT LOSSES
The ACL is established through provision expense to provide an estimated ACL. The following table shows the components of the provision for credit losses for the three months endedJune 30, 2022 and 2021. Three Months Ended Six Months Ended June 30, June 30, June 30, June 30, 2022 2021 2022 2021 (dollars in thousands) (dollars in thousands) Provision for credit losses - loans and leases$ 12,141 $ (141) $ 8,292 $ 5,852 Provision for credit losses - off-balance sheet exposures (941) 141 (8) 870 Provision for credit losses - held to maturity securities - - - (9) Total provision for credit losses$ 11,200 $ - $
8,284
The Company's total provision for credit losses was$11.2 million for the second quarter of 2022, compared to no provision for the second quarter of 2021. The increase was due to the CECL Day 2 provision of$11.0 million as a result of the GFED acquisition. This decrease in provision related to OBS was due to a decrease in the balance of those OBS exposures with increase of line of credit usage. Provision for the first six months of 2022 totaled$8.3 million , which was up from$6.7 million in the first six months of 2021. The increase in provision on loans and leases was driven by the CECL Day 2 credit loss expense of$11.0 million as a result of the GFED acquisition offset by negative provision on other charters. The provision related to OBS was a negative$8 thousand , compared to$870 thousand for the six months endedJune 30, 2021 . The decrease was due to the decrease in the balance of those OBS exposures with decrease of line of credit usage. The ACL for loans and leases is established based on a number of factors, including the Company's historical loss experience, delinquencies and charge-off trends, economic and other forecasts, the local, state and national economies and risk associated with the loans/leases and securities in the portfolio as described in more detail in the "Critical Accounting Policies" section.
The Company had an ACL on loans/leases of 1.59% of total gross loans/leases at
Management evaluates the allowance needed on the acquired loans factoring in the remaining discount, which was$13.0 million and$2.2 million atJune 30, 2022 andJune 30, 2021 , respectively.
Additional discussion of the Company's allowance can be found in the "Financial Condition" section of this Report.
49 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
NONINTEREST INCOME
The following tables set forth the various categories of noninterest income for
the three and six months ended
Three Months Ended June 30, June 30, 2022 2021 $ Change % Change (dollars in thousands) Trust department fees$ 2,497 $ 2,848 $ (351) (12.3) %
Investment advisory and management fees 983 1,039 (56) (5.4) Deposit service fees 2,223 1,492 731 49.0 Gains on sales of residential real estate loans, net 809 1,184 (375) (31.7) Swap fee income/capital markets revenue 13,004 9,568 3,436 35.9 Securities losses, net - (88) 88 (100.0) Earnings on bank-owned life insurance 350 451
(101) (22.4) Debit card fees 1,499 1,084 415 38.3 Correspondent banking fees 244 269 (25) (9.3) Other 1,173 1,449 (276) (19.0) Total noninterest income$ 22,782 $ 19,296 $ 3,486 18.1 % Six Months Ended June 30, June 30, 2022 2021 $ Change % Change (dollars in thousands) Trust department fees$ 5,460 $ 5,649 $ (189) (3.3) %
Investment advisory and management fees 2,019 1,979 40 2.0 Deposit service fees 3,778 2,900 878 30.3 Gains on sales of residential real estate loans, net 1,302 2,521 (1,219) (48.4) Gains on sales of government guaranteed portions of loans, net 19 - 19 100.0 Swap fee income/capital markets revenue 19,426 23,125 (3,699) (16.0) Securities losses, net - (88) 88 (100.0) Earnings on bank-owned life insurance 696 922
(226) (24.5) Debit card fees 2,506 2,059 447 21.7 Correspondent banking fees 521 583 (62) (10.6) Other 2,688 3,135 (447) (14.3) Total noninterest income$ 38,415 $ 42,785 $ (4,370) (10.2) % In recent years, the Company has been successful in expanding its wealth management client base. Trust department fees continue to be a significant contributor to noninterest income. Assets under management decreased by$468.8 million in the second quarter of 2022 and decreased by$550.4 million sinceJune 30, 2021 due to market volatility. Income is generated primarily from fees charged based on assets under administration for corporate and personal trusts and for custodial services. The majority of the trust department fees are determined based on the value of the investments within the fully-managed trusts. Trust department fees decreased 12%, comparing the second quarter of 2022 to the same period of the prior year and they decreased 3% when comparing the first half of 2022 to the first half of 2021. The Company expects trust department fees to be negatively impacted during periods of significantly lower market valuations and positively impacted during periods of significantly higher market valuations. Investment advisory and management fees decreased 5%, comparing the second quarter of 2022 to the same period of the prior year and they increased 2% when comparing the first half of 2022 to the first half of 2021. Similar to trust department fees, investment advisory and management fees are largely determined based on the value of the investments managed. As a result, fee income from this line of business fluctuates with market valuations. 50 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
Deposit service fees increased 49% comparing the second quarter of 2022 to the same period of the prior year, and increased 30% when comparing the first half of 2022 to the first half of 2021. This increase was primarily due the GFED acquisition. The Company continues to emphasize shifting the mix of deposits from retail time deposits to non-maturity demand deposits across all its markets. With this continuing shift in mix, the Company has increased the number of demand deposit accounts, which tend to be lower in interest cost and higher in-service fees. The Company plans to continue this shift in mix and to further focus on growing deposit service fees. Gains on sales of residential real estate loans, net, decreased 32% when comparing the second quarter of 2022 to the same period of the prior year, and decreased 48% when comparing the first half of 2022 to the same period of the prior year. The decrease was primarily due to decreased residential real estate purchase and the refinancing of residential real estate loans with higher interest rates in 2022. The Company has grown its interest rate swap program significantly over the past several years. The Company's interest rate swap program consists of back-to-back interest rate swaps with two types of commercial borrowers: (1) traditional commercial loans of a certain minimum