National Bank Holdings Corp (NBHC) FY 2024 MD&A

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

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The following management's discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes as of and for the years ended December 31, 2024, 2023, and 2022, and with the other financial and statistical data presented in this annual report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions that may cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in the section entitled “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors” and should be read herewith.

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Management’s discussion focuses on 2024 results compared to 2023. For a discussion of 2023 results compared to 2022, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2023.

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All amounts are in thousands, except share and per share data, or as otherwise noted.

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Overview

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Our focus is on building relationships by creating a win-win scenario for our clients and our Company. We believe in providing solutions and services to our clients that are based on fairness and simplicity. We have established a solid financial services franchise with a sizable presence for deposit gathering and building client relationships necessary for growth. We have executed on strategic acquisition opportunities to expand our presence in attractive markets and to diversify our revenue streams. Additionally, we are innovating and building strategic fintech partnerships with the goal of delivering a comprehensive digital financial ecosystem for our clients. We are focused on providing small and medium-sized businesses with alternative digital access to address borrowing, depository and cash management needs, while also providing information management and access to digital payment tools, under the safety of a regulated bank. We believe that our established presence in our core markets of Colorado, the greater Kansas City region, Utah, Wyoming, Texas, New Mexico and Idaho, as well as our ongoing investment in digital solutions and strategic acquisitions, position us well for growth opportunities. As of December 31, 2024, we had $9.8 billion in assets, $7.8 billion in loans, $8.2 billion in deposits, $1.3 billion in equity and $994.3 million in assets under management in our trust and wealth management business.

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Operating Highlights

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Profitability and returns

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Strategic execution

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Loan portfolio

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Credit quality

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Client deposit funded balance sheet

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Liquidity

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Revenues

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Expenses

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Strong capital position

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Key Challenges

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Macroeconomic pressures have resulted in volatility and uncertainty in the banking industry. The sustained higher-interest rate environment, declines in the fair value of securities, lack of available funding, uninsured deposits and risk from concentrations in loan and deposit segments along with declines in commercial real estate property values are drawing increased scrutiny on financial institutions. Liquidity within the financial services sector has tightened, and we expect the intense competition for deposits throughout our markets to continue. While these are widespread challenges for the banking industry, the Company has not experienced a material impact to our financial condition, operations, client base, liquidity, capital position or risk profile.

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Additionally, we face continual challenges implementing our business strategy. These include growing our assets, particularly loans, and deposits amidst intense competition, changing interest rates, adhering to changes in the regulatory environment and identifying and consummating disciplined acquisition and other expansionary opportunities in a very competitive and inflationary environment. In connection with our digital growth strategy and our digital solution 2UniFi, we have made and will continue to make investments in and also partner with third party fintech companies. The innovations these companies develop for utilization by 2UniFi may prove difficult to successfully integrate into our existing operations and may require additional operational and control systems to manage fraud, cybersecurity, operational, legal and compliance risks.

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Future growth in our interest income will ultimately be dependent on our ability to originate high-quality loans and other high-quality earning assets such as investment securities as well as our ability to access liquidity and manage our cost of funds. During the years ended December 31, 2023 and 2022, the Federal Reserve increased prevailing interest rates by a total of 100 and 425 basis points, respectively. In the second half of 2024, the Federal Reserve decreased the prevailing interest rates by a total of 100 basis points. While further cuts in 2025 remain unclear, our future earnings will be impacted by the Federal Reserve’s future interest rate policy decisions. Management employs risk management policies to monitor and limit exposure to changes in market rates, which is discussed in more detail in the Asset/Liability Management and Interest Rate Risk section of Management’s Discussion and Analysis.

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Summary of Selected Historical Consolidated Financial Data

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The following table sets forth a summary of selected historical financial information derived from our audited consolidated financial statements as of and for the five years ended December 31, 2024. This information should be read together with the related notes thereto included elsewhere in this annual report. Such information is not necessarily indicative of anticipated future results. All amounts are presented in thousands, except share and per share data, or as otherwise noted.

