FIRST INTERSTATE BANCSYSTEM INC (FIBK) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K for the year ended December 31, 2023. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. All of such forward-looking statements are expressly qualified by reference to the cautionary statements provided under the caption “Cautionary Note Regarding Forward-Looking Statements” included on page 1 in Part I of this report. Furthermore, a number of known and unknown factors may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. Therefore, you are encouraged to read in its entirety the information provided under the caption “Risk Factors” included under Item 1A in Part I of this report for a discussion of risk factors that may negatively impact our expected results, performance, or achievements discussed below.

Non-GAAP Financial Measures

In addition to financial measures presented in accordance with GAAP, this document contains GAAP financial measures and non-GAAP financial measures where management believes it to be helpful in understanding our results of operations or financial position. Where non-GAAP financial measures are used, the comparable GAAP financial measure, as well as the reconciliation to the comparable GAAP financial measure, can be found herein.

Fully-Taxable Equivalent Basis. Interest income, yields, and ratios on an FTE basis are considered non-GAAP financial measures. Management believes net interest income on an FTE basis provides an insightful picture of the interest margin for comparison purposes. The FTE basis also allows management to assess the comparability of revenue arising from both taxable and tax-exempt sources. The FTE basis assumes a federal statutory tax rate of 21 percent. We encourage readers to consider the Consolidated Financial Statements and other financial information contained in this Form 10-K in their entirety, and not to rely on any single financial measure.

Executive Overview

We are a financial and bank holding company headquartered in Billings, Montana. As of December 31, 2023, we had consolidated assets of $30.7 billion, deposits of $23.3 billion, loans held for investment of $18.3 billion, and total stockholders’ equity of $3.2 billion.

As of December 31, 2023, we had 304 banking offices in operation, including branches and detached drive-up facilities, in communities across Arizona, Colorado, Idaho, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, North Dakota, Oregon, South Dakota, Washington, and Wyoming. Through our bank subsidiary, FIB, we deliver a comprehensive range of banking products and services—including online and mobile banking—to individuals, businesses, governmental entities, and others throughout our market areas. Our clients participate in a wide variety of industries, including:

Our Business

Our principal business activity is lending to, accepting deposits from, and conducting financial transactions for individuals, businesses, governmental entities, and other entities located in the communities we serve. We derive our income principally from interest charged on loans and, to a lesser extent, from interest and dividends earned on fixed income investments. We also derive income from non-interest sources such as: (i) fees received in connection with various lending and deposit services; (ii) wealth management services, such as trust, employee benefit, investment, and insurance services; (iii) mortgage loan originations, sales, and servicing; (iv) merchant and electronic banking services; and (v) from time-to-time, gains on sales of assets and securities.

Our principal expenses include: (i) interest expense on deposit accounts and other borrowings; (ii) salaries and employee benefits; (iii) furniture, equipment, and occupancy expenses for maintaining our facilities; (iv) data processing and communication costs primarily associated with maintaining loan and deposit functions; (v) professional fees, including FDIC insurance assessments; (vi) income tax expense; (vii) provisions for credit losses; (viii) intangible amortization; (ix) other real estate owned expenses; and (x) other ancillary expenses including legal expenses, credit card rewards expense, fees associated with originating and closing loans, insurance, and other expenses necessary to support our employees and service our clients. From time to time, we also incur acquisition costs related to our strategic acquisitions.

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Our loan portfolio consists of a mix of real estate, consumer, commercial, agricultural, and other loans, including fixed and variable rate loans. Our real estate loans comprise commercial real estate, construction (including residential, commercial, and land development construction loans), residential, agricultural, and other real estate loans. Fluctuations in the loan portfolio are directly related to the economies of the communities we serve. While each loan we originate must meet minimum underwriting standards we establish through our credit policies, our bankers are granted limited discretion to approve and price loans within pre-approved limits which assures that we are responsive to community needs in each market area and remain competitive. We fund our loan portfolio primarily with the core deposits from our clients and cash flows off of the investment portfolio. We generally do not rely on brokered deposits to fund our loans and rely to a limited extent on wholesale funding sources. For additional information about our underwriting standards and loan approval process, see “Business—Lending Activities,” included in Part I, Item 1 of this report.

Recent Trends and Developments

Acquisitions

During the past few years, we have increased our community banking footprint across the Rocky Mountain and Pacific Northwest regions and have expanded into the Midwest and Southwest regions, in large part due to our acquisition activity. As part of our overall growth strategy, we will continue to evaluate bank acquisitions and other opportunities in a strategic thoughtful manner that we believe will enhance our franchise and provide greater shareholder value.

During 2022, we acquired Great Western Bancorp, Inc., the parent company of GWB, a Sioux Falls, South Dakota based community bank, for total consideration of $1,723.3 million, consisting of the issuance of 46.9 million shares of the Company’s Class A common stock valued at $36.76 per share. The merger was completed on February 1, 2022 and the core systems were converted in May 2022, at which point GWB’s operations were integrated with the Company’s operations. The acquisition of GWB’s 174 banking offices across Arizona, Colorado, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota expanded the Company’s geographical footprint. The accompanying consolidated statements of income for the period ended December 31, 2023, include the results of operations of the acquired entity from the February 1, 2022 acquisition date.

Common Stock

On March 25, 2022, all outstanding shares of the Company’s Class B common stock automatically converted into shares of the Company’s Class A common stock on a one-for-one basis, pursuant to the terms of the Company’s Third Amended and Restated Articles of Incorporation, as amended (the “Charter”). No additional shares of Class B common stock are permitted to be issued. On May 24, 2023, the Company’s shareholders approved a conversion of the Company’s state of incorporation from Montana to Delaware. At the effective time of the conversion, each outstanding share of the Company’s Class A common stock became an outstanding share of common stock of the Company and each outstanding option, warrant or other right to acquire shares of the Company’s previously designated Class A common stock became an outstanding option, warrant or other right to acquire shares of common stock of the Company. The former holders of Class A and Class B common stock now hold common stock with the same voting powers, preferences, rights and qualifications, limitations and restrictions as the other holders of common stock. All shares of the Company’s outstanding capital stock are now composed solely of shares of common stock and are entitled to one vote per share. The Company’s common stock continues to trade on the NASDAQ Stock Market under the ticker symbol “FIBK.”

Economic Conditions

During the first half of 2023, the banking industry experienced significant volatility with multiple high-profile bank failures leading to broader industry concerns related to funding and liquidity. Despite these developments, the Company’s liquidity position and balance sheet remains strong, and the capital ratios continue to exceed all regulatory well-capitalized requirements as of December 31, 2023. Our deposit base is diversified, including by depositor, which includes individuals, businesses across multiple industries, municipalities, and other entities, as well as geographically, across our 14-state footprint. As of December 31, 2023, our FDIC insured deposits were 65.6% of total deposits, including accounts eligible for pass-through insurance.

Beginning in the third quarter of 2022, the Bank began borrowing from the FHLB to fund loan growth and provide excess liquidity for deposit outflows. Total deposits decreased $1.8 billion at December 31, 2023 compared to December 31, 2022. As a result of the declines in deposits, and limited re-investment of portfolio cash flows, at December 31, 2023, other borrowed funds which are comprised of FHLB advances increased $0.3 billion to $2.6 billion at December 31, 2023, from $2.3 billion at December 31, 2022 at an average rate of 5.32% and 3.72%, respectively.

As of February 23, 2024, the Bank had available borrowing capacity of $3.8 billion with the FHLB and $2.0 billion with the Federal Reserve Bank based on pledged investment securities and loan collateral.

