UMB FINANCIAL CORP (UMBF) FY 2021 MD&A

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

Management’s Discussion and Analysis

This Management’s Discussion and Analysis highlights the material changes in the results of operations and changes in financial condition for each of the three years in the period ended December 31, 2021.  It should be read in conjunction with the accompanying Consolidated Financial Statements, Notes to Consolidated Financial Statements, and other financial statistics appearing elsewhere in this Annual Report on Form 10-K. Results of operations for the periods included in this review are not necessarily indicative of results to be attained during any future period.

CAUTIONARY NOTICE ABOUT FORWARD-LOOKING STATEMENTS

From time to time the Company has made, and in the future will make, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often use words such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project,” “outlook,” “forecast,” “target,” “trend,” “plan,” “goal,” or other words of comparable meaning or future-tense or conditional verbs such as “may,” “will,” “should,” “would,” or “could.” Forward-looking statements convey the Company’s expectations, intentions, or forecasts about future events, circumstances, results, or aspirations.

This report, including any information incorporated by reference in this report, contains forward-looking statements. The Company also may make forward-looking statements in other documents that are filed or furnished with the SEC. In addition, the Company may make forward-looking statements orally or in writing to investors, analysts, members of the media, or others.

All forward-looking statements, by their nature, are subject to assumptions, risks, and uncertainties, which may change over time and many of which are beyond the Company’s control. You should not rely on any forward-looking statement as a prediction or guarantee about the future.  Actual future objectives, strategies, plans, prospects, performance, conditions, or results may differ materially from those set forth in any forward-looking statement. While no list of assumptions, risks, or uncertainties could be complete, some of the factors that may cause actual results or other future events, circumstances, or aspirations to differ from those in forward-looking statements include:

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Any forward-looking statement made by the Company or on its behalf speaks only as of the date that it was made. The Company does not undertake to update any forward-looking statement to reflect the impact of events, circumstances, or results that arise after the date that the statement was made, except as required by applicable securities laws. You, however, should consult further disclosures (including disclosures of a forward-looking nature) that the Company may make in any subsequent Annual Report on Form 10-K, Quarterly Report on Form 10-Q, or Current Report on Form 8-K.

Results of Operations

Overview

During the first quarter of 2020, the global economy began experiencing a downturn related to the impacts of the COVID-19 global pandemic (the COVID-19 pandemic, or the pandemic).  Such impacts have included significant volatility in the global stock and fixed income markets, a 150-basis-point reduction in the target federal funds rate, the enactment of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the American Rescue Plan Act of 2021, both authorizing the Paycheck Protection Program (PPP) administered by the Small Business Administration, and a variety of rulings from the Company’s banking regulators.

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The Company continues to actively monitor developments related to COVID-19 and its impact to its business, customers, employees, counterparties, vendors, and service providers. During the year ended December 31, 2021, the Company’s results of operations included continued maintenance of the allowance for credit losses (ACL) at a level appropriate given the state of key macroeconomic variables utilized in the econometric models at December 31, 2021.  Additionally, the Company continued to see impacts of the volatile equity and debt markets and low interest rate environment in its fee-based businesses.

In response to the COVID-19 pandemic, the Company formed a Pandemic Taskforce and a steering group comprised of associates across multiple lines of business and support functions and has taken several actions to offer various forms of support to its customers, employees, and communities that have experienced impacts resulting from the COVID-19 pandemic. The Company has also increased purchases of computer hardware to support a remote workforce, as well as incurred additional cleaning and janitorial expense to disinfect branch and office locations.  The Company has actively worked with customers impacted by the economic downturn by offering payment deferrals and other loan modifications.  See further details under “Credit Risk Management” within “Item 7A. Quantitative and Qualitative Disclosures about Market Risk.”

The COVID-19 pandemic and stay-at-home and similar mandates have also necessitated certain actions related to the way the Company operates its business. The Company transitioned most of its workforce off-site or to work-from-home to help mitigate health risks and is currently moving forward with plans to bring associates back in the office in a phased approach during the first half of 2022. The Company is also carefully monitoring the activities of its vendors and other third-party service providers to mitigate the risks associated with any potential service disruptions.