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Consolidated Statements of Financial Condition Data:

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Consolidated Statements of Operations Data:

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Key Metrics

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About Non-GAAP Financial Measures

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Certain of the financial measures and ratios we present, including “tangible assets,” “average tangible assets,” “return on average tangible assets,” “tangible common equity,” “tangible common equity to tangible assets,” “return on average tangible common equity,” “tangible common book value,” “tangible common book value per share,” “tangible common equity to tangible assets,” “tangible common book value, excluding accumulated other comprehensive loss, net of tax,” “tangible common book value per share, excluding accumulated other comprehensive loss, net of tax,” “net income excluding the impact of other intangible assets amortization expense, after tax,” “adjusted net income,” “adjusted net income, after tax,” “adjusted net income excluding the impact of other intangible assets amortization expense, after tax,” “adjusted earnings per share – diluted,” “adjusted return on average tangible assets,” “adjusted return on average tangible common equity,” “efficiency ratio excluding other intangible assets amortization FTE, adjusted,” “efficiency ratio excluding other intangible assets amortization, loss on security sales and acquisition-related expenses FTE,” “pre-provision net revenue,” “pre-provision net revenue FTE, adjusted for loss on security sales and acquisition-related expenses,” “non-interest income adjusted for loss on security sales,” “non-interest expense adjusted for acquisition-related expenses,” “non-interest expense excluding other intangible assets amortization and acquisition-related expenses,” and “fully taxable equivalent” metrics, are supplemental measures that are not required by, or are not presented in accordance with, U.S. generally accepted accounting principles (GAAP). We refer to these financial measures and ratios as “non-GAAP financial measures.” We consider the use of select non-GAAP financial measures and ratios to be useful for financial and operational decision making and useful in evaluating period-to-period comparisons. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding certain expenditures or assets that we believe are not indicative of our primary business operating results or by presenting certain metrics on an FTE basis. We believe that management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, analyzing and comparing past, present and future periods.

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These non-GAAP financial measures should not be considered a substitute for financial information presented in accordance with GAAP and you should not rely on non-GAAP financial measures alone as measures of our performance. The non-GAAP financial measures we present may differ from non-GAAP financial measures used by our peers or other companies. We compensate for these limitations by providing the equivalent GAAP measures whenever we present the non-GAAP financial measures and by including a reconciliation of the impact of the components adjusted for in the non-GAAP financial measure so that both measures and the individual components may be considered when analyzing our performance.

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A reconciliation of our GAAP financial measures to the comparable non-GAAP financial measures is as follows:

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Tangible Common Book Value Ratios

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Return on Average Tangible Assets and Return on Average Tangible Equity

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Fully Taxable Equivalent Yield on Earning Assets and Net Interest Margin

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Efficiency Ratio and Pre-provision Net Revenue

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Adjusted Net Income and Earnings Per Share

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Application of Critical Accounting Policies and Significant Estimates

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We use accounting principles and methods that conform to GAAP and general banking practices. We are required to apply significant judgment and make material estimates in the preparation of our financial statements and with regard to various accounting, reporting and disclosure matters. Assumptions and estimates are required to apply these principles where actual measurement is not possible or practical. The most significant of these estimates relate to the determination of the allowance for credit losses and accounting for acquired loans. See additional discussion of our ACL policy in note 2 – Summary of Significant Accounting Policies in the notes to our consolidated financial statements for the year ended December 31, 2024.

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Allowance for credit losses

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The determination of the ACL, which represents management’s estimate of lifetime credit losses inherent in our loan portfolio at the balance sheet date, involves a high degree of judgment and complexity. The Company estimates the ACL by first disaggregating the loan portfolio into segments based upon broad characteristics such as primary use and underlying collateral. Within these segments, the portfolio is further disaggregated into classes of loans with similar attributes and risk characteristics. The ACL is determined at the class level, analyzing loss history based upon specific loss drivers and risk factors affecting each loan class. The Company utilizes a discounted cash flow (“DCF”) model developed within a third-party software tool that incorporates forecasts of certain national macroeconomic factors (reasonable and supportable forecasts) which drive the losses predicted in establishing the Company’s ACL. Management accounts for the inherent uncertainty of the underlying economic forecast by reviewing and weighting alternate forecast scenarios. For periods beyond the reasonable and supportable forecast period, the Company reverts to historical long-term average loss rates on a straight-line basis. Additionally, the ACL calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience. Changes in these assumptions, estimates or the conditions surrounding them may have a material impact on our financial condition. For further discussion of the ACL, see notes 2 and 7 to our consolidated financial statements.