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During the first quarter of 2023, the Federal Reserve Bank (“FRB”) offered a new Bank Term Funding Program (“BTFP”) for eligible depository institutions. The BTFP offers loans of up to one-year to institutions pledging collateral eligible for purchase by the FRB in open market operations such as U.S. Treasuries, U.S. Agency securities, and U.S. agency mortgage-backed securities. These assets will be valued at par for pledging purposes. In January 2024, the Company accessed borrowings through the BTFP which enabled the Company to pay off higher rate FHLB advances and support its current cash position.

U.S. inflation, as reported by the Bureau of Labor Statistics, has been volatile with data showing a multi-decade high in June 2022, climbing to 9.1%, going as low as 3.0% in June 2023, and finishing at 3.4% in December 2023. While our operating expenses are affected by general inflation, the asset and liability structure of the Company largely consists of monetary items. Monetary items, such as cash, investments, loans, deposits and other borrowings, are assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates have a more significant impact on a financial institution’s performance than does general inflation. However, inflation may have negative impacts on the Company’s clients and their customers, impacting their ability or willingness to repay loans or maintain deposits.

The Federal Reserve stated its current objective is to return the rate of inflation to 2% and it has been aggressively acting to achieve this goal. In response to sustained inflationary pressures, the Federal Reserve increased short-term interest rates 525 basis points between March 16, 2022 and July 26, 2023. With the general inflationary pressures easing, the Federal Reserve slowed it’s pace of raising interest rates in the second half of 2023. The recent interest rate increases have resulted in increased returns on our interest earning assets. The Company’s yield on interest earning assets increased to 4.57% as of December 31, 2023 from 3.63% as of December 31, 2022, and 2.96% as of December 31, 2021.

However, as the short end (up to two years) of the yield curve on the U.S. Treasuries has increased, interest rates have had a more significant impact on the Company’s cost of funds, primarily as a result of the shift of non-interest-bearing deposits into higher-cost interest-bearing and time deposit balances and higher levels of variable rate debt. The Company’s cost of funds increased to 1.46% at December 31, 2023, from 0.29% at December 31, 2022, and 0.10% at December 31, 2021. Overall, the change in the mix and cost of funds has offset the changes in the mix and yield on earning assets, resulting in compression of the Company’s FTE net interest margin, a non-GAAP measure, to 3.14% at December 31, 2023, from 3.36% at December 31, 2022, and expansion from 2.85% at December 31, 2021, as a result of higher levels and yields on earning assets more than offsetting higher levels and costs of interest bearing liabilities.

While gross domestic product has expanded at or above 2.0% since the second quarter of 2022, it is unclear whether the volatility of 2022 and 2023 in the economic performance of the U.S. economy will lead to an economic slowdown, downturn, or recession or whether its regular pattern of growth will continue. Any economic slowdown, downturn, or recession could impact the Company and one of its primary funding sources, by impacting the level of deposits held by our clients, whether through a higher volume of withdrawals or through a lower volume of inflows to deposits. The credit quality of the Company’s loans may also be impacted if clients must weather adverse economic conditions which could result in an increase in credit losses or other related expenses.

Primary Factors Used in Evaluating Our Business

As a banking institution, we manage and evaluate our financial condition and our results of operations. We monitor and evaluate the levels and trends of the line items included in our balance sheet and statements of income, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against both our own historical levels as well as and the financial condition and performance of comparable banking institutions in our region and nationally.

Results of Operations

Principal tools we use to manage and evaluate the results of our operations include tracking performance through metrics such as return on average equity, return on average assets, efficiency ratio, non-interest expense as a percent of total average assets, earnings per share, total shareholder return, net interest income, non-interest income, non-interest expense, and net income.

Net interest income is affected by a number of factors such as the level of interest rates, changes in interest rates, the speed of changes in interest rates, and changes in the volume and composition of interest earning assets and interest-bearing liabilities. Changes in interest rate spread, which is the difference between interest earned on assets and interest paid on liabilities, has the most significant impact on net interest income. Other factors like volume of loans, investment securities, and other interest earning assets, compared to the volume of interest-bearing deposits, short-term borrowings, and other indebtedness, also cause changes in our net interest income between periods. Non-interest bearing sources of funds, such as demand deposits and stockholders’ equity, help support earning assets.

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The impact of funding, including non-interest-bearing deposit sources, is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. We evaluate our net interest income by assessing the yields on our loans and other earning assets, the costs of our deposits and other funding sources, and the levels of our net interest spread and net interest margin.

We seek to increase our non-interest income over time, and we evaluate our non-interest income relative to the trends of the individual types of non-interest income in view of changes in the regulatory environment and prevailing market conditions. We manage our non-interest expenses in consideration of growth opportunities and our community banking model that emphasizes client service and responsiveness. We evaluate our non-interest expense on factors that include our non-interest expense relative to our average assets, our efficiency ratio, and the trends of the individual categories of non-interest expense.

Finally, we seek to increase our net income and provide favorable shareholder returns over time, and we evaluate our net income relative to the performance of similar bank holding companies on factors that include return on average assets, return on average equity, total shareholder return, and growth in earnings.

Financial Condition

We manage and evaluate our financial condition by focusing on liquidity, the diversification and quality of our loans, the adequacy of our allowance for credit losses, the diversification and terms of our deposits, short-term borrowings and other funding sources, the re-pricing characteristics and maturities of our assets and liabilities, including potential interest rate exposure, and the adequacy of our capital levels. We seek to maintain sufficient levels of cash and investment securities to meet potential payment and funding obligations, and we evaluate our liquidity on factors that include the levels of cash and highly liquid assets relative to our liabilities, the quality and maturities of our investment securities, the ratio of loans held for investment to deposits, and any reliance on brokered certificates of deposit or other wholesale funding sources.

We seek to maintain a diverse and high-quality loan portfolio and evaluate our asset quality on factors that include the allocation of our loans among loan types, credit exposure to any single borrower or industry type, non-performing assets as a percentage of loans held for investment and OREO, and loan charge-offs as a percentage of average loans. We maintain our allowance for credit losses based on an estimate of expected credit losses in the loans held for investment portfolio over the life of the loan, including the incorporation of a two-year forecast period at each balance sheet date, and we evaluate the level of our allowance for credit losses relative to our overall loan portfolio and the level of non-performing loans and potential charge-offs.

We seek to fund our assets primarily using core client deposits spread among various deposit categories, and we evaluate our deposit and funding mix on factors that include the allocation of our deposits among deposit types, the level of our non-interest-bearing deposits, the ratio of our core deposits (i.e. excluding time deposits above $250,000) to our total deposits, and our reliance on brokered deposits or other wholesale funding sources, such as borrowings from other banks or agencies. We seek to manage the mix, maturities, and re-pricing characteristics of our assets and liabilities to mitigate the impact of a changing interest rate environment on our net interest margin, and we evaluate our asset-liability management using models to evaluate the changes to our net interest income under different interest rate scenarios.

Finally, we seek to maintain adequate capital levels to absorb unforeseen operating losses and to help support the growth of our balance sheet. We evaluate our capital adequacy using the regulatory and financial capital ratios including tangible common equity to tangible assets, leverage capital ratio, tier 1 common capital to total risk-weighted assets, tier 1 risk-based capital ratio, and total risk-based capital ratio.

Critical Accounting Estimates and Significant Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States and follow practices prescribed within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant accounting policies we follow are summarized in “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” included in Part IV, Item 15 of this report.

Our critical accounting estimates are summarized below. Management considers an accounting estimate to be critical if: (1) the accounting estimate requires management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain, and (2) changes in the estimate that are reasonably likely to occur from period to period, or the use of different estimates that management could have reasonably used in the current period, would have a material impact on our consolidated financial statements, results of operations, or liquidity.