The Company has detailed the impact of the COVID-19 pandemic in each applicable section of “Management's Discussion and Analysis of Financial Condition and Results of Operations” included below.

The Company focuses on the following four core financial objectives.  Management believes these objectives will guide its efforts to achieve its vision, to deliver the Unparalleled Customer Experience, all while seeking to improve net income and strengthen the balance sheet while undertaking prudent risk management.

The first financial objective is to continuously improve operating efficiencies. The Company has focused on identifying efficiencies that simplify its organizational and reporting structures, streamline back office functions and take advantage of synergies and newer technologies among various platforms and distribution networks. The Company has identified and expects to continue identifying ongoing efficiencies through the normal course of business that, when combined with increased revenue, will contribute to improved operating leverage.  For 2021, total revenue decreased 0.7%, and noninterest expense increased 1.4%, as compared to the previous year.  Revenue for 2020 included a gain on the Company’s investment in Tattooed Chef, Inc. (TTCF) of $108.8 million. Revenue for 2021 included a loss of $15.4 million on TTCF.  The Company continues to invest in technological advances that it believes will help management drive operating leverage in the future through improved data analysis and automation. The Company also continues to evaluate core systems and will invest in enhancements that it believes will yield operating efficiencies.

The second financial objective is to increase net interest income through profitable loan and deposit growth and the optimization of the balance sheet.  For 2021, net interest income increased $84.3 million, or 11.5%, as compared to the previous year. The Company has shown increased net interest income through the effects of increased volume, the mix of average earning assets, and PPP income.  Loans recorded under the PPP increased loan interest income by $12.4 million in 2021 as compared to 2020.  The additional increase in interest income was driven by increased loan and securities balances and liquidity.  These increases were offset by a lower rate environment.  Average earning assets increased $6.7 billion, or 24.7%, compared to 2020.  Average loan balances increased $1.5 billion, average securities increased $2.2 billion, and average interest-bearing due from banks increased $2.8 billion from prior year. Average PPP loans decreased $229.0 million.  The funding for these assets was driven primarily by a 17.5% increase in average interest-bearing liabilities and 43.5% increase in noninterest-bearing deposits.  Net interest margin, on a tax-equivalent basis, decreased 31 basis points compared to the same period in 2020.

The third financial objective is to grow the Company’s revenue from noninterest sources.  The Company seeks to grow noninterest revenues throughout all economic and interest rate cycles, while positioning itself to benefit in periods of economic growth.  Noninterest income decreased $93.0 million, or 16.6%, to $467.2 million for the year ended December 31, 2021, compared to the same period in 2020.  This decrease was primarily driven by the $108.8

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million gain on the Company’s investment in TTCF in 2020, coupled with a loss on TTCF of $15.4 million in 2021.  The decreased revenue attributed to TTCF is offset by increased fund services income and corporate trust income.  These changes are discussed in greater detail below under Noninterest income. As of December 31, 2021, noninterest income represented 36.4% of total revenues, as compared to 43.4% for 2020.

The fourth financial objective is effective capital management.  The Company places a significant emphasis on maintaining a strong capital position, which management believes promotes investor confidence, provides access to funding sources under favorable terms, and enhances the Company’s ability to capitalize on business growth and acquisition opportunities. The Company continues to maximize shareholder value through a mix of reinvesting in organic growth, evaluating acquisition opportunities that complement the Company’s strategies, increasing dividends over time, and appropriately utilizing a share repurchase program.  At December 31, 2021, the Company had a total risk-based capital ratio of 13.88% and $3.1 billion in total shareholders’ equity, an increase of $128.5 million, or 4.3%, compared to total shareholders’ equity at December 31, 2020. The Company repurchased 68 thousand shares of common stock at an average price of $81.36 per share during 2021 and declared $67.3 million in dividends, which represents a 10.9% increase compared to dividends declared during 2020.