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Future Accounting Pronouncements

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In November 2024, the FASB issued ASU 2024-03, Income Statement—Reporting Comprehensive Income—Expense Disaggregation Disclosures (Topic 220): Disaggregation of Income Statement Expenses. The update requires public business entities to disclose specific components of certain expense categories. This includes expense categories such as employee compensation, depreciation, and intangible asset amortization. The amendments in this update are effective for fiscal years beginning after December 15, 2026 and are to be applied on a prospective basis with an option for retrospective application. Early adoption is permitted. The Company is evaluating the impact from ASU 2024-03, and does not expect the adoption of this pronouncement to have a material impact on its financial statements apart from the inclusion of additional disclosures.

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In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The update requires public business entities to disclose specific categories related to rate reconciliation. It also requires more detailed information for reconciling items, provided certain quantitative thresholds are met. The amendments in this update

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are effective for fiscal years beginning after December 15, 2024 and are to be applied on a prospective basis. Early adoption is permitted. The Company is evaluating the impact from ASU 2023-09, and does not expect the adoption of this pronouncement to have a material impact on its financial statements apart from the inclusion of additional disclosures.

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In March 2024, the FASB issued ASU 2024-01, Compensation – Stock Compensation (Topic 718): Scope Application of Profits Interest and Similar Awards. This update improves GAAP by adding an illustrative example that includes four fact patterns to demonstrate how an entity should apply the scope guidance in paragraph 718-10-15-3 to determine whether a profit interest award should be accounted for in accordance with Topic 718. The amendments in this update are effective for annual periods beginning after December 15, 2024, and interim periods within those annual periods. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance. The Company is evaluating the impact from ASU 2024-01, and does not expect the adoption of this pronouncement to have a material impact on its financial statements.

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On March 6, 2024, the SEC adopted a new set of rules that require a wide range of climate-related disclosures. The disclosures will include material climate-related risks, information on any climate-related targets or goals that are material to the registrant’s business, results of operations, or financial condition, Scope 1 and Scope 2 Greenhouse Gas emissions and disclosure of the financial statement effects of severe weather events and other natural conditions including costs and losses. Disclosures on Greenhouse Gas emissions will be subject to adoption on a phased-in basis by certain larger registrants when those emissions are material, and an attestation report covering the same will also need to be filed. Compliance dates under the final rule are phased in by registrant category. Multiple lawsuits have been filed challenging the SEC’s new climate rules, which have been consolidated and will be heard in the U.S. Court of Appeals for the Eighth Circuit. On April 4, 2024, the SEC issued an order staying the final rules until judicial review is complete.

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Financial Condition

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Total assets were $9.8 billion at December 31, 2024, compared to $9.9 billion at December 31, 2023. At December 31, 2024, cash and cash equivalents decreased $63.0 million, compared to December 31, 2023, and investment securities decreased $153.2 million, or 12.6%, primarily due to sales during the fourth quarter of 2024 as part of the Company’s strategic balance sheet management. Total loans increased $52.4 million, or 0.7% compared to December 31, 2023, and the allowance for credit losses totaled $94.5 million, or 1.22% of total loans, at December 31, 2024. At December 31, 2024 and 2023, lower cost demand, savings, and money market deposits ("transaction deposits") totaled $7.2 billion, representing 87.6% and 88.0% of total deposits, respectively. Total deposits increased $47.5 million to $8.2 billion at December 31, 2024, compared to December 31, 2023. FHLB advances totaled $50.0 million at December 31, 2024, compared to $340.0 million at December 31, 2023.

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Investment securities

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Available-for-sale

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Total investment securities available-for-sale were $527.5 million at December 31, 2024, compared to $628.8 million at December 31, 2023, a decrease of $101.3 million, or 16.1%. During the year ended December 31, 2024, purchases of available-for-sale securities totaled $185.7 million. During 2024, the Company sold $132.1 million of AFS investment securities on the open market as part of the Company’s strategic balance sheet management resulting in a pre-tax loss of $6.6 million. Proceeds from the sale have been redeployed into higher yielding securities during the first quarter of 2025. During 2023, the Company did not purchase or sell available-for-sale securities. Maturities and paydowns of available-for-sale securities during 2024 and 2023 totaled $157.5 million and $92.0 million, respectively.

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Available-for-sale investment securities are summarized in the following table as of the dates indicated. The weighted average yield was calculated based on amortized cost. Yields on tax exempt securities have not been adjusted for tax exempt status.