size and sophistication, and (2) LIHTC permanent loans. Most of the growth has been in the latter category as the Company has grown relationships with strong LIHTC developers with many years of experience. The LIHTC industry is strong and growing with an increased need for affordable housing. The interest rate swaps allow commercial borrowers to pay a fixed interest rate while the Company receives a variable interest rate as well as an upfront nonrefundable fee dependent upon the pricing. Swap fee income/capital markets revenue totaled$13.0 million for the second quarter of 2022, compared to$9.6 million for the second quarter of 2021. Swap fee income/capital markets revenue totaled$19.4 for the first half of 2022, compared to$23.1 million for the first half of 2021. Swap fee income relative to the increase in notional amount of the non-hedging interest rate swap contracts was 9.0% for the three months endedJune 30, 2022 and 12.0% for the same period of the prior year. Swap fee income relative to the increase in notional amount of the non-hedging interest rate swap contracts was 10.3% for the first half of 2022 as compared to 10.9% for the first half of 2021. The decrease in the ratio was primarily due to the steepening of the yield curve. In the traditional commercial portfolio, the pricing is more competitive and the duration is shorter as compared to the LIHTC permanent loans. The mix of loans with interest rate swaps continued to be heavily weighted towards LIHTC permanent loans. Future levels of swap fee income are dependent upon the needs of our traditional commercial and LIHTC borrowers, and the size of the related nonrefundable swap fee may fluctuate depending on the interest rate environment. There were no securities gains or losses for the three and six months endedJune 30, 2022 . Securities losses totaled$88 thousand for the three and six months endedJune 30, 2021 . Earnings on BOLI decreased 22% comparing the second quarter of 2022 to the second quarter of 2021 and decreased 25% comparing the first half of 2022 to the first half of 2021. There were no purchases of BOLI within the last 12 months. Notably, a portion of the Company's BOLI is variable rate whereby returns are determined by the performance of the equity markets. Management intends to continue to review its BOLI investments to be consistent with policy and regulatory limits in conjunction with the rest of its earning assets in an effort to maximize returns while minimizing risk. Debit card fees are the interchange fees paid on certain debit card customer transactions. Debit card fees increased 38% comparing the second quarter of 2022 to the second quarter of the prior year, and increased 22% comparing the first half of 2022 to the first half of 2021. The increase was primarily due to the GFED acquisition. The fees can vary based on customer debit card usage, so fluctuations from period to period may occur. As an opportunity to maximize fees, the Company offers a deposit product with a higher interest rate that incentivizes debit card activity. Correspondent banking fees decreased 9% comparing the second quarter of 2022 to the second quarter of the prior year, and decreased 11% comparing the first half of 2022 to the first half of 2021. These fees are generally included in the earnings credit rates which incent the correspondent bank to maintain higher levels of noninterest bearing deposits to offset the correspondent banking fees. Management will continue to evaluate earnings credit rates and the resulting impact on deposit balances and fees while balancing the ability to grow market share. Correspondent banking continues to be a core strategy for the Company, as this line of business provides a high level of deposits that can be used to
fund loan growth as 51 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
well as a steady source of fee income. The Company now serves approximately 189
banks in
Other noninterest income decreased 19% comparing the second quarter of 2022 to the first quarter of the prior year, and decreased 14% comparing the first half of 2022 to the first half of 2021. The decrease was primarily due to lower equity investment income and lower gains on disposal of leased assets.
NONINTEREST EXPENSE
The following tables set forth the various categories of noninterest expense for
the three and six months ended
Three Months Ended June 30, June 30, 2022 2021 $ Change % Change (dollars in thousands)
Salaries and employee benefits$ 29,972 $ 23,044 $ 6,928 30.1 % Occupancy and equipment expense 5,978 3,965 2,013 50.8 Professional and data processing fees 4,365 3,702 663 17.9 Acquisition costs 1,973 - 1,973 100.0 Post-acquisition compensation, transition and integration costs 4,796 - 4,796 100.0FDIC insurance, other insurance and regulatory fees 1,394 986 408 41.4 Loan/lease expense 761 457 304 66.5 Net cost of (income from) and gains/losses on operations of other real estate 59 (113)
172 (152.2) Advertising and marketing 1,198 853 345 40.4 Bank service charges 610 572 38 6.6
Correspondent banking expense 213 198
15 7.6 Intangibles amortization 787 508 279 54.9 Other 2,142 1,503 639 42.5 Total noninterest expense$ 54,248 $ 35,675 $ 18,573 52.1 % Six Months Ended June 30, June 30, 2022 2021 $ Change % Change (dollars in thousands)
Salaries and employee benefits$ 53,599 $ 47,891 $ 5,708 11.9 % Occupancy and equipment expense 9,915 8,073 1,842 22.8 Professional and data processing fees 8,036 7,145 891 12.5 Acquisition costs 3,824 - 3,824 100.0 Post-acquisition compensation, transition and integration costs 4,796 - 4,796 100.0 Disposition costs - 8 (8) (100.0)FDIC insurance, other insurance and regulatory fees 2,704 2,051 653 31.8 Loan/lease expense 1,028 757 271 35.8 Net cost of (income from) and gains/losses on operations of other real estate 58 (74)
132 (178.4) Advertising and marketing 1,959 1,480 479 32.4 Bank service charges 1,151 1,095 56 5.1 Correspondent banking expense 412 398 14 3.5 Intangibles amortization 1,280 1,016 264 26.0 Other 3,811 3,063 748 24.4 Total noninterest expense$ 92,573 $ 72,903 $ 19,670 27.0 % Management places a strong emphasis on overall cost containment and is committed to improving the Company's general efficiency. One-time charges relating to acquisitions and employment separation expenses impacted expense in 2022 and 2021. Salaries and employee benefits, which is the largest component of noninterest expense, increased from the second quarter of 2021 to the second quarter of 2022 by 30%, and increased from the first half of 2021 to the first half of 2022 by 12%. 52 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
The increased expense was primarily related to the GFED acquisition which resulted in an increase of 165 full-time equivalent employees.