Earnings Summary

The Company recorded consolidated net income of $353.0 million for the year ended December 31, 2021.  This represents a 23.2% increase over 2020.  Net income for 2020 was $286.5 million, or an increase of 17.6% compared to 2019.  Basic earnings per share for the year ended December 31, 2021, were $7.31 per share compared to $5.95 per share in 2020, an increase of 22.9%.  Basic earnings per share were $4.99 per share in 2019, or an increase of 19.2% from 2019 to 2020. Fully diluted earnings per share increased 22.1% from 2020 to 2021 and increased 19.6% from 2019 to 2020.  Return on average assets and return on average common shareholder’s equity for the year ended December 31, 2021 were 1.00% and 11.43%, respectively, compared to 1.00% and 10.21%, respectively, for the year ended December 31, 2020.  Return on average assets and return on average common shareholder’s equity for the year ended December 31, 2019 were 1.02% and 9.94%, respectively.

The Company’s net interest income increased to $815.5 million in 2021 compared to $731.2 million in 2020 and $670.9 million in 2019.  In total, net interest income increased $84.3 million, as compared to 2020, primarily driven by a favorable volume variance of $85.0 million.  See Table 2.  The favorable volume variance on earning assets was predominantly driven by an increase of $6.7 billion in average earning assets, or 24.7%.  Average interest-bearing due from banks increased $2.8 billion, average securities balances increased $2.2 billion, and average loan balances increased $1.5 billion for 2021 compared to the same period in 2020.  Net interest margin, on a fully tax-equivalent basis (FTE), decreased to 2.50% for 2021, compared to 2.81% for the same period in 2020, as the asset yields and the cost of interest-bearing liabilities decreased, coupled with an increased balance sheet.  This created significant margin compression.  The Company has seen a decrease in the benefit from interest-free funds as compared to 2020 driven by the lower rate environment.  The impact of this benefit decreased seven basis points compared to 2020 and is illustrated on Table 3.  The magnitude and duration of this impact will be largely dependent upon the FRB’s policy decisions and market movements. See Table 18 in Item 7A for an illustration of the impact of an interest rate increase or decrease on net interest income as of December 31, 2021.

The provision for credit losses totaled $20.0 million for the year ended December 31, 2021, which is a decrease of $110.5 million, or 84.7%, compared to the same period in 2020.  This change is the result of the adoption of the CECL standard in 2020 and applying this methodology for computing the allowance for credit losses, coupled with the impacts of the current and forecasted economic environment related to the COVID-19 pandemic. See further discussion in “Provision and Allowance for Credit Losses” in this report.

The Company had a decrease of $93.0 million, or 16.6%, in noninterest income in 2021, as compared to 2020, and an increase of $133.4 million, or 31.3%, in 2020, compared to 2019.  The decrease in 2021 and increase in 2020 is primarily attributable to a decrease of $115.6 million and an increase of $118.4 million in Investment securities gains, net.  This is primarily driven by the $108.8 million gain on the Company’s investment in TTCF in 2020 and a loss of $15.4 million in 2021.  The decrease in 2021 is also impacted by increased fund services income, corporate trust, and bankcard income.  These are offset by a decrease in brokerage income.  The change in noninterest income in 2021 from 2020, and 2020 from 2019 is illustrated in Table 6.

Noninterest expense increased in 2021 by $11.6 million, or 1.4%, compared to 2020 and increased by $43.1 million, or 5.5%, in 2020 compared to 2019.  The increase in 2021 is primarily driven by increases in processing

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fees and salary and employee benefits expense, offset by lower operating losses and equipment expense.  The increase in noninterest expense in 2021 from 2020, and 2020 from 2019 is illustrated in Table 7.

Net Interest Income

Net interest income is a significant source of the Company’s earnings and represents the amount by which interest income on earning assets exceeds the interest expense paid on liabilities.  The volume of interest earning assets and the related funding sources, the overall mix of these assets and liabilities, and the interest rates paid on each affect net interest income.  Table 2 summarizes the change in net interest income resulting from changes in volume and rates for 2021, 2020 and 2019.

Net interest margin, presented in Table 1, is calculated as net interest income on a fully tax- equivalent basis as a percentage of average earning assets.  Net interest income is presented on a tax-equivalent basis to adjust for the tax-exempt status of earnings from certain loans and investments, which are primarily obligations of state and local governments.  A critical component of net interest income and related net interest margin is the percentage of earning assets funded by interest-free sources.  Table 3 analyzes net interest margin for the three years ended December 31, 2021, 2020 and 2019.  Net interest income, average balance sheet amounts and the corresponding yields earned and rates paid for the years 2019 through 2021 are presented in Table 1 below.