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As of December 31, 2024 and 2023, nearly all of the available-for-sale investment portfolio was backed by mortgages. The residential mortgage pass-through securities portfolio is comprised of both fixed rate and adjustable rate Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) and Government National Mortgage Association (“GNMA”) securities. The other mortgage-backed securities (“MBS”) are comprised of securities backed by FHLMC, FNMA and GNMA securities.

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Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average life of the available-for-sale mortgage-backed securities portfolio was 5.3 years and 5.2 years at December 31, 2024 and December 31, 2023, respectively. This estimate is based on assumptions and actual results may differ. At December 31, 2024 and December 31, 2023, the duration of the total available-for-sale investment portfolio was 4.3 years.

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At December 31, 2024 and 2023, adjustable rate securities comprised 5.9% and 13.0%, respectively, of the available-for-sale mortgage-backed security portfolio. The remainder of the portfolio was comprised of fixed rate amortizing securities with 10 to 30 year contractual maturities, with a weighted average coupon of 2.31% per annum and 1.73% per annum at December 31, 2024 and 2023, respectively.

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The available-for-sale investment portfolio included $90.9 million of unrealized losses and $0.5 million of unrealized gains at December 31, 2024. At December 31, 2023, the available-for-sale investment portfolio included $99.0 million of unrealized losses and $57 thousand of unrealized gains. We believe any unrealized losses are a result of prevailing interest rates, and as such, we do not believe that any of the securities with unrealized losses were impaired. Management believes that default of the available-for-sale securities is highly unlikely. FHLMC, FNMA and GNMA guaranteed mortgage-backed securities and U.S. Treasury securities have a long history of zero credit losses, an explicit guarantee by the U.S. government (although limited for FNMA and FHLMC securities) and yields that generally trade based on market views of prepayment and liquidity risk rather than credit risk.

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Our investment security portfolio consists of high-quality securities, which are largely backed by either U.S. government agencies or U.S. government sponsored entities. We regularly model liquidity stress scenarios to assess potential liquidity issues.

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Held-to-maturity

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At December 31, 2024, we held $533.1 million of held-to-maturity investment securities, compared to $585.1 million at December 31, 2023, a decrease of $51.9 million, or 8.9%. Purchases of held-to-maturity securities totaled $10.5 million and $2.5 million during 2024 and 2023, respectively. Maturities and paydowns of held-to-maturity securities totaled $63.1 million and $69.6 million during 2024 and 2023, respectively.

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Held-to-maturity investment securities are summarized as follows as of the dates indicated:

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The residential mortgage pass-through and other residential MBS held-to-maturity investment portfolios are comprised of fixed rate FHLMC, FNMA and GNMA securities.

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The fair value of the held-to-maturity investment portfolio included $81.8 million of unrealized losses and $51 thousand of unrealized gains at December 31, 2024. At December 31, 2023, the held-to-maturity investment portfolio included $81.0 million of unrealized losses and $0.2 million of unrealized gains.

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The Company does not measure expected credit losses on a financial asset, or groups of financial assets, in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero. Management evaluated held-to-maturity securities noting they are backed by loans guaranteed by either U.S. government agencies or U.S. government sponsored entities, and management believes that default is highly unlikely given this governmental backing and long history without credit losses. Additionally, management notes that yields on which the portfolio generally trades are based upon market views of prepayment and liquidity risk and not credit risk. The Company has no intention to sell the securities and believes it will not be required to sell the securities before the recovery of their amortized cost.

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Mortgage-backed securities may have actual maturities that differ from contractual maturities depending on the repayment characteristics and experience of the underlying financial instruments. The estimated weighted average expected life of the held-to-maturity mortgage-backed securities portfolio as of December 31, 2024 and December 31, 2023 was 5.6 years and 5.7 years, respectively. This estimate is based on assumptions and actual results may differ. The duration of the total held-to-maturity investment portfolio was 4.4 years and 4.6 years as of December 31, 2024 and December 31, 2023, respectively.

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Non-marketable securities

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The carrying balance of non-marketable securities are summarized as follows as of the dates indicated:

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Non-marketable securities included FRB stock, FHLB stock, convertible preferred stock and equity method investments. During the year ended December 31, 2024, purchases of non-marketable securities totaled $44.9 million, and proceeds from redemptions and sales of non-marketable securities totaled $57.5 million. During the year ended December 31, 2023, purchases of non-marketable securities totaled $106.2 million, and proceeds from redemptions and sales of non-marketable securities totaled $100.0 million. Changes in the Company’s FHLB stock holdings were directly correlated to FHLB line of credit advances and paydowns. Purchases consisted primarily of FHLB stock, and proceeds consisted primarily of redemptions of FHLB stock.