Occupancy and equipment expense increased 51% comparing the second quarter of 2022 to the same period of the prior year, and increased 23% comparing the first half of 2022 to the first half of 2021. The increase was due to higher depreciation expense and computer hardware expense related to the GFED acquisition. Professional and data processing fees increased 18% comparing the second quarter of 2022 to the same period in 2021, and increased 13% comparing the first half of 2022 to the first half of 2021. Generally, professional and data processing fees can fluctuate depending on certain one-time project costs. Management will continue to focus on minimizing such one-time costs and driving recurring costs down through contract negotiation or managed reduction in activity where costs are determined on a usage basis. Acquisition costs totaled$2.0 million in the second quarter of 2022 and$3.8 million in the first half of 2022. There were no acquisition costs incurred in the three and six months of 2021. The acquisition costs, which were primarily legal, accounting and other professional fees, relate to the acquisition of GFED as discussed in Note 2 of the consolidated financial statements. Post-acquisition compensation, transition and integration costs totaled$4.8 million for the three and six months endedJune 30, 2022 . There were no post-acquisition compensation, transition and integration costs incurred in the three and six months of 2021. These costs were comprised primarily of personnel costs, IT integration and data conversion costs related to the acquisition of GFED. There were no disposition costs for the first six months of 2022, compared with$8 thousand for the first half of 2021. The disposition costs in 2021 were comprised primarily of legal, accounting and personnel costs related to the sale of the Bates Companies in the third quarter of 2020.FDIC insurance, other insurance and regulatory fee expense increased 41%, comparing the second quarter of 2022 to the second quarter of 2021, and increased 32% comparing the first half of 2022 to the first half of 2021. The increase in expense was due to the GFED acquisition as well as an increase in the asset size of the Company in 2022, which increased the Company's rates. Loan/lease expense increased 67% when comparing the second quarter of 2022 to the same quarter of 2021, and increased 36% comparing the first half of 2022 to the same period of the prior year. Generally, loan/lease expense has a direct relationship with the level of NPLs; however, it may deviate depending upon the individual NPLs. Net cost of (income from) and gains/losses on operations of other real estate includes gains/losses on the sale of OREO, write-downs of OREO and all income/expenses associated with OREO. Net cost of and gains/losses on operations of other real estate totaled$59 thousand for the second quarter of 2022, compared to net income from and gains/losses on operations of other real estate of$113 thousand for the second quarter of 2021. Net cost of and gains/losses on operations of other real estate totaled$58 thousand for the first half of 2022, compared to net income from and gains/losses on operations of other real estate of$74 thousand for the first half of 2021. Advertising and marketing expense increased 40% comparing the second quarter of 2022 to the second quarter of 2021, and increased 32% comparing the first half of 2022 to the first half of 2021. The increase in expense was primarily due to the return to more normal operations during the second half of 2021 and first half of 2022 in response to improvements in the general economic environment tied to COVID-19 as compared to the first half of 2021. Bank service charges, a large portion of which includes indirect costs incurred to provide services to QCBT's correspondent banking customer portfolio, increased 7% when comparing the second quarter of 2022 to the same quarter of 2021, and increased 5% when comparing the first half of 2022 to the same period of 2021. As transaction volumes continue to increase and the number of correspondent banking clients increases, the associated expenses are expected to also increase. 53 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Correspondent banking expense increased 8% when comparing the second quarter of 2022 to the second quarter of 2021, and increased 4% when comparing the first half of 2022 to the same period of the prior year. These are direct costs incurred to provide services to QCBT's correspondent banking customer portfolio, including safekeeping and cash management services. Intangibles amortization expense increased 55% when comparing the second quarter of 2022 to the same quarter of 2021 and increased 26% when comparing the first half of 2022 to the same period of the prior year. The increase is due to the GFED acquisition. These expenses will naturally decrease as intangibles become fully amortized unless there is an addition to intangible assets. Other noninterest expense increased 43% when comparing the second quarter of 2022 to the second quarter of 2021 and increased 24% when comparing the first half of 2022 to the same period of the prior year primarily due to increased travel and debit card processing expenses. Also included in other noninterest expense are other items such as subscriptions, sales and use tax and expenses related to wealth management.