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The following table presents, for the periods indicated, the average earning assets and resulting yields, as well as the average interest-bearing liabilities and resulting yields, expressed in both dollars and rates.

Table 1

THREE YEAR AVERAGE BALANCE SHEETS/YIELDS AND RATES (tax-equivalent basis)

(in millions)

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THREE YEAR AVERAGE BALANCE SHEETS/YIELDS AND RATES (tax-equivalent basis)

(in millions)

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Table 2

RATE-VOLUME ANALYSIS (in thousands)

This analysis attributes changes in net interest income either to changes in average balances or to changes in average interest rates for earning assets and interest-bearing liabilities.  The change in net interest income that is due to both volume and interest rate has been allocated to volume and interest rate in proportion to the relationship of the absolute dollar amount of the change in each.  All interest rates are presented on a tax-equivalent basis and give effect to tax-exempt interest income net of the disallowance of interest expense for federal income tax purposes, related to certain tax-free assets.  The loan average balances and rates include nonaccrual loans.

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Table 3

ANALYSIS OF NET INTEREST MARGIN (in thousands)

The Company experienced an increase in net interest income of $84.3 million, or 11.5%, for the year ended December 31, 2021, compared to 2020.  This follows an increase of $60.3 million, or 9.0%, for the year ended December 31, 2020, compared to 2019.  Average earning assets for the year ended December 31, 2021 increased by $6.7 billion, or 24.7%, compared to the same period in 2020.  Net interest margin, on a tax-equivalent basis, decreased to 2.50% for 2021 compared to 2.81% in 2020.

The Company funds a significant portion of its balance sheet with noninterest-bearing demand deposits.  Noninterest-bearing demand deposits represented 45.9%, 36.5% and 32.1% of total outstanding deposits at December 31, 2021, 2020 and 2019, respectively.  As illustrated in Table 3, the impact from these interest-free funds was eight basis points in 2021, as compared to 15 basis points in 2020 and 43 basis points in 2019.

The Company has experienced an increase in net interest income during 2021 due to a volume variance of $85.0 million, offset by a very minimal negative rate variance of $0.7 million.  The average rate on earning assets during 2021 has decreased by 46 basis points, while the average rate on interest-bearing liabilities decreased by 22 basis points, resulting in a 24 basis-point decrease in spread.  The volume of loans has increased from an average of $15.1 billion in 2020 to an average of $16.6 billion in 2021 driven by organic loan growth.  The volume of interest-bearing liabilities increased from $17.5 billion in 2020 to $20.6 billion in 2021.  The Company expects to see continued volatility in the economic markets and government responses to these changes as a result of the COVID-19 pandemic.  These changing economic conditions and governmental responses could have impacts on the balance sheet and income statement of the Company in 2022.  Loan-related earning assets tend to generate a higher spread than those earned in the Company’s investment portfolio.  By design, the Company’s investment portfolio is moderate in duration and liquid in its composition of assets.

During 2022, approximately $1.6 billion of available-for-sale securities are expected to have principal repayments.  This includes approximately $453 million which will have principal repayments during the first quarter of 2022.  The available-for-sale investment portfolio had an average life of 67.6 months, 70.1 months, and 70.9 months as of December 31, 2021, 2020, and 2019, respectively.

Provision and Allowance for Credit Losses

The ACL represents management’s judgment of total expected losses included in the Company’s loan portfolio as of the balance sheet date.  The Company’s process for recording the ACL is based on the evaluation of the Company’s lifetime historical loss experience, management’s understanding of the credit quality inherent in the loan portfolio, and the impact of the current economic environment, coupled with reasonable and supportable economic forecasts.

A mathematical calculation of an estimate is made to assist in determining the adequacy and reasonableness of management’s recorded ACL.  To develop the estimate, the Company follows the guidelines in Accounting Standards Codification (ASC) Topic 326, Financial Instruments – Credit Losses (ASC 326).  The estimate reserves for assets held at amortized cost and any related credit deterioration in the Company’s available-for-sale debt security portfolio.  Assets held at amortized cost include the Company’s loan book and held-to-maturity security portfolio.