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Allowance for Credit Losses

The allowance for credit losses is a valuation account that creates an allowance for credit losses expected over the life of loans at each balance sheet date, which is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Increases in the allowance are recorded through net income as a provision for credit loss expense. Decreases in the allowance are recorded through net income as a reversal of provision for credit loss expense. Loans are charged-off against the allowance when management confirms the uncollectibility of a loan balance. Expected recoveries recorded in the valuation account do not exceed the aggregate of loan amounts previously charged-off. The allowance for credit losses represents management’s estimate of expected credit losses in the loans held for investment portfolio over the life of the loan, including the incorporation of a two-year forecast period with one-year reversion period for economic conditions.

We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant loan we have assessed to have weaknesses that does not share common risk characteristics with other loans. Based on this analysis, we record a provision for credit losses in order to maintain the allowance for credit losses at appropriate levels. In determining the allowance for credit losses, management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency level, or term as well as for changes in environmental and economic conditions, such as changes in unemployment rates, property values, or other relevant factors. The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist.

For loans acquired in a business combination with no significant evidence of credit deterioration since origination, the Company estimates an allowance for credit losses of the loans determined using the same methodology as other loans held for investment.

The allowance for credit losses is maintained at an amount we believe to be sufficient to provide for estimated losses expected over the life of the loans at each balance sheet date resulting from management’s assessment of the quantitative and qualitative factors utilized to determine the allowance for credit losses. Management monitors trends in the loan portfolio, including changes in the levels of past due, internally classified, and non-performing loans. Changes in the estimates and assumptions are possible and may have a material impact on our allowance, and as a result, on our consolidated financial statements or results of operations.

See “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” for a description of the methodology used to determine the allowance for credit losses and our policy pertaining to acquired loans. See “Notes to Consolidated Financial Statements—Loans” for a discussion on the factors driving changes in the amount of the allowance for credit losses. See also Part I, Item 1A, “Risk Factors—Credit Risks.”

Goodwill

The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates it is likely impairment has occurred. Goodwill impairment is determined by comparing the fair value of a reporting unit to its carrying amount. In any given year, the Company may elect to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is in excess of its carrying value. If it is not more likely than not that the fair value of the reporting unit is in excess of the carrying value, or if the Company elects to bypass the qualitative assessment, a quantitative impairment test is performed. In performing a quantitative test for impairment, the fair value of net assets is estimated based on analyses of the Company’s market value, discounted cash flows, and peer values. The determination of goodwill impairment is sensitive to market-based economics and other key assumptions used in determining or allocating fair value. Variability in the market and changes in assumptions or subjective measurements used to estimate fair value are reasonably possible and may have a material impact on our consolidated financial statements or results of operations.

Our annual goodwill impairment test is performed each year as of July 1. The Company performed its 2023 annual goodwill impairment qualitative assessment as of July 1, 2023 and performed a quantitative assessment as of October 31, 2023 and determined the Company’s goodwill was not considered impaired.

For additional information regarding goodwill, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” included in Part IV, Item 15 of this report and “Risk Factors—Operational Risks,” included in Part I, Item 1A of this report.

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Fair Values of Loans Acquired in Business Combinations

Loans acquired in business combinations are initially recorded at fair value as adjusted for credit risk and an allowance for credit losses at the date of acquisition. For loans with no significant evidence of credit deterioration since origination, the difference between the fair value and the unpaid principal balance of the loan at the acquisition date is amortized into interest income using the effective interest method over the remaining period to contractual maturity.

Loans acquired with evidence of deterioration in credit quality since origination, or PCD loans, are accounted for in accordance with ASC Topic 326-20 “Financial instruments - credit losses.” Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and then discounting those cash flows at an appropriate market rate of interest. An allowance for credit losses is recognized by estimating the expected credit losses of the purchased asset and recording an adjustment to the acquisition date fair value to establish the initial amortized cost basis of the asset. Differences between the established fair value, or amortized cost basis, and the unpaid principal balance of the asset is considered to be a non-credit discount/premium and is accreted/amortized into interest income using the interest method accounted for in accordance with ASC 310-10. Subsequent changes to the allowance for credit losses are recorded through provision for credit loss expense using the same methodology as other loans held for investment.

For additional information regarding acquired loans, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” “Notes to Consolidated Financial Statements—Acquisitions,” and “Notes to Consolidated Financial Statements—Loans Held for Investment,” included in Part IV, Item 15 of this report.

Results of Operations

The following discussion and analysis is intended to provide detail about the results of operations by comparing the years ended December 31, 2023 to December 31, 2022. A similar discussion and analysis that compares the fiscal year 2022 to the fiscal year ended December 31, 2021, may be found in Part II, Item 7, “Results of Operations” of our Form 10-K for the fiscal year ended December 31, 2022, which is incorporated herein by reference.

Net Income

Net income increased $55.3 million, or 27.3%, to $257.5 million, or $2.48 per diluted share, in 2023, compared to $202.2 million, or $1.96 per diluted share, in 2022. There were no acquisition related expenses in 2023 compared to $118.9 million of acquisition related expenses incurred in 2022 related to the 2022 acquisition of GWB. The after-tax impact of acquisition related expenses on earnings per share was $0.90 in 2022.

(1)Our efficiency ratio definition conforms with the FDIC definition for all periods presented as non-interest expense less amortization of intangible assets divided by net interest income plus non-interest income.

(2)Common stock dividend payout ratio represents dividends per common share divided by basic earnings per common share.

Net Interest Income

Net interest income, the largest source of our operating income, is derived from interest, dividends, and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. Interest earning assets primarily include loans and investment securities. Interest bearing liabilities include deposits, short-term borrowings, and various other forms of indebtedness. Net interest income is affected by the level of interest rates, changes in interest rates, the speed of changes to interest rates, and changes in the volume and composition of interest earning assets and interest-bearing liabilities.

Changes in interest rate spread, which is the difference between interest earned on assets and interest paid on liabilities, has the most significant impact on net interest income. Other factors like volume of loans, investment securities, and other interest earning assets compared to the volume of interest-bearing deposits, short-term borrowings, and other indebtedness also cause changes in our net interest income between periods. Non-interest-bearing sources of funds, such as demand deposits and stockholders’ equity, help to support earning assets.

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Net interest income decreased $63.8 million during 2023, as compared to the same period in 2022, primarily due to a decrease in interest accretion related to the fair valuation of acquired loans and an increase in interest expense as a result of the cost of interest-bearing liabilities.

Net interest income included interest accretion related to the fair value of acquired loans of $20.4 million during 2023 as compared to $50.4 million in 2022, of which $2.5 million was the result of early loan payoffs during 2023, as compared to $21.8 million in 2022. There were no material recoveries of previously charged-off loan interest in 2023 or 2022.

Our net interest margin ratio decreased 21 basis points to 3.12% during 2023, as compared to 3.33% in 2022. Our net FTE interest margin ratio, a non-GAAP financial measure, decreased 22 basis points to 3.14% during 2023, as compared to 3.36% in 2022. Exclusive of the impact of interest accretion on acquired loans and the impact of recoveries of charged-off interest, our 2023 net FTE interest margin ratio decreased 11 basis points over our similarly calculated net interest margin ratio in 2022.

The following table presents, for the periods indicated, condensed average balance sheet information using daily average balances, together with interest income and yields earned on average interest earning assets and interest expense and rates paid on average interest-bearing liabilities.

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The table below sets forth, for the periods indicated, a summary of the changes in interest income and interest expense resulting from estimated changes in average asset and liability balances (volume) and estimated changes in average interest rates (rate). Changes which are not due solely to volume or rate have been allocated to these categories based on the respective percent changes in average volume and average rate as they compare to each other.