INCOME TAXES
In the second quarter of 2022, the Company incurred income tax expense of$1.5 million . During the first half of the year, the Company incurred income tax expense of$3.8 million . Following is a reconciliation of the expected income tax expense to the income tax expense included in the consolidated statements of income for the three and six months endedJune 30, 2022 and 2021. For the Three Months Ended June 30, For the Six Months Ended June 30, 2022 2021 2022 2021 % of % of % of % of Pretax Pretax Pretax Pretax Amount Income Amount Income Amount Income Amount Income (dollars in thousands) Computed "expected" tax expense$ 3,514 21.0 %$ 5,699 21.0 %$ 8,965 21.0 %$ 10,219 21.0 % Tax exempt income, net (2,476) (14.8) (1,802) (6.6) (4,698) (11.0) (3,521) (7.2) Bank-owned life insurance (73) (0.4) (95) (0.4) (146) (0.3) (194) (0.4) State income taxes, net of federal benefit, current year 982 5.9 1,247 4.6 2,273 5.3 2,271 4.7 Provision adjustment from accounting method change - - - - (1,181) (2.8) - - Tax credits (289) (1.7) (57) (0.2) (531) (1.2) (114) (0.2) Income from tax credit equity investments 158 0.9 - - (143) (0.3) - - Acquisition costs 242 1.4 - - 372 0.9 - - Excess tax benefit on stock options exercised and restricted stock awards vested (40) (0.2) (40) (0.1) (474) (1.1) (204) (0.4) Other (526) (3.2) (164) (0.7) (612) (1.5) (128) (0.3) Federal and state income tax expense$ 1,492 8.9 %$ 4,788 17.6 %$ 3,825 9.0 %$ 8,329 17.2 %
The effective tax rate for the quarter endedJune 30, 2022 was 8.9%, which was a decrease from the effective tax rate of 17.6% for the quarter endedJune 30, 2021 . The effective tax rate for the six months endedJune 30, 2022 was 9.0%, which was a decrease from the effective tax rate of 17.2% for the six months endedJune 30, 2021 . The decrease was primarily due to:
? Reduced pre-tax income due to elevated non-recurring costs related to the GFED
acquisition;
? Increased tax-exempt income;
? Provision adjustment of
? Excess tax benefit on stock compensation in the first quarter of 2022. 54 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
FINANCIAL CONDITION
Following is a table that represents the major categories of the Company's balance sheet. As of June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 (dollars in thousands) Amount % Amount % Amount % Amount % Cash, federal funds sold, and interest-bearing deposits$ 148,911 2 %$ 116,930
2 %$ 125,152 2 %$ 144,378 2 % Securities 879,918 12 % 823,311 13 % 810,215 13 % 810,445 14 % Net loans/leases 5,705,478 77 % 4,753,082 77 % 4,601,411 75 % 4,338,811 75 % Derivatives 97,455 1 % 107,326 2 % 222,220 4 % 193,395 3 % Other assets 561,179 8 % 375,170 6 % 337,134 6 % 340,383 6 % Total assets$ 7,392,941 100 %$ 6,175,819 100 %$ 6,096,132 100 %$ 5,827,412 100 % Total deposits$ 5,820,657 78 %$ 4,839,689 78 %$ 4,922,772 80 %$ 4,688,935 80 % Total borrowings 583,166 8 % 443,270 7 % 170,805 3 % 198,908 3 % Derivatives 113,305 2 % 116,193 2 % 225,135 4 % 196,092 3 % Other liabilities 132,675 2 % 108,743 2 % 100,410 2 % 113,001 2 %
Total stockholders' equity 743,138 10 % 667,924
11 % 677,010 11 % 630,476 11 % Total liabilities and stockholders' equity$ 7,392,941 100 %$ 6,175,819 100 %$ 6,096,132 100 %$ 5,827,412 100 % During the second quarter of 2022, the Company's total assets increased$1.2 billion , or 20% fromMarch 31, 2022 , to a total of$7.4 billion . The Company's net loans/leases increased$952.4 million in the second quarter of 2022. Total deposits increased$981.0 million in the second quarter of 2022. Borrowings increased$139.9 million in the second quarter of 2022. These increases were primarily due to the GFED acquisition. At the acquisition date, GFED had$1.2 billion in assets,$801.7 million in net loans/leases,$1.1 billion in deposits and$45.9 million in borrowings.
INVESTMENT SECURITIES
The composition of the Company's securities portfolio is managed to meet liquidity needs while prioritizing the impact on interest rate risk, maximizing return and minimizing credit risk. Over the years, the Company has further diversified the portfolio by decreasingU.S government sponsored agency securities and increasing residential mortgage-backed and related securities and tax-exempt municipal securities. Of the latter, the majority are privately placed tax-exempt debt issuances by municipalities located in the Midwest (with some in or near the Company's existing markets) and require a thorough underwriting process before investment and are generated by our specialty finance group.
Following is a breakdown of the Company's securities portfolio by type, the percentage of unrealized gains (losses) to carrying value, net of allowance for credit losses, on the total portfolio, and the portfolio duration:
As of June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 Amount % Amount % Amount % Amount % (dollars in thousands)U.S. treasuries and govt. sponsored agency securities$ 20,448 2 %$ 21,380 3 %$ 23,328 3 %$ 14,670 2 % Municipal securities 710,440 82 % 667,048 81 % 639,601 79 % 641,430 79 % Residential mortgage-backed and related securities 81,247 9 % 86,380 10 % 94,323 12 % 106,138 13 % Asset-backed securities 19,956 2 % 23,232 3 % 27,124 3 % 31,779 4 % Other securities 47,827 5 % 25,271 3 % 25,839 3 % 16,428 2 %$ 879,918 100 %$ 823,311 100 %$ 810,215 100 %$ 810,445 100 % Securities as a % of total assets 11.90 % 13.33 % 13.29 % 13.96 % Net unrealized gains (losses) as a % of Amortized Cost (6.12) % (1.63) % 7.17 % 7.63 % Duration (in years) 7.8 7.9 8.2 8.1 Yield on investment securities (tax equivalent) 3.91 % 3.83 % 3.66 % 3.66 % 55 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Due to the sharp increase in intermediate and long-term interest rates during the six months endedJune 30, 2022 , the valuation of the Company's AFS portfolio declined significantly. As a result, the Company's net unrealized gain as a percentage of amortized cost changed from 7.17% as ofDecember 31, 2021 to a net unrealized loss as a percentage of amortized cost of -6.12% as ofJune 30, 2022 .
The Company has not invested in non-agency commercial or residential mortgage-backed securities or pooled trust preferred securities.
See Note 3 to the Consolidated Financial Statements for additional information regarding the Company's investment securities.