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FRB and FHLB stock

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At December 31, 2024 and December 31, 2023, the Company held FRB stock and FHLB stock for regulatory or debt facility purposes. These are restricted securities which, lacking a market, are carried at cost. There have been no identified events or changes in circumstances that may have an adverse effect on the FRB and FHLB stock carried at cost.

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Convertible preferred stock

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Non-marketable securities include convertible preferred stock without a readily determinable fair value. During the years ended December 31, 2024 and 2023, the Company purchased $0.4 million of convertible preferred stock. During the year ended December 31, 2024, convertible preferred stock was redeemed upon the sale of a single investment position that totaled $1.0 million, which generated realized gains of $0.1 million recorded in other non-interest income in the Company’s consolidated statements of operations. The Company recorded $3.9 million of impairment during the year ended December 31, 2024, compared to $4.0 million during 2023, on convertible preferred stock related to venture capital investments, included in other non-interest income in the Company’s consolidated statements of operations.

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Equity method investments

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Non-marketable securities also include equity method investments totaling $26.2 million and $24.6 million at December 31, 2024 and December 31, 2023, respectively, and equity method investments without a readily determinable fair value totaling $1.8 million and zero at December 31, 2024 and December 31, 2023, respectively. Purchases of equity method investments during the years ended December 31, 2024 and 2023 totaled $1.5 million and $3.6 million, respectively. During the years ended December 31, 2024 and 2023, the Company recorded net unrealized gains totaling $1.0 million and net unrealized losses totaling $35 thousand, respectively, on equity method investments. These gains and losses were recorded in other non-interest income in the Company’s consolidated statements of operations. Carrying values of equity method investments without a readily determinable fair value are updated periodically and impairments may be taken to reflect a new basis. The Company recorded no impairment related to equity method investments without a readily determinable fair value for the years ended December 31, 2024 or 2023.

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Loans overview

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At December 31, 2024, our loan portfolio was comprised of new loans that we have originated and loans that were acquired in connection with our acquisitions.

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The table below shows the loan portfolio composition at the respective dates:

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The Company maintains a granular and well-diversified loan portfolio with self-imposed concentration limits. The loan portfolio increased $52.4 million, or 0.7%, from December 31, 2023 to December 31, 2024, led by an increase in commercial loans of $171.4 million.

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Our commercial and industrial loan portfolio is highly diversified across industry sectors and geography. As of December 31, 2024, there were no industry sectors representing more than 15.0% of our total loan portfolio. Key sectors included government/non-profit loans of $825.6 million, or 10.7% of total loans, and health care/hospital loans of $584.9 million, or 7.5% of total loans. The commercial and industrial portfolio also includes loans to companies that operate in the transportation industry. The transportation industry, trucking in particular, experienced some economic challenges in 2024. As a result of these industry challenges, some of the transportation loans may be subject to higher credit risk. The Company’s exposure to this industry is small, consisting of $205.2 million, or 2.6% of total loans, at December 31, 2024.

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Non-owner occupied CRE loans were 152.6% of the Company’s risk based capital, or 23.4% of total loans, and no specific property type comprised more than 10.0% of total loans. The Company maintains very little exposure to non-owner occupied CRE retail properties and office properties, comprising 2.0% and 1.3% of total loans, respectively. Multi-family loans totaled $321.8 million, or 4.2% of total loans as of December 31, 2024.

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The agriculture industry continues to be impacted by volatile commodity prices and generally by higher input costs, combining to stress margins. Our food and agribusiness portfolio is 3.9% of total loans and is well-diversified across food production, crop and livestock types. Crop and livestock loans represent 1.1% of total loans. We have maintained relationships with food and agribusiness clients that generally possess low leverage and, correspondingly, low bank debt to assets, minimizing any potential credit losses in the future.

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New loan origination is a direct result of our ability to recruit and retain top banking talent, connect with clients in our markets and provide needed services at competitive rates. Loan fundings totaled $1.5 billion during 2024, led by commercial loan fundings of $1.0 billion. Fundings are defined as closed end funded loans and revolving lines of credit advances net of any current period paydowns. Management utilizes this definition of fundings to better approximate the impact of fundings on loans outstanding and ultimately net interest income.