(1)Interest income and average rates for tax exempt loans and securities are presented on a FTE basis.

Non-GAAP Reconciliation

The table below provides a reconciliation of the GAAP measure of net interest margin to the non-GAAP measure of net FTE interest margin.

Provision for (reduction of) Credit Losses

Fluctuations in the provision for credit losses reflect management’s estimate of possible credit losses based upon the composition of our loan portfolio, evaluation of the borrowers’ ability to repay, collateral value underlying loans, loan loss trends, and estimated effects of current and forecasted economic conditions on our loans held for investment and investment securities portfolios.

During 2023, the Company recorded a provision for credit losses of $32.2 million, as compared to a $82.7 million provision for credit losses in 2022. The provision during 2023 includes a provision for credit losses of $31.1 million related to loans held for investment, provision for credit losses of $2.2 million related to unfunded commitments, and a reduction of credit losses of $1.1 million related to held-to-maturity securities. The allowance for credit losses is updated quarterly based on the current loan and investment securities portfolios, asset quality metrics, and a review of the current economic outlook. The provision for credit losses is reflective of net charge-offs of $23.5 million, or 0.13% of average loans outstanding, for 2023, compared to $30.1 million, or 0.18% of average loans outstanding in 2022.

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For information regarding our non-performing loans, see “Non-Performing Assets” included herein. For information regarding our allowance for credit losses, see “Financial Condition—Allowance for Credit Losses” included herein.

Non-interest Income

Non-interest income also contributes to our operating results with fee-based revenues such as payment services, mortgage banking and wealth management revenues, service charges on deposit accounts, and other service charges, commissions, and fees. The following table presents the composition of our non-interest income as of the dates indicated:

Non-interest income decreased $16.2 million in 2023 as compared to the same period in 2022. Significant components of these fluctuations are discussed below.

Mortgage banking revenues include origination and processing fees on residential real estate loans held for sale, gains on residential real estate loans sold to third parties, income earned from the servicing of mortgages originated by the Company which are held by third parties, and any impairments to or subsequent recovery of the Company’s mortgage servicing rights valuation. Mortgage banking revenues decreased $10.3 million in 2023 as compared to the same period in 2022, primarily as a result of the decline in home loan production volume as a result of rising interest rates, along with tighter gain-on-sale spreads compared to 2022. The realized revenue during 2023 was not impacted by a recovery of a previous impairment of our mortgage servicing rights as compared with a $3.4 million recovery in 2022.

Other service charges, commissions, and fees primarily include fees earned on certain derivative interest rate contracts, insurance commissions, and safe deposit boxes. Other service charges, commissions, and fees decreased $6.0 million in 2023 as compared to the same period in 2022, primarily due to a decrease of $4.5 million in swap fee revenues earned on derivative interest rate swap contracts offered to clients.

Non-interest Expense

Non-interest expense decreased $109.2 million in 2023 as compared to the same period in 2022. The decrease was primarily a result of the $118.9 million decrease in acquisition expenses related the GWB acquisition incurred during 2022, in addition to lower incentive compensation accruals, partially offset by increased expenses in 2023 as a result of a full year of combined operations, post-GWB acquisition and a special FDIC insurance assessment of $10.5 million. Expenses related to acquisitions include legal fees, consulting fees, investment banking fees, conversion and contract termination costs, and retention and severance compensation costs. Other significant components of non-interest expense are discussed below. For additional information regarding acquisitions, see “Note 2 – Acquisition” in the accompanying “Notes to Consolidated Financial Statements” included in this report.

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The following table presents the composition of our non-interest expense as of the dates indicated:

Salaries and wages expense primarily consist of salaries, severance, commissions, overtime, bonus accrual, and temporary employee expenses. Salaries and wages expense decreased $19.0 million in 2023 as compared to the same period in 2022, primarily as a result of lower short-term incentives of $31.0 million, which were partially offset by higher salaries and wages of $11.9 million as a result of the full year of combined operations, post-GWB acquisition and higher severance costs.

Outsourced technology services primarily include technology services related to the core system platform, software as a service, automated teller machines, technology equipment and software maintenance. Outsourced technology services expense increased $4.7 million in 2023 as compared to the same period in 2022, primarily due to inflationary impacts to technology contracts and costs associated with higher transaction volumes from a full year of expenses resulting from the GWB acquisition.

Occupancy, net expense include building expenses such as lease, depreciation, rent, maintenance and repairs, property taxes, snow removal, utility and janitorial, and insurance. Occupancy, net expense increased $4.0 million in 2023 as compared to the same period in 2022, primarily due to increased expenses resulting from the GWB acquisition.

The FDIC insures deposits at FDIC-insured financial institutions and charges insured financial institutions premiums to maintain the DIF at a specific level. FDIC insurance premiums increased $17.5 million in 2023 as compared to the same period in 2022, primarily attributable to the incremental two basis point assessment fee imposed by the FDIC which began in the first quarter of 2023 and the special assessment of $10.5 million to cover the losses incurred by the DIF in response to 2023 bank failures. Under the special assessment, the Bank was assessed 13.4 basis points annually on an assessment base equal to its estimated uninsured deposits, after excluding the first $5 billion of uninsured deposits. The special assessment will be collected on a quarterly basis for eight quarters beginning with the first quarter of 2024, although the FDIC retained the flexibility to extend the special assessment period as well as impose a one-time shortfall assessment to collect any remaining amount to fully recover the losses to the DIF.

Other expenses primarily include advertising and public relations costs; office supply, postage, freight, telephone, and travel expenses; donations expense; debit and credit card expenses; board of director fees; legal expenses; and other operational losses. Other expenses increased $7.0 million in 2023 as compared to the same period in 2022. The increase in other expenses are mainly attributable to an increase in our credit card rewards accrual as a result of higher engagement by our clients in our improved rewards program and swap servicing.

Acquisition related expenses primarily include legal and professional fees; technology, conversion, and contract termination costs; employee severance and retention payments; and travel expenses. There were no acquisition related expenses incurred during 2023, compared to $118.9 million of acquisition related expenses incurred during 2022, related to the 2022 acquisition of GWB. For additional information regarding our GWB acquisition, see “Recent Trends and Developments” included herein and “Notes to Consolidated Financial Statements—Acquisitions,” included in Part IV, Item 15 of this report.

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Income Tax Expense

Our effective federal tax rate was 18.4% for the year ended December 31, 2023 compared to 16.1% for the year ended December 31, 2022. Fluctuations in effective federal income tax rates are primarily due to an increase in pre-tax income, a decrease in net tax exempt interest income, a decrease in tax credits, and an increase in the non-deductible portion of FDIC premium expense, which was partially offset by an increase in the cash surrender value of company owned life insurance, and a decrease in non-deductible acquisition costs.

State income tax applies primarily to pretax earnings generated within Arizona, Colorado, Idaho, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, North Dakota, Oregon, and South Dakota. Our effective state tax rate was 5.1% for the year ended December 31, 2023 compared to 5.2% for the year ended December 31, 2022.

Financial Condition

The financial condition discussion below is based upon our Consolidated Balance Sheet in Part IV, Item 15 of this Report. A similar discussion and analysis comparing fiscal year 2022 to fiscal year ended December 31, 2021 may be found in Part II, Item 7, “Financial Condition” in our Annual Report on Form 10-K for the year ended December 31, 2022, which is incorporated herein by reference.