LOANS/LEASES
Total loans/leases, excluding acquired and PPP loans (non-GAAP), grew 14.0% on an annualized basis during the first half of 2022. The mix of the loan/lease types within the Company's loan/lease portfolio is presented in the following tables. As of June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 Amount % Amount % Amount % Amount % (dollars in thousands) C&I - revolving$ 322,258 5 %$ 263,441 5 %$ 248,483 5 %$ 182,882 4 % C&I - other * 1,403,689 24 % 1,374,221 28 1,346,602 29 1,505,384 34
CRE - owner occupied 628,565 11 % 439,257 9 421,701 9 427,734 10 CRE - non-owner occupied 889,530 15 % 679,898 14 646,500 14 618,879 14 Construction and land development 1,080,372 19 % 863,116 18 918,571 20 708,289 16 Multi-family 860,742 15 % 711,682 15 600,412 12 466,804 10 Direct financing leases 40,050 1 % 43,330 1 45,191 1 56,153 1 1-4 family real estate 473,141 8 % 379,613 8 377,361 8 382,142 9 Consumer 99,556 2 % 73,310 2 75,311 2 69,438 2
Total loans/leases
$ 4,680,132 100 %$ 4,417,705 100 % Less allowance (92,425) (74,786) (78,721) (78,894) Net loans/leases$ 5,705,478 $ 4,753,082 $ 4,601,411 $ 4,338,811
*Includes PPP loans totaling
As CRE loans have historically been the Company's largest portfolio segment, management places a strong emphasis on monitoring the composition of the Company's CRE loan portfolio. For example, management tracks the level of owner-occupied CRE loans relative to non-owner-occupied loans because owner-occupied loans are generally considered to have less risk. As ofJune 30, 2022 andMarch 31, 2022 , approximately 18% and 22% of the CRE loan portfolio was owner-occupied, respectively. Following is a listing of significant industries within the Company's CRE loan portfolio. These include loans in the following portfolio segments as ofJune 30, 2022 : CRE owner occupied, CRE non-owner occupied, certain construction and land development, multifamily and certain 1-4 family real estate. As of June 30, As of March 31, As of December 31, As of June 30, 2022 2022 2021 2021 Amount % Amount % Amount % Amount % (dollars in thousands)
Lessors of Residential Buildings
50 %
20 % 557,859 21 % 557,786 24 % Hotels 124,503 4 % 71,448 3 % 73,639 3 % 75,850 3 % Lessors of Other Real Estate Property 64,211 2 % 63,759 2 % 60,605 2 % 41,707 2 % New Housing For-Sale Builders 60,826 2 % 71,285
3 % 61,028 2 % 56,143 2 % Other * 972,870 28 % 620,129 22 % 611,291 23 % 593,568 25 % Total CRE Loans$ 3,442,304 100 %$ 2,789,006 100 %$ 2,681,273 100 %$ 2,327,956 100 % * "Other" consists of all other industries. None of these had concentrations greater than$49.4 million , or approximately 1.4% of total CRE loans in the most recent period presented. 56 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued The Company's construction and land development loan portfolio includes the following: As of June 30, 2022 March
31, 2022
Amount % Amount % Amount % Amount % (dollars in thousands) LIHTC$ 641,460 59 % $
556,717 65 %
256,622 24 245,927 28 274,385 30 243,848 34 Construction (residential) 107,798 10 17,327 2 15,244 2 12,945 2 Land development 74,492 7 43,145 5 41,791 5 41,030 6
Total construction and land development
The Company's 1-4 family real estate loan portfolio includes the following:
Certain loans that do not meet the criteria for sale into the secondary market.
? These are often structured as adjustable rate mortgages with maturities ranging
from three to seven years to avoid long-term interest rate risk.
? A limited amount of 15-year, 20-year and 30-year fixed rate residential real
estate loans that meet certain credit guidelines.
The remaining 1-4 family real estate loans originated by the Company were sold on the secondary market to avoid the interest rate risk associated with longer term fixed rate loans. Loans originated for this purpose were classified as held for sale and are included in the residential real estate loans above. The Company has not originated any subprime, Alt-A, no documentation, or stated income residential real estate loans throughout its history.
Following is a listing of significant equipment types within the m2 loan and lease portfolio:
As of June 30, As of March 31, As of December 31, As of June 30, 2022 2022 2021 2021 Amount % Amount % Amount % Amount % (dollars in thousands) Trucks, Vans and Vocational Vehicles$ 69,383 24 %$ 70,241 25 %$ 69,392 26 %$ 65,063 25 % Trailers 19,723 7 % 15,702 6 % 12,832 5 % 10,715 4 % Manufacturing - General 17,524 6 % 17,350 6 % 17,320 6 % 18,474 7 % Freightliners 17,471 6 % 14,224 5 % 10,386 4 % 3,853 2 % Tractor 15,255 5 % 12,858 4 % 10,508 4 % 8,478 3 %
Marine - Travelifts 14,825 5 % 15,513 5 %
14,498 5 % 13,279 5 % Construction - General 14,279 5 % 13,851 5 % 13,560 5 % 12,918 5 % Food Processing Equipment 13,946 5 % 14,846 5 % 14,907 6 % 14,569 6 % Computer Hardware 9,682 3 % 10,792 4 % 11,223 4 % 12,745 5 % Other * 101,347 34 % 100,493 35 %
95,648 35 % 98,426 38 % Total m2 loans and leases
$ 293,435 100 %$ 285,870 100 %
* "Other" consists of all other equipment types. None of these had concentrations greater than 3% of total m2 loan and lease portfolio in the most recent period presented.
See Note 4 to the Consolidated Financial Statements for additional information regarding the Company's loan and lease portfolio.
ALLOWANCE FOR CREDIT LOSSES ON LOANS/LEASES AND OFF-BALANCE SHEET EXPOSURES
The adequacy of the ACL was determined by management based on factors that included the overall composition of the loan/lease portfolio, types of loans/leases, historical loss experience, loan/lease delinquencies, potential substandard and doubtful credits, economic conditions, collateral positions, government guarantees and other factors that, in management's judgment, deserved evaluation. To ensure that an adequate ACL was maintained, provisions were made based on a number of factors, including the increase in loans/leases and a detailed analysis of the loan/lease portfolio. The loan/lease portfolio is reviewed and analyzed quarterly with specific detailed reviews completed on all credits risk-rated less than "fair quality", as described in Note 1 to the Consolidated Financial Statements contained in the Company's Annual Report
on 57 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Form 10-K for the year endedDecember 31, 2021 , and carrying aggregate exposure in excess of$250 thousand . The adequacy of the allowance is monitored by the credit administration staff and reported to management and the board of directors.