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The following tables represent new loan fundings during 2024 and 2023:

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Included in fundings are net fundings (paydowns) under revolving lines of credit totaling $64,375, $16,302, $19,281 and $(59,523) for the dates noted in the table above, respectively.

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Included in the table above are quarterly net fundings (paydowns) under revolving lines of credit totaling $16,954, ($12,877), $13,766 and ($7,096) for the dates noted in the table above, respectively.

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The tables below show the contractual maturities of our total loans for the dates indicated:

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The stated interest rate (which excludes the effects of non-refundable loan origination and commitment fees, net of costs and the accretion of fair value marks) of total loans with maturities over one year is as follows at the dates indicated:

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Asset quality

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Asset quality is fundamental to our success and remains a strong point, driven by our disciplined adherence to our self-imposed concentration limits across industry sector and real estate property type. Accordingly, for the origination of loans, we

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have established a credit policy that allows for responsive, yet controlled lending with credit approval requirements that are scaled to loan size. Within the scope of the credit policy, each prospective loan is reviewed in order to determine the appropriateness and the adequacy of the loan characteristics and the security or collateral prior to making a loan. We have established underwriting standards and loan origination procedures that require appropriate documentation, including financial data and credit reports. For loans secured by real property, we require property appraisals, title insurance or a title opinion, hazard insurance and flood insurance, in each case where appropriate.

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Additionally, we have implemented procedures to timely identify loans that may become problematic in order to ensure the most beneficial resolution for the Company. Asset quality is monitored by our credit risk management department and evaluated based on quantitative and subjective factors such as the timeliness of contractual payments received. Additional factors that are considered, particularly with commercial loans over $500,000, include the financial condition and liquidity of individual borrowers and guarantors, if any, and the value of our collateral. To facilitate the oversight of asset quality, loans are categorized based on the number of days past due and on an internal risk rating system, and both are discussed in more detail below.

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Our internal risk rating system uses a series of grades which reflect our assessment of the credit quality of loans based on an analysis of the borrower's financial condition, liquidity and ability to meet contractual debt service requirements. Loans that are perceived to have acceptable risk are categorized as “Pass” loans. “Special mention” loans represent loans that have potential credit weaknesses that deserve close attention. Special mention loans include borrowers that have potential weaknesses or unwarranted risks that, unless corrected, may threaten the borrower's ability to meet debt service requirements. However, these borrowers are still believed to have the ability to respond to and resolve the financial issues that threaten their financial situation. Loans classified as “Substandard” have a well-defined credit weakness and are inadequately protected by the current paying capacity of the obligor or of the collateral pledged, if any. Although these loans are identified as potential problem loans, they may never become non-performing. Substandard loans have a distinct possibility of loss if the deficiencies are not corrected. “Doubtful” loans are loans that management believes that collection of payments in accordance with the terms of the loan agreement are highly questionable and improbable. Doubtful loans are deemed impaired and put on non-accrual status.

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The Company’s policy is to review each prospective credit to determine the appropriateness and the adequacy of security or collateral prior to making a loan. In the event of borrower default, the Company seeks recovery in compliance with lending laws, the respective loan agreements, and credit monitoring and remediation procedures that may include modifying a loan to provide a concession by the Company to the borrower from their original terms due to borrower financial difficulties in order to facilitate repayment. Such modified loans are considered troubled debt modifications (“TDMs”). TDMs may include principal forgiveness, interest rate reductions, other-than-insignificant-payment delays, term extensions or any combination thereof. Assets that have been foreclosed on or acquired through deed-in-lieu of foreclosure are classified as OREO until sold, and are carried at the fair value of the collateral less estimated costs to sell, with any initial valuation adjustments charged to the ACL and any subsequent declines in carrying value charged to impairments on OREO.

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Non-performing assets and past due loans

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Non-performing assets consist of non-accrual loans and OREO. Interest income that would have been recorded had non-accrual loans performed in accordance with their original contract terms during 2024 and 2023 was $2.0 million and $0.6 million, respectively.

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Past due status is monitored as an indicator of credit deterioration. Loans are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. Loans that are 90 days or more past due are put on non-accrual status unless the loan is well secured and in the process of collection.