Total Assets

Total assets decreased $1,616.6 million, or 5.0%, to $30,671.2 million as of December 31, 2023, from $32,287.8 million as of December 31, 2022, primarily due to declines in deposits and securities sold under repurchase agreements, partially offset by an increase in other borrowed funds. Significant fluctuations in balance sheet accounts are discussed below.

Investment Securities

We manage our investment portfolio to obtain the highest yield possible while meeting our risk tolerance and liquidity guidelines and satisfying the pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. Our portfolio principally comprises U.S treasury notes, U.S. government agency, U.S. government agency commercial mortgage-backed securities, U.S. government residential mortgage-backed securities, collateralized mortgage obligations, corporate securities, and tax-exempt securities. Debt securities rated in the highest category by nationally recognized rating agencies and debt securities backed by the U.S. Government and government sponsored agencies, both on a direct and indirect basis, represented approximately 94.8% of the investment portfolio’s HTM segment at December 31, 2023. All other held-to-maturity debt securities rated below AAA, not backed by the U.S. Government or government sponsored agencies, or which are not rated represented approximately 5.2% of total HTM debt securities at December 31, 2023. Federal funds sold and interest-bearing deposits in the Bank are additional investments that are classified as cash equivalents rather than as investment securities. Investment securities classified as available-for-sale are recorded at fair value, while investment securities classified as held-to-maturity are recorded at amortized cost. Unrealized gains or losses, net of the deferred tax effect, on available-for-sale securities are reported as increases or decreases in accumulated other comprehensive income or loss, a component of stockholders’ equity.

Investment securities decreased $1,348.5 million, or 13.0%, to $9,049.4 million as of December 31, 2023, from $10,397.9 million as of December 31, 2022. The decrease was the result of the disposition of $853.0 million of investment securities during the first quarter of 2023, with proceeds primarily used to reduce short-term borrowings, and normal amortization of the portfolio, partially offset by increases in fair market values and purchases of $134.7 million during the period.

See Notes “Investment Securities” included in Part IV, Item 15 of this report for additional details.

As of December 31, 2023, the estimated duration of our investment portfolio was 3.5 years, as compared to 3.7 years as of December 31, 2022. The weighted average yield on investment securities increased 72 basis points to 2.91% in 2023, from 2.19% in 2022.

As of December 31, 2023, investment securities with amortized costs and fair values of $3,858.6 million and $3,462.2 million, respectively, were pledged to secure public deposits and securities sold under repurchase agreements, as compared to $4,998.9 million and $4,432.0 million, respectively, as of December 31, 2022. For additional information concerning securities sold under repurchase agreements, see “—Securities Sold Under Repurchase Agreements” included herein.

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Mortgage-backed securities and, to a limited extent other securities, have uncertain cash flow characteristics that present additional interest rate risk in the form of prepayment or extension risk primarily caused by changes in market interest rates. This additional risk is generally rewarded in the form of higher yields. Maturities of mortgage-backed securities presented below are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. As of December 31, 2023, the carrying value of our investments in non-agency mortgage-backed securities totaled $241.3 million. All other mortgage-backed securities included in the table below were issued by U.S. government entities and sponsored entities. As of December 31, 2023, there were no significant concentrations of investments (greater than 10% of stockholders’ equity) in any individual security issuer, except for U.S. government or agency-backed securities.

Approximately 74.2% and 77.9% of our tax-exempt securities were general obligation securities as of December 31, 2023 and 2022, respectively, of which 31.1% and 38.0%, respectively, were issued by political subdivisions or agencies within the states we operate, including Arizona, Colorado, Idaho, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, North Dakota, Oregon, South Dakota, Washington, and Wyoming.

As of December 31, 2023, we had investment securities with fair values aggregating $8,284.5 million that had been in a continuous loss position more than 12 months. Gross unrealized losses on these securities totaled $803.4 million as of December 31, 2023, and were attributable to changes in interest rates. At December 31, 2023 and December 31, 2022, the Company had no allowance for credit losses on available-for-sale securities and an allowance for credit losses on held-to maturity securities classified as corporate and municipal securities of $0.8 million and $1.9 million, respectively.

The following table sets forth the carrying value as of December 31, 2023 and 2022, and the percentage of total investment securities and weighted average yields on investment securities as of December 31, 2023. Weighted-average yields have been computed on a fully taxable-equivalent basis using a tax rate of 21%.

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Maturities of the 2023 securities noted above reflect $1,603.3 million of investment securities at their final maturities, which have call provisions within the next year. Based on current market interest rates, management expects approximately $1.0 million of these securities will be called in 2024. For additional information concerning investment securities, see “Notes to Consolidated Financial Statements — Investment Securities” included in Part IV, Item 15.

Federal Reserve Bank (FRB) and Federal Home Loan Bank (FHLB) Stock

The Bank is a member of the FHLB of Minneapolis and the FRB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. As of December 31, 2023 and December 31, 2022, the Company held $223.2 million and $198.6 million, respectively, in equity securities in a combination of FRB and FHLB stocks, which are restricted nonmarketable securities acquired to meet regulatory requirements. These securities are carried at cost.

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Loans Held for Sale

Loans held for sale consist of residential mortgage loans pending sale to investors in the secondary market and loans reclassified from loans held for investment due to management’s intent and decision to sell the loans. Loans held for sale decreased $32.5 million, or 40.7%, to $47.4 million as of December 31, 2023, compared to $79.9 million as of December 31, 2022, primarily due to the transfer of $29.6 million of agricultural loans to loans held for investment, the transfer of a $6.4 million construction real estate loan to OREO, the repayment or pay-off of $15.5 million of loans, and a decrease in mortgage loan activity. The decrease was partially offset by the transfer of a $27.3 million commercial real estate loan from loans held for investment to loans held for sale during 2023.

Loans Held for Investment, Net of Deferred Fees and Costs

The following table presents the composition of our loan portfolio as of the dates indicated:

Loans Outstanding

(Dollars in millions)

Loans held for investment, net of deferred fees and costs, increased $180.4 million, or 1.0%, to $18,279.6 million as of December 31, 2023, as compared to $18,099.2 million as of December 31, 2022,

Real Estate Loans. We provide interim construction and permanent financing for both single-family and multi-unit properties, medium-term loans for commercial, agricultural and industrial property and/or buildings and equity lines of credit secured by real estate.

Commercial real estate loans. Commercial real estate loans include loans for property and improvements used commercially by the borrower or for lease to others for the production of goods or services. Approximately 34.4% and 37.0% of our commercial real estate loans were owner occupied as of December 31, 2023 and 2022, respectively.

Construction loans. Construction loans are primarily to commercial builders for residential lot development and the construction of single-family residences and commercial real estate properties. Construction loans are generally underwritten pursuant to pre-approved permanent financing. As of December 31, 2023, our construction loan portfolio was divided among the following categories: approximately $343.6 million, or 18.8%, residential construction; approximately $1,147.9 million, or 62.9%, commercial construction; and approximately $335.0 million, or 18.3%, land acquisition and development.

Residential real estate loans. Residential real estate loans are typically secured by first liens on the financed property. Included in residential real estate loans were home equity loans and lines of credit of $541.8 million, or 24.1%, and $548.9 million, or 25.1%, as of December 31, 2023 and 2022, respectively.

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Agricultural real estate loans. Agricultural real estate loans are secured by farmland or ranchland consisting of short, intermediate, and long-term structures to experienced agriculturalists who have demonstrated management capabilities, established production and historical financial performance.