Changes in the ACL for loans/leases for the three and six months ended
Three Months Ended Six Months Ended June 30, 2022 June 30, 2021 June 30, 2022 June 30, 2021 (dollars in thousands) (dollars in thousands) Balance, beginning$ 74,786 $ 81,831 $ 78,721 $ 84,376 Impact of adopting ASU 2016-13 - - - (8,102) Initial ACL recorded for acquired PCD loans 5,902 - 5,902 - Provision 12,141 (141) 8,292 5,852 Charge-offs (620) (3,674) (1,076) (4,387) Recoveries 216 878 586 1,155 Balance, ending$ 92,425 $ 78,894 $ 92,425 $ 78,894
Changes in the ACL for OBS exposures for the three and six months ended
Three Months Ended
Six Months Ended
June 30, 2022 June 30, 2021
(dollars in thousands) (dollars in thousands) Balance, beginning $ 7,819 $ 9,846 $ 6,886 $ -
Impact of adopting ASU 2016-13 - - - 9,117 Provisions (credited) to expense (941) 141
(8) 870 Balance, ending $ 6,878 $ 9,987 $ 6,878 $ 9,987
The Company recorded a
The Company's levels of criticized and classified loans are reported in the following table.
As of Internally Assigned Risk Rating * June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 (dollars in thousands) Special Mention (Rating 6)$ 54,558 $ 63,622 $ 62,510$ 51,613 Substandard (Rating 7) 83,048 54,491 53,296 79,719 Doubtful (Rating 8) - - - -$ 137,606 $ 118,113 $ 115,806$ 131,332 Criticized Loans **$ 137,606 $ 118,113 $ 115,806$ 131,332 Classified Loans ***$ 83,048 $ 54,491 $ 53,296$ 79,719 Criticized Loans as a % of Total Loans/Leases 2.37 % 2.45 % 2.47 % 2.97 % Classified Loans as a % of Total Loans/Leases 1.43 % 1.13 % 1.14 % 1.80 % * Amounts above include the government guaranteed portion, if any. For the calculation of ACL, the Company assigns internal risk ratings of Pass (Rating 2) for the government guaranteed portion.
** Criticized loans are defined as non homogeneous loans with internally assigned risk ratings of 6, 7, or 8, regardless of performance.
*** Classified loans are defined as non homogeneous loans with internally assigned risk ratings of 7 or 8, regardless of performance.
58 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Criticized loans increased 17% and classified loans increased 52% fromMarch 31, 2022 toJune 30, 2022 which was primarily the result of the GFED acquisition. The Company continues its strong focus on improving credit quality in an effort to limit NPLs. As of June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 ACL on loans/leases / Gross loans/leases 1.59 % 1.55 % 1.68 % 1.79 % ACL on loans/leases / NPLs 387.66 % 2,721.47 % 2,825.21 % 952.02 % Although management believes that the ACL atJune 30, 2022 was at a level adequate to absorb losses on existing loans/leases, there can be no assurance that such losses will not exceed the estimated amounts or that the Company will not be required to make additional provisions in the future. Unpredictable future events could adversely affect cash flows for both commercial and individual borrowers, which could cause the Company to experience increases in problem assets, delinquencies and losses on loans/leases, and require further increases in the provision for credit losses. Asset quality is a priority for the Company and its subsidiaries. The ability to grow profitably is in part dependent upon the ability to maintain that quality. The Company continually focuses efforts at its subsidiary banks and leasing company with the intention to improve the overall quality of the Company's loan/lease portfolio.
See Note 4 to the Consolidated Financial Statements for additional information regarding the Company's ACL.
NONPERFORMING ASSETS
The table below presents the amount of NPAs and related ratios.
As of June 30, As of March 31, As of December 31, As of June 30, 2022 2022 2021 2021 (dollars in thousands) Nonaccrual loans/leases (1) $ 23,574 $ 2,744 $ 2,759 $ 8,230 Accruing loans/leases past due 90 days or more 268 4 1 57 Total NPLs 23,842 2,748 2,760 8,287 OREO 205 - - 1,820 Total NPAs $ 24,047 $ 2,748 $ 2,760 $ 10,107
NPLs to total loans/leases 0.41 % 0.06 % 0.06 % 0.19 % NPAs to total loans/leases plus repossessed property 0.41 % 0.06 % 0.06 % 0.23 % NPAs to total assets 0.33 % 0.04 % 0.05 % 0.17 % Nonaccrual loans/leases to total loans/leases 0.41 % 0.06 % 0.06 % 0.19 % ACL to nonaccrual loans 392.06 % 2,725.44 % 2,853.24 % 994.30 %
(1) Includes government guaranteed portion of loans, as applicable.
NPAs atJune 30, 2022 were$24.0 million , up$21.3 million fromMarch 31, 2022 and up$13.9 million fromJune 30, 2021 . The increase was primarily the result of the GFED acquisition and two specific legacy relationships from other charters. The ratio of NPAs to total assets was 0.33% atJune 30, 2022 , up from 0.04% atMarch 31, 2022 , and up from 0.17% atJune 30, 2021 .
The majority of the NPAs consist of nonaccrual loans/leases. For nonaccrual loans/leases, management has thoroughly reviewed these loans/leases and has provided specific allowances as appropriate.
OREO is carried at the lower of carrying amount or fair value less costs to sell.
The Company's lending/leasing practices remain unchanged and asset quality remains a priority for management.
59 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
DEPOSITS
Deposits increased
The table below presents the composition of the Company's deposit portfolio. As of June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 Amount % Amount % Amount % Amount % (dollars in thousands) Noninterest bearing demand deposits$ 1,514,005 26 %$ 1,275,493 26 %$ 1,268,788 26 %$ 1,258,885 27 % Interest bearing demand deposits 3,758,566 65 % 3,181,685 66 % 3,232,633 65 % 2,976,696 63 % Time deposits 540,074 9 % 382,268 8 % 421,348 9 % 452,171 10 % Brokered deposits 8,012 0 % 243 0 % 3 0 % 1,183 0 %$ 5,820,657 100 %$ 4,839,689 100 %$ 4,922,772 100 %$ 4,688,935 100 %
The Company has been successful in growing its noninterest-bearing deposit portfolio over the past several years, growing average balances 21% in 2021.