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The process involves the consideration of quantitative and qualitative factors relevant to the specific segmentation of loans.  These factors have been established over decades of financial institution experience and include economic observation and loan loss characteristics.  This process is designed to produce a lifetime estimate of the losses, at a reporting date, that includes evaluation of historical loss experience, current economic conditions, reasonable and supportable forecasts, and the qualitative framework outlined by the Office of the Comptroller of the Currency in the published 2020 Interagency Policy Statement.  This process allows management to take a holistic view of the recorded ACL reserve and ensure that all significant and pertinent information is considered.

The Company considers a variety of factors to ensure the safety and soundness of its estimate including a strong internal control framework, extensive methodology documentation, credit underwriting standards which encompass the Company’s desired risk profile, model validation, and ratio analysis.  If the Company’s total ACL estimate, as determined in accordance with the approved ACL methodology, is either outside a reasonable range based on review of economic indicators or by comparison of historical ratio analysis, the ACL estimate is an outlier and management will investigate the underlying reason(s).  Based on that investigation, issues or factors that previously had not been considered may be identified in the estimation process, which may warrant adjustments to estimated credit losses.

The ending result of this process is a recorded consolidated ACL that represents management’s best estimate of the total expected losses included in the loan portfolio, held-to-maturity securities, and credit deterioration in available-for-sale securities.

Table 4 presents the components of the allowance by loan portfolio segment.  The Company manages the ACL against the risk in the entire loan portfolio and therefore, the allocation of the ACL to a particular loan segment may change in the future.  Management of the Company believes the present ACL is adequate considering the Company’s loss experience, delinquency trends and current economic conditions.  Future economic conditions and borrowers’ ability to meet their obligations, however, are uncertainties which could affect the Company’s ACL and/or need to change its current level of provision.  For more information on loan portfolio segments and ACL methodology refer to Note 3, “Loans and Allowance for Credit Losses,” in the Notes to the Consolidated Financial Statements.

Table 4

ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES ON LOANS (in thousands)

This table presents an allocation of the allowance for credit losses on loans and percent of loans to total loans by loan portfolio segment, which represents the total expected losses derived by both quantitative and qualitative methods. The amounts presented are not necessarily indicative of actual future charge-offs in any particular category and are subject to change.

Table 5 presents a summary of the Company’s ACL for the years ended December 31, 2021 and 2020.  Also, please see “Quantitative and Qualitative Disclosures About Market Risk – Credit Risk Management” in this report for information relating to nonaccrual, past due, restructured loans, and other credit risk matters.  For more information on loan portfolio segments and ACL methodology refer to Note 3, “Loans and Allowance for Credit Losses,” in the Notes to the Consolidated Financial Statements.

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As illustrated in Table 5 below, the ACL decreased as a percentage of total loans to 1.13% as of December 31, 2021, compared to 1.34% as of December 31, 2020.  The provision for credit losses, including provision for off-balance sheet credit exposures, totaled $20.0 million for the year ended December 31, 2021, which is a decrease of $110.5 million, or 84.7%, compared to the same period in 2020. The provision for credit losses, including provision for off-balance sheet credit exposures, totaled $130.5 million for the year ended December 31, 2020.  This decrease is the result of the impacts of the current and forecasted economic environment related to the COVID-19 pandemic during 2020 and 2021, coupled with various portfolio changes.

Table 5

ANALYSIS OF ALLOWANCE FOR CREDIT LOSSES (in thousands)

Noninterest Income

A key objective of the Company is the growth of noninterest income to provide a diverse source of revenue not directly tied to interest rates.  Fee-based services are typically non-credit related and are not generally affected by fluctuations in interest rates.  Noninterest income decreased in 2021 by $93.0 million, or 16.6%, compared to 2020 and increased in 2020 by $133.4 million, or 31.3%, compared to 2019.  The decrease in 2021 is primarily

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attributable to a decrease in investment securities gains, net, offset by increased fund services income, corporate trust income, and bankcard income. These are offset by a decrease in brokerage income.  The increase in 2020 is primarily attributable to investment securities gains, net, fund services income, and trading and investment banking income.