Consumer Loans. Our consumer loans include direct personal loans; credit card loans and lines of credit; and indirect loans created when we purchase consumer loan contracts advanced for the purchase of automobiles, boats, and other consumer goods from the consumer product dealer network within the market areas we serve. Personal loans and indirect dealer loans are generally secured by automobiles, recreational vehicles, boats, and other types of personal property and are made on an installment basis. Credit cards are offered to clients in our market areas. Lines of credit are generally floating rate loans that are unsecured or secured by personal property. Approximately 77.3% and 78.4% of our consumer loans as of December 31, 2023 and 2022, respectively, were indirect consumer loans.

Commercial Loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small and medium-sized manufacturing, wholesale, retail, and service businesses for working capital needs and business expansions. Commercial loans generally include lines of credit, business credit cards, and loans with maturities of five years or less and outstanding balances tend to be cyclical in nature. The loans are generally made with business operations as the primary source of repayment and are typically collateralized by inventory, accounts receivable, equipment, and/or personal guarantees.

Agricultural Loans. Our agricultural loans generally consist of short- and medium-term loans and lines of credit that are primarily used for crops, livestock, equipment, and general operations. Agricultural loans are ordinarily secured by assets such as livestock or equipment and are repaid from the operations of the farm or ranch. Agricultural loans generally have maturities of five years or less, with operating lines for one production season.

The following table presents the contractual maturity distribution and interest rates of our loan portfolio as of December 31, 2023. The amounts provided below do not reflect scheduled repayment or prepayment assumptions related to the loan portfolio. The within one year category includes loans overdrafts and loans with no stated maturity.

Maturities and Interest Rate Sensitivities

Non-Performing Assets

Non-performing assets include non-accrual loans, loans contractually past due by 90 days or more and still accruing interest, and OREO.

Non-accrual loans. We generally place loans on non-accrual status when they become 90 days past due unless they are well secured and in the process of collection. When a loan is placed on non-accrual status, any interest previously accrued but not collected is reversed from income. Non-accrual loans increased $47.2 million, to $106.4 million, as of December 31, 2023, from $59.2 million as of December 31, 2022, primarily due to a $28.7 million agricultural loan transferred loans held for sale to loans held for investment and a construction real estate and commercial real estate loan. Accruing loans past due 90 days or more decreased $1.5 million, or 23.4% driven by a decrease in all loan types except for agricultural loans as a result of the transfer of a loan from loans held for sale to loans held for investment. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and when, in the opinion of management, the loans are estimated to be fully collectible as to both principal and interest.

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Other Real Estate Owned (OREO). OREO consists of real property acquired through foreclosure on the collateral underlying defaulted loans. We initially record OREO at fair value less estimated selling costs. Any excess of loan carrying value over the fair value of the real estate acquired is recorded as a charge against the allowance for credit losses. Estimated losses that result from the ongoing periodic valuation of these properties are charged to earnings in the period in which they are identified. The fair values of OREO properties are estimated using appraisals and management estimates of current market conditions. OREO properties are appraised every 18-24 months unless deterioration in local market conditions indicates the need to obtain new appraisals sooner.

OREO properties are evaluated by management quarterly to determine if additional write-downs are appropriate or necessary based on current market conditions. Quarterly evaluations include a review of the most recent appraisal of the property and reviews of recent appraisals and comparable sales data for similar properties in the same or adjacent market areas. Commercial and agricultural OREO properties are listed with unrelated third party professional real estate agents or brokers local to the areas where the marketed properties are located. Residential properties are typically listed with local realtors, after any redemption period has expired. We rely on these local real estate agents and/or brokers to list the properties on the local multiple listing system, to provide marketing materials and advertisements for the properties, and to conduct open houses.

OREO increased to $16.5 million as of December 31, 2023, from $12.7 million as of December 31, 2022, primarily attributable to the transfer of a $5.8 million loan held for sale to OREO, partially offset by dispositions. As of December 31, 2023, 60.7% of our OREO balance was related to an agricultural real estate property, 38.5% was related to commercial properties, and 0.8% was related to a construction property.

The following table sets forth information regarding non-performing assets as of the dates indicated:

For additional information regarding non-performing loans, see “Notes to Consolidated Financial Statements—Loans Held For Investment” included in financial statements included Part IV, Item 15 of this report.

Non-performing loans. Non-performing loans include non-accrual loans and loans contractually past due 90 days or more and still accruing interest. The following table sets forth the allocation of our non-performing loans among our different types of loans as of the dates indicated.

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Collateral-dependent loans. Collateral-dependent loans rely solely on the operation or sale of the collateral for repayment. In evaluating the overall risk associated with a loan, the Company considers character, overall financial condition and resources, and payment record of the borrower; the prospects for support from any financially responsible guarantors; and the nature and degree of protection provided by the cash flow and value of any underlying collateral. The loan may become collateral-dependent where the borrower is experiencing financial difficulty and as sources of repayment become inadequate over time and that repayment is expected to be provided substantially through the operation or sale of the collateral. Collateral-dependent loans increased to $52.6 million as of December 31, 2023, from $39.1 million as of December 31, 2022, primarily due to a construction loan.

Modifications to borrowers experiencing financial difficulty. Modifications of loans are made in the ordinary course of business and are completed on a case-by-case basis through negotiation with the borrower in connection with the ongoing loan collection processes. Loan modifications are made to provide borrowers payment relief. From time to time, we may modify certain loans to borrowers who are experiencing financial difficulty. In some cases, these modifications may result in new loans. Loan modifications to borrowers experiencing financial difficulty may be in the form of principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay, or a term extension or a combination thereof, among other things. Those modifications deemed to be for borrowers experiencing financial difficulty are monitored centrally to ensure proper classification and if or when the loan may be placed on accrual status.

Effective January 1, 2023, the Company adopted ASU 2022-02, which eliminated accounting guidance for troubled debt restructurings while requiring disclosures of borrowers experiencing financial difficulty for modifications related to principal reductions, interest rate reductions, term extensions, and more than insignificant payment delay. See “Notes to Consolidated Financial Statements—Recent Authoritative Accounting Guidance” included in financial statements included Part IV, Item 15 of this report for further discussion of the amendments in this update. For additional information regarding modifications to borrowers experiencing financial difficulty, see “Notes to Consolidated Financial Statements—Loans Held For Investment” included in financial statements included Part IV, Item 15 of this report.

Allowance for Credit Losses

The Company performs a quarterly assessment of the appropriateness of its allowance for credit losses in accordance with GAAP. The allowance for credit losses is established through a provision for credit losses based on our evaluation of quantitative and qualitative risk factors in our loan portfolio at each balance sheet date. In determining the allowance for credit losses, we estimate losses on specific loans, or groups of loans, where the expected loss can be identified and reasonably determined over the life of the loans. The balance of the allowance for credit losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature or tenure of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current environmental and economic factors, and the estimated impact of forecasted economic conditions on historical loan loss rates. See the discussion under “Critical Accounting Estimates and Significant Accounting Policies — Allowance for Credit Losses” above.

The allowance for credit losses is increased by provisions charged against earnings and net recoveries of charged-off loans and is reduced by negative provisions credited to earnings and net loan charge-offs. The allowance for credit losses consists of three elements:

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(1)Specific valuation allowances associated with collateral-dependent and other individually evaluated loans. Specific valuation allowances are determined based on assessment of the fair value of the collateral underlying the loans as determined through independent appraisals, the present value of future cash flows, observable market prices, and any relevant qualitative or environmental factors impacting loans.