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The following table sets forth the non-performing assets and past due loans as of the dates presented:

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During 2024 and 2023, total non-performing loans totaled $36.0 million and $28.2 million, respectively. During 2024 and 2023, accruing TDMs totaled $15.3 million and $15.1 million, respectively. Total non-performing assets to total loans and OREO totaled 0.47% and 0.42% at December 31, 2024 and 2023, respectively.

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Loans 30-89 days past due and still accruing interest were 0.30% and 0.16% of total loans at December 31, 2024 and December 31, 2023, respectively. Loans 90 days or more past due and still accruing interest were 0.19% and 0.01% of total loans for December 31, 2024 and 2023, respectively.

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Allowance for credit losses

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The ACL represents the amount that we believe is necessary to absorb estimated lifetime credit losses inherent in the loan portfolio at the balance sheet date and involves a high degree of judgment and complexity. The Company utilizes a DCF model developed within a third-party software tool to establish expected lifetime credit losses for the loan portfolio. The ACL is calculated as the difference between the amortized cost basis and the projections from the DCF analysis. The DCF model allows for individual lifetime loan cash flow modeling, excluding extensions and renewals, using loan-specific interest rates and repayment schedules including estimated prepayment rates and loss recovery timing delays. The model incorporates forecasts of certain national macro-economic factors, including unemployment rates, home price index (“HPI”), retail sales and gross domestic product (“GDP”), which drive correlated loss rates. The determination and application of the ACL accounting policy involves judgments, estimates and uncertainties that are subject to change. For periods beyond the reasonable and supportable forecast period, the Company reverts to historical long-term average loss rates on a straight-line basis.

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We measure expected credit losses for groups of loans included in segments with similar risk characteristics. We have identified four primary loan segments within the ACL model that are further stratified into 11 loan classes to provide more granularity in analyzing loss history and to allow for more definitive qualitative adjustments based upon specific risk factors

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affecting each loan class. Generally, the underlying risk of loss for each of these loan segments will follow certain norms/trends in various economic environments. Loans that do not share risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. Following are the loan classes within each of the four primary loan segments:

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Loans on non-accrual, in bankruptcy and TDMs with a balance greater than $250 thousand are excluded from the pooled analysis and are evaluated individually. If management determines that foreclosure is probable, expected credit losses are evaluated based on the criteria listed below, adjusted for selling costs as appropriate. Typically, these loans consist of commercial, commercial real estate and agriculture loans and exclude homogeneous loans such as residential real estate and consumer loans. Specific allowances are determined by collectively analyzing:

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The resulting ACL for loans is calculated as the sum of the general reserves, specific reserves on individually evaluated loans, and qualitative factor adjustments. While these amounts are calculated by individual loan or by segment and class, the entire ACL is available for any loan that, in our judgment, should be charged off. The determination and application of the ACL accounting policy involves judgments, estimates, and uncertainties that are subject to change. Changes in these assumptions, estimates or the conditions surrounding them may have a material impact on our financial condition, liquidity or results of operations.

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At December 31, 2024 and 2023, the allowance for credit losses totaled $94.5 million and $97.9 million, respectively. The decrease during 2024 was driven by the resolution of non-performing loans and changes in the CECL model’s underlying macro-economic forecast. Specific reserves on loans totaled $6.4 million at December 31, 2024, compared to $8.6 million at December 31, 2023.

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Net charge-offs on loans during the year ended December 31, 2024 totaled $9.8 million, and the ratio of net charge-offs to average total loans totaled 0.13%. Net charge-offs on loans during the year ended December 31, 2023 totaled $1.1 million, and the ratio of net charge-offs to average total loans totaled 0.02%.

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The Company has elected to exclude accrued interest receivable (“AIR”) from the ACL calculation. As of December 31, 2024 and December 31, 2023, AIR from loans totaled $41.5 million and $42.4 million, respectively. When a loan is placed on non-accrual, any recorded AIR is reversed against interest income.

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Total ACL

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After considering the above mentioned factors, we believe that the ACL of $94.5 million is adequate to cover estimated lifetime losses inherent in the loan portfolio at December 31, 2024. However, it is likely that future adjustments to the ACL will be necessary. Any changes to the underlying assumptions, circumstances or estimates, including but not limited to changes in the underlying macro-economic forecast, used in determining the ACL, could negatively or positively affect the Company's results of operations, liquidity or financial condition.

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The following schedule presents, by class stratification, the changes in the ACL during the years listed:

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The following tables present the allocation of the ACL and the percentage of the total amount of loans in each loan category listed as of the dates presented:

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