Balances can fluctuate a great deal due to large customer and correspondent bank activity. During the past year, the Company had significant core deposit growth mostly from its correspondent banking clients. As a result of strong core deposit growth, the Company reduced its reliance on higher cost CDs and brokered deposits.
The Company's correspondent bank deposit portfolio and funds managed consists of the following:
? Noninterest-bearing deposits which represent the correspondent banks' operating
cash used for processing transactions with the
? Money market deposits which represent some excess liquidity, and
? The correspondent banks' EBA at the FRB.
The Company has modified the structure and interest rates paid for those correspondent bank deposits on the balance sheet which are the noninterest-bearing deposits and the money market deposits. This has led to more of the correspondent bank portfolio's excess liquidity to shift to the EBAs at the FRB which is managed by the Company, but is off the Company's balance sheet. On average, over the past two years, the correspondent banks' EBA portfolio ranged from$1.3 billion to$1.5 billion which is approximately$1 billion more than pre-pandemic levels. Management will continue to focus on growing its core deposit portfolio, including its correspondent banking business at QCBT, as well as shifting the mix from brokered and other higher cost deposits to lower cost core deposits. With the significant success achieved by QCBT in growing its correspondent banking business, QCBT has developed procedures to proactively monitor this industry concentration of deposits and loans. Other deposit-related industry concentrations and large accounts are monitored by the internal asset liability management committees. 60 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
BORROWINGS
The subsidiary banks purchase federal funds for short-term funding needs from the FRB or from their correspondent banks. The table below presents the composition of the Company's short-term borrowings.
As of June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 (dollars in thousands) Federal funds purchased $ 1,070 $ 1,190 $ 3,800 $ 7,070
The Company's federal funds purchased fluctuate based on the short-term funding needs of the Company's subsidiary banks.
As a result of their memberships in the FHLB ofDes Moines , the subsidiary banks have the ability to borrow funds for short or long-term purposes under a variety of programs. The subsidiary banks can utilize FHLB advances for loan matching as a hedge against the possibility of changing interest rates and when these advances provide a less costly or more readily available source of funds than customer deposits.
The table below presents the Company's overnight FHLB advances. The Company did not have any term FHLB advances for the dates in the table below.
As of June 30, 2022 March 31, 2022 December 31, 2021 June 30, 2021 (dollars in thousands) Overnight FHLB advances$ 400,000 $ 290,000 $ 15,000$ 40,000 FHLB advances (all overnight) increased$110.0 million in the current quarter compared to the prior quarter due to strong loan growth and a decrease in core deposits when excluding the GFED acquisition.
The Company renewed its revolving credit note in the second quarter of 2022. At
renewal, the line amount was increased from
Interest on the revolving line of credit was calculated at the greater of: (a) the effective Prime Rate less 0.50% and (b) 3.00% per annum. The collateral on the revolving line of credit is 100% of the outstanding stock of the Company's bank subsidiaries. There was no outstanding balance on the revolving line of credit atJune 30, 2022 . The Company had subordinated notes totaling$133.6 million as ofJune 30, 2022 and$113.9 million as ofMarch 31, 2022 . The Company acquired$19.6 million of subordinated notes with the GFED acquisition. The Company prepaid$5.0 million in subordinated debt in the second quarter of 2021 with no gain/loss.
The Company acquired
It is management's intention to reduce its reliance on wholesale funding, including FHLB advances and brokered deposits. Replacement of this funding with core deposits helps to reduce interest expense as wholesale funding tends to be higher cost. However, the Company may choose to utilize advances and/or brokered deposits to supplement funding needs, as this is a way for the Company to effectively and efficiently manage interest rate risk. 61 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
The table below presents the maturity schedule including weighted average interest cost for the Company's combined wholesale funding portfolio (defined as FHLB advances and brokered deposits).
June 30, 2022 December 31, 2021 Weighted Weighted Average Average Maturity: Amount Due Interest Rate Amount Due Interest Rate (dollars in thousands) Year endingDecember 31 : 2022$ 408,012 1.73 %$ 15,003 0.31 % 2023 - - - - 2024 - - - - 2025 - - - - Total Wholesale Funding$ 408,012 1.73 %$ 15,003 0.31 %
During the first six months of 2022, wholesale funding, primarily overnight FHLB
advances, increased
STOCKHOLDERS' EQUITY
The table below presents the composition of the Company's stockholders' equity. As ofJune 30, 2022 March 31 ,
2022
(dollars in thousands)
Common stock$ 17,064 $ 15,580 $ 15,613$ 15,764 Additional paid in capital 375,358 272,370 273,768 275,485 Retained earnings 400,790 405,762 386,077 335,424 AOCI (50,074) (25,788) 1,552 3,803 Total stockholders' equity$ 743,138 $ 667,924 $ 677,010$ 630,476 TCE / TA ratio (non-GAAP) 8.11 % 9.60 % 9.87 % 9.51 %
* TCE is defined as total common stockholders' equity excluding goodwill and other intangibles. This ratio is a non-GAAP financial measure. See GAAP to Non-GAAP Reconciliations.