(2)Collective valuation allowances based on loan loss experience and future expectations for similar loans with similar characteristics and trends. The Company applies open pool methodologies for all portfolio segments. The open pool methodology averages quarterly loss rates by modeling segment, calculated as quarter-to-date net charge off balance divided by the end of period balance. Loss rates are recalculated quarterly with recoveries captured in the quarter a loan was charged off, are averaged across a look back period from 2009 to the current period, and are annualized. Macroeconomic-conditioned historical loss rates are applied to loan-level cash flows. Expected future principal and interest cash flows are calculated using contractual repayment terms and prepayment, utilization, interest rate, and probability of default assumptions. Macroeconomic sensitivity models calculate segment-specific multipliers using third party forecast data. The multipliers condition the annual loss rates over the 2-year forecast period, followed by a 1-year straight-line reversion to the unadjusted historical average loss rates. The unadjusted loss rates then apply for the remaining life of the loan. Estimated losses are totaled and aggregated to the segment level.

(3)General valuation allowances determined based on asset quality trends, industry concentrations, environmental risks, changes in portfolio composition, and other qualitative risk factors, both internal and external to the Company. Other qualitative factors, including changes in loan and lending policies, collateral quality, underwriting standards and personnel, credit review quality, and model imprecision, are also considered.

Based on the assessment of the appropriateness of the allowance for credit losses, the Company records provisions for credit losses to maintain the allowance for credit losses at appropriate levels.

Loans acquired in business combinations are initially recorded at fair value as adjusted for credit risk and an allowance for credit losses at the date of acquisition. For loans with no significant evidence of credit deterioration since origination, the difference between the fair value and the unpaid principal balance of the loan at the acquisition date is amortized into interest income using the effective interest method over the remaining period to contractual maturity. An allowance for credit loss is recorded for the expected credit losses over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through provision expense using the same methodology as other loans held for investment.

For loans acquired in business combinations with evidence of deterioration in credit quality since origination, the Company determines the fair value of the loans by estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. An allowance for credit losses is recognized by estimating the expected credit losses of the purchased asset and recording an adjustment to the acquisition date fair value to establish the initial amortized cost basis of the asset. Differences between the established amortized cost basis, and the unpaid principal balance of the asset, is considered to be a non-credit discount/premium and is accreted/amortized into interest income using the level yield interest method. Subsequent changes to the allowance for credit losses are recorded through provision expense using the same methodology as other loans held for investment.

Loans, or portions thereof, are charged-off against the allowance for credit losses when management believes the collectability of the principal is unlikely, or, with respect to consumer installment loans, according to an established delinquency schedule. Generally, loans are charged-off when (1) there has been no material principal reduction within the previous 90 days and there is no pending sale of collateral or other assets, (2) there is no significant or pending event which will result in principal reduction within the upcoming 90 days, (3) it is clear that we will not be able to collect all or a portion of the loan, (4) payments on the loan are sporadic, will result in an excessive amortization, or are not consistent with the collateral held, or (5) foreclosure or repossession actions are pending. Loan charge-offs do not directly correspond with the receipt of independent appraisals or the use of observable market data if the collateral value is determined to be sufficient to repay the principal balance of the loan.

If a collateral-dependent loan is adequately collateralized, a specific valuation allowance for credit losses is not recorded. As such, significant changes in collateral-dependent and non-performing loans do not necessarily correspond proportionally with changes in the specific valuation component of the allowance for credit losses. Additionally, the Company expects the timing of charge-offs will vary between quarters and will not necessarily correspond proportionally to changes in the allowance for credit losses or changes in non-performing or collateral-dependent loans due to timing differences among the initial identification of a collateral-dependent loan, recording of a specific valuation allowance for collateral-dependent loans, and any resulting charge-off of uncollectible principal.

Our allowance for credit losses on loans was $227.7 million, or 1.25% of loans held for investment as of December 31, 2023, as compared to $220.1 million, or 1.22% of loans held for investment, as of December 31, 2022. The increase in the percentage from December 31, 2022 is primarily a result of loan growth and credit migration.

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Although we have established our allowance for credit losses in accordance with GAAP in the United States and we believe that the allowance for credit losses is appropriate to provide for known and expected losses in the portfolio at all times, future provisions will be subject to on-going evaluations of the risks in the loan portfolio. If the economy declines or asset quality deteriorates, material additional provisions could be required. The following table sets forth information regarding our allowance for credit losses as of the dates and for the periods indicated.

Allowance for Credit Losses

(Dollars in millions)

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The allowance for credit losses is allocated to loan categories based on the relative risk characteristics, asset classifications, and expected losses of the loan portfolio. The following table provides a summary of the allocation of the allowance for credit losses for specific loan categories as of the dates indicated. The allocations presented should not be interpreted as an indication that charges to the allowance for credit losses will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each loan category represents the total amount available for future losses that may occur within these categories.

Allocation of the Allowance for Credit Losses

(Dollars in millions)

Deferred Tax Asset

The net deferred tax asset decreased $60.5 million, to $150.0 million as of December 31, 2023, from $210.5 million as of December 31, 2022, primarily due to a decrease in deferred tax assets related to the unrealized fair value of investment securities, deferred compensation, and interest rate swap contracts designated as hedges.

Other Assets

Other assets decreased $80.3 million, to $268.4 million as of December 31, 2023, from $348.7 million as of December 31, 2022, primarily attributable to a decrease in interest rate swap contracts.

Total Liabilities

Total liabilities decreased $1,770.3 million, or 6.1%, to $27,443.7 million as of December 31, 2023, from $29,214.0 million as of December 31, 2022, primarily due to a decrease of $1,750.5 million in deposits and decreases in securities sold under repurchase agreements and accounts payable and accrued expenses. These decreases were partially offset by an increase in other borrowed funds. Significant fluctuations in liability accounts are discussed below.

Deposits

Total deposits decreased $1,750.5 million, to $23,323.1 million as of December 31, 2023, from $25,073.6 million as of December 31, 2022, with decreases in all types of deposits with the exception of time deposits.

As of December 31, 2023 and 2022, we had Certificate of Deposit Account Registry Service, or CDARS, deposits of $26.6 million and $36.6 million, respectively. As of December 31, 2023 and 2022, we had zero and $12.5 million of brokered deposits, respectively.

The following table summarizes our deposits as of the dates indicated:

Deposits

(Dollars in millions)

For additional information concerning client deposits, including the use of repurchase agreements, see “Business—Community Banking—Deposit Products,” included in Part I, Item 1 and “Notes to Consolidated Financial Statements—Deposits,” included in Part IV, Item 15 of this report.

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Securities Sold Under Repurchase Agreements

Under repurchase agreements with commercial and municipal depositors, client deposit balances are invested in U.S. government agency securities overnight and are then repurchased the following day. All outstanding repurchase agreements are due in one day and balances fluctuate in the normal course of business. Repurchase agreement balances decreased $270.2 million, or 25.7%, to $782.7 million as of December 31, 2023, from $1,052.9 million as of December 31, 2022.

The following table sets forth certain information regarding securities sold under repurchase agreements as of the dates indicated:

Securities Sold Under Repurchase Agreements

(Dollars in millions)

Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses decreased $65.5 million, to $380.4 million as of December 31, 2023, from $445.9 million as of December 31, 2022, primarily attributable to a decrease in derivative liabilities of $32.3 million and a decrease in accrued salaries and wages and employee benefits of $29.2 million.

Other Borrowed Funds

Other borrowed funds consists of FHLB borrowings with maturity tenors of up to three-months, to address short-term funding needs. Other borrowed funds increased $276.0 million, to $2,603.0 million as of December 31, 2023 compared to 2,327.0 million at December 31, 2022, primarily as a result of a decrease in total deposits and securities under repurchase agreements, partially offset by a decline in investment securities and cash and cash equivalents.

Capital Resources and Liquidity

Capital Resources

Stockholders’ equity is influenced primarily by earnings, dividends, sales and redemptions of common stock, and changes in the unrealized holding gains or losses, net of taxes, on available-for-sale investment securities. Stockholders’ equity increased $153.7 million, or 5.0%, to $3,227.5 million as of December 31, 2023 from $3,073.8 million as of December 31, 2022, due to changes in accumulated other comprehensive loss related to unrealized gains on available-for-sale securities and retention of earnings, which are partially offset by stock repurchases of vested restricted shares tendered in lieu of cash for payment of income tax withholding amounts by participants, a stock purchase pursuant to an agreement, and cash dividends paid. Regular cash dividends paid to common shareholders during 2023 amounted to approximately $195.1 million.

On January 26, 2024, we declared a quarterly dividend to common stockholders of $0.47 per share, which was paid on February 19, 2024 to shareholders of record as of February 9, 2024. The dividend equates to a 7.2% annual yield based on the $26.01 average closing price of the Company’s common stock as reported on NASDAQ during the fourth quarter of 2023.

On December 14, 2023, the Company completed the repurchase of one million shares of its common stock from the estate of a stockholder at a price of $32.14 per share, or the closing price per share of the common stock as reported on the Nasdaq Stock Market on December 14, 2023, representing an aggregate purchase price of $32.1 million. For additional information regarding the repurchase, see “Notes to Consolidated Financial Statements—Related Party Transactions” included in Part IV, Item 15 of this report.

During 2022, the Company repurchased and retired the five million shares of common stock under its previously existing stock repurchase program. As of December 31, 2023, the Company did not have a repurchase program in effect.

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For additional information regarding the repurchases, see “Notes to Consolidated Financial Statements—Capital Stock and Dividend Restrictions” included in Part IV, Item 15 of this report.

During 2023, the Company issued 54,414 shares of its common stock to directors for their annual service on the Company’s board of directors. The aggregate value of the shares issued to directors of $1.2 million is amortized into stock-based compensation expense in the accompanying consolidated statements of changes in stockholders’ equity over a one-year service-based period.

As a bank holding company, the Company must comply with the capital requirements established by the Federal Reserve, and our subsidiary Bank must comply with the capital requirements established by the FDIC. The current risk-based guidelines applicable to us and our Bank are based on the Basel III framework, as implemented by the federal bank regulators. As of December 31, 2023 and 2022, the Company had capital levels that, in all cases, exceeded the guidelines to be deemed “well-capitalized.”

For additional information regarding our capital levels, see “Notes to Consolidated Financial Statements—Regulatory Capital,” included in Part IV, Item 15 of this report.

Liquidity

Liquidity measures our ability to meet current and future cash flow needs on a timely basis and at a reasonable cost. We manage our liquidity position to meet the daily cash flow needs of clients, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders. Our liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest bearing deposits in banks, federal funds sold, available-for-sale investment securities, and maturing or prepaying balances in our held-to-maturity investment and loan portfolios. Liquid liabilities include core deposits, federal funds purchased, securities sold under repurchase agreements, and borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market funds through non-core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, additional borrowings through the Federal Reserve’s discount window or BTFP, and the issuance of preferred or common securities.

The primary effect of inflation on our operations is reflected in increased operating costs. In our management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond our control, including changes in the expected rate of inflation, the influence of general and local economic conditions, and the monetary and fiscal policies of the United States government, its agencies, and various other governmental regulatory authorities.

In the ordinary course of business, we have entered into contractual obligations and have made other commitments to make future payments. Our short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures, and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of prepaying and maturing balances in our loan and investment portfolios, debt financing, and increases in client deposits. For additional information regarding our operating, investing and financing cash flows, see “Consolidated Financial Statements—Consolidated Statements of Cash Flows,” included in Part IV, Item 15 of this report.

The Company had deposits without a stated maturity of $20,313.2 million and time deposits of $2,648.7 million, due in one year or less in addition to time deposits due in more than one year of $361.2 million as of December 31, 2023. For additional details in regard to the Company’s deposits see “Notes to Consolidated Financial Statements—Deposits” included in Part IV, Item 15 of this report.

As of December 31, 2023, the Company had securities sold under repurchase agreements of $782.7 million due in one year or less as the agreements with our client counterparties mature on the next banking day.

As of December 31, 2023, the Company had $2,603.0 million of FHLB borrowings due in less than one year, $99.0 million of fixed-to-floating rate subordinated notes due in more than one year, and available borrowing capacity of $3,619.6 million with the FHLB. The Company has unused federal fund lines of credit with third parties amounting to $235.0 million, subject to funds availability. These lines are subject to cancellation without notice. The Company also has an unused line of credit with the FRB for borrowings up to $3,039.5 million secured by government and agency backed securities and a blanket pledge of agricultural and commercial loans and has an unused $50.0 million revolving line of credit with another third party. For additional information concerning long-term debt, see “Notes to Consolidated Financial Statements—Long Term Debt and Other Borrowed Funds” included in Part IV, Item 15 of this report.

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The Company guarantees the distribution and payment for redemption or liquidation of capital trust preferred securities issued by our wholly owned subsidiary business trusts to the extent of funds held by the trusts. Although the guarantees are not separately recorded, the obligations underlying the guarantees are fully reflected on our consolidated balance sheets as subordinated debentures held by subsidiary trusts. The subordinated debentures currently qualify as tier 2 capital under the Federal Reserve capital adequacy guidelines. As of December 31, 2023, the Company had subordinated debentures held by subsidiary trusts of $163.1 million due in more than one year. For additional information concerning the subordinated debentures, see “Notes to Consolidated Financial Statements—Subordinated Debentures Held by Subsidiary Trusts” included in Part IV, Item 15 of this report.

The Company has future minimum rental commitments, exclusive of maintenance and operating costs, required under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 2023 with $11.6 million due in one year or less and $39.0 million due in more than one year. For additional information concerning leases, see “Notes to Consolidated Financial Statements—Commitments and Contingencies” included in Part IV, Item 15 of this report.

The Company is a limited partner in several tax-advantaged limited partnerships that have been formed for the purpose of investing in approved qualified affordable housing, renewable energy, or other renovation or community revitalization projects. As of December 31, 2023, the Company expects to recover its investments through the use of tax credits generated by the investments.

The Company has entered into various arrangements not reflected on the consolidated balance sheet that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, or liquidity. As of December 31, 2023, the Company had unused credit card lines of $814.0 million, commitments to extend credit of $4,069.2 million and standby letters of credit of $97.1 million. Among the $4,069.2 million in credit commitments outstanding, $658.5 million are related to home equity and home equity lines of credit, $1,786.4 million are related to traditional working capital commercial lines, and $926.9 million are unfunded for current or future construction projects. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. For additional information regarding our off-balance sheet arrangements, see “Notes to Consolidated Financial Statements—Financial Instruments with Off-Balance Sheet Risk” included in Part IV, Item 15 of this report.

As a bank holding company, we are a corporation separate and apart from our subsidiary Bank and, therefore, we provide for our own liquidity. Our primary sources of funding include management fees and dividends declared and paid by the Bank and access to capital markets. There are statutory, regulatory, and debt covenant limitations that affect the ability of our Bank to pay dividends to us. Management believes that such limitations will not impact our ability to meet our ongoing short-term cash obligations. For additional information regarding dividend restrictions, see “Financial Condition—Capital Resources and Liquidity” above, “Business—Government Regulation and Supervision—Dividends and Restrictions on Transfers of Funds” included in Part I, Item 1 of this report, and “Risk Factors—Liquidity Risks and Regulatory and Compliance Risks” included in Part I, Item 1A of this report.

Management continuously monitors our liquidity position and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Our management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources, or operations. In addition, our management is not aware of any regulatory recommendations regarding liquidity, which if implemented, would have a material adverse effect on us.