Due to the sharp increase in intermediate and long-term interest rates, the valuation of the Company's AFS securities portfolio and certain hedged financial instruments declined significantly. The valuation change, net of taxes, that flows through the Company's AOCI was a net decline of$51.6 million for the first half of 2022. OnFebruary 13, 2020 , the board of directors of the Company approved a share repurchase program under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, up to 800,000 shares of its outstanding common stock, or approximately 5% of the outstanding shares as ofDecember 31, 2019 . As ofJune 30, 2022 , the Company had purchased 794,085 shares under the program and all shares purchased have been retired. OnMay 19, 2022 , the board of directors of the Company approved a share repurchase program under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, up to 1,500,000 shares of its outstanding common stock, or approximately 10% of the outstanding shares as ofDecember 31, 2021 . As ofJune 30, 2022 , the Company had purchased 280,000 shares under the program and all shares purchased have been retired. 62 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
LIQUIDITY AND CAPITAL RESOURCES
Liquidity measures the ability of the Company to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers' credit needs. The Company monitors liquidity risk through contingency planning stress testing on a regular basis. The Company seeks to avoid over-concentration of funding sources and to establish and maintain contingent funding facilities that can be drawn upon if normal funding sources become unavailable. One source of liquidity is cash and short-term assets, such as interest-bearing deposits in other banks and federal funds sold, which averaged$73.2 million during the second quarter of 2022 and$73.5 million during the first six months of 2022. The Company's on balance sheet liquidity position can fluctuate based on short-term activity in deposits and loans. The subsidiary banks have a variety of sources of short-term liquidity available to them, including federal funds purchased from correspondent banks, FHLB advances, wholesale structured repurchase agreements, brokered deposits, lines of credit, borrowing at the Federal Reserve Discount Window, sales of securities AFS, and loan/lease participations or sales. The Company also generates liquidity from the regular principal payments and prepayments made on its loan/lease portfolio, and on the regular monthly payments on its securities portfolio. AtJune 30, 2022 , the subsidiary banks had 28 lines of credit totaling$485.9 million , of which$15.1 million was secured and$470.8 million was unsecured. AtJune 30, 2022 , the full$485.9 million was available.
At
The Company has emphasized growing the number and amount of lines of credit in an effort to strengthen this contingent source of liquidity. Additionally, the Company maintains a$50.0 million secured revolving credit note with a variable interest rate and a maturity ofJune 30, 2023 . AtJune 30, 2022 , the full$50.0 million was available. As ofJune 30, 2022 , the Company had$608.6 million in average correspondent banking deposits spread over 189 relationships. While the Company believes that these funds are relatively stable, there is the potential for large fluctuations that can impact liquidity. Seasonality and the liquidity needs of these correspondent banks can impact balances. Management closely monitors these fluctuations and runs stress scenarios to measure the impact on liquidity and interest rate risk with various levels of correspondent deposit run-off. Investing activities used cash of$146.8 million during the first six months of 2022, compared to$143.4 million for the same period of 2021. The net decrease in interest-bearing deposits at financial institutions was$38.0 million for the first six months of 2022, compared to a net increase of$844 thousand for the same period of 2021. Proceeds from calls, maturities, and paydowns of securities were$42.3 million for the first six months of 2022, compared to$110.9 million for the same period of 2021. Purchases of securities used cash of$134.7 million for the first six months of 2022, compared to$108.6 million for the same period of 2021. Proceeds from sales of securities were$111.4 million for the first six months of 2022, compared to$23.9 million for the first six months of 2021.
The net increase in loans/leases used cash of
Financing activities provided cash of$148.1 million for the first six months of 2022, compared to$104.9 million for same period of 2021. Net decreases in deposits totaled$178.7 million for the first six months of 2022, compared to net increases in deposits of$89.8 million for the same period of 2021. During the first six months of 2022, the Company's short-term borrowings increased$2.7 million , compared to a decrease in short-term borrowings of$1.6 million for the same period of 2021. There were no long-term FHLB advances during the first six months of 2022 and 2021. There were no maturities and principal payments on FHLB term advances in the first six months of 2022 and 2021. Net increase in overnight advances totaled$385.0 million for the first six months of 2022.
In
the first six months of 2021, the Company increased overnight FHLB advances by$25.0 million . Prepayment of subordinated notes totaled$5.0 million during the first six months of 2021. Repurchase and cancellation of shares totaled$37.4 million in the first six months of 2022, as compared to$4.8 million in the first six months of 2021. 63 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
Total cash provided by operating activities was
Throughout its history, the Company has secured additional capital through various sources, including the issuance of common and preferred stock, as well as trust preferred securities and, most recently, subordinated notes.
The Company (on a consolidated basis) and the subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and subsidiary banks' financial statements. Refer to Note 10 of the Consolidated Financial Statements for additional information regarding regulatory capital.
SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "bode," "predict," "suggest," "project," "appear," "plan," "intend," "estimate," "may," "will," "would," "could," "should," "likely," or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:
? The strength of the local, state, and national and international economies
(including effects of inflationary pressures and supply chain constraints).
The economic impact of any future terrorist threats and attacks, widespread
disease or pandemics (including the COVID-19 pandemic in
? acts of war or threats thereof and other adverse external events that could
cause economic deterioration or instability in credit markets, and the response
of the local, state and national governments to any such adverse external
events.
? Changes in accounting policies and practices, as may be adopted by state and
federal regulatory agencies, the FASB, the
? Changes in state and federal laws, regulations and governmental policies
concerning the Company's general business.
? Changes in the interest rates and prepayment rates of the Company's assets
(including the impact of LIBOR phase-out).
? Increased competition in the financial services sector and the inability to
attract new customers.
? Changes in technology and the ability to develop and maintain secure and
reliable electronic systems.
Unexpected results of acquisitions which may include failure to realize the
? anticipated benefits of acquisitions and the possibility that transaction costs
may be greater than anticipated.
? The loss of key executives or employees.
? Changes in consumer spending.
64 Table of Contents Part I Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
? Unexpected outcomes of existing or new litigation involving the Company.
? The economic impact of exceptional weather occurrences such as tornadoes,
floods and blizzards.
? The ability of the Company to manage the risks associated with the foregoing as
well as anticipated.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. For a discussion of the factors that could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries, see the "Risk Factors" section included under Item 1A of Part I of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 . 65 Table of Contents Part I Item 3
© Edgar Online, source