The Company’s fee-based services offer multiple products and services, which management believes will more closely align with customer product demands.  The Company is currently emphasizing fee-based services including trust and securities processing, bankcard, securities trading and brokerage and cash and treasury management.  Management believes that it can offer these products and services both efficiently and profitably, as most have common platforms and support structures.

Table 6

SUMMARY OF NONINTEREST INCOME (in thousands)

Noninterest income and the year-over-year changes in noninterest income are summarized in Table 6 above.  The dollar change and percent change columns highlight the respective net increase or decrease in the categories of noninterest income in 2021 compared to 2020, and in 2020 compared to 2019.

Trust and securities processing income consists of fees earned on personal and corporate trust accounts, custody of securities services, trust investments and wealth management services, and mutual fund assets servicing.  This income category increased by $29.5 million, or 15.1% in 2021, compared to 2020, and increased by $17.7 million, or 10.0%, in 2020, compared to 2019.  During 2021, fund services income increased $27.5 million and corporate trust income increased $5.8 million, offset by a decrease in wealth management income of $3.8 million.  During 2020, fund services income increased $10.6 million and corporate trust income increased $7.2 million.

Trading and investment banking income decreased $2.0 million, or 6.1%, in 2021 compared to 2020 and increased $9.5 million, or 40.4%, in 2020 compared to 2019.  The decrease in 2021 compared to 2020 was driven by slightly lower trading volume and lower market values.  The increase in 2020 compared to 2019 was driven by increased bond trading volume.

Service charges on deposits income increased $2.2 million, or 2.6%, in 2021 compared to 2020 and increased $1.1 million, or 1.4%, in 2020 compared to 2019.  The increase in 2021 compared to 2020 was driven by increased corporate service charge income.  The increase in 2020 compared to 2019 was driven by increased healthcare services income.

Brokerage fees decreased $12.2 million, or 50.0%, in 2021 compared to 2020 and $6.9 million, or 22.1%, in 2020 compared to 2019.  These decreases were primarily due to lower money market and 12b-1 income driven by a decrease in volume and interest rates.

Bankcard fees increased $4.0 million, or 6.7%, in 2021 compared to 2020, and decreased $6.2 million, or 9.3%, in 2020 compared to 2019.  The increase in 2021 compared to 2020 was primarily driven by increased interchange income, offset by increased rewards and rebate expense.  The decrease in 2020 compared to 2019 was primarily driven by decreased interchange income, offset by decreased rewards and rebate expense.

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Investment securities gains, net decreased $115.6 million in 2021 compared to 2020 but increased by $118.4 million in 2020 compared to 2019, primarily driven by changes in valuation of the Company’s investment in TTCF.  The decrease in 2021 was driven by the $15.4 million loss in 2021 on TTCF, coupled with the $108.8 million gain on TTCF recorded in 2020.  This decrease was offset by an increase of $5.9 million in gains on equity securities without readily determinable fair values.  The increase in 2020 was driven by the $108.8 million gain on TTCF, an increase of $3.9 million in gains on equity securities without readily determinable fair values, and an increase of $3.8 million in gains on sales of available-for-sale securities.

Noninterest Expense

Noninterest expense increased in 2021 by $11.6 million, or 1.4%, compared to 2020 and increased in 2020 by $43.1 million, or 5.5%, compared to 2019.  From 2020 to 2021 the increases were driven by processing fees and salary and employee benefits expense, offset by other miscellaneous expense, and equipment expense.  The main drivers of the increase from 2019 to 2020 were driven by salary and employee benefits expense, other miscellaneous expense, and equipment expense, offset by a decrease in marketing and business development expense.  Table 7 below summarizes the components of noninterest expense and the respective year-over-year changes for each category.

Table 7

SUMMARY OF NONINTEREST EXPENSE (in thousands)

Salaries and employee benefits expense increased $9.0 million, or 1.8%, in 2021 compared to 2020 and $34.0 million, or 7.4%, in 2020 compared to 2019.  In 2021, bonus and commission expense increased $8.7 million, or 7.5%, driven by business volumes and revenue growth, and higher company performance.  Salary and wage expense increased $1.7 million, or 0.6%.  These increases were offset by a decrease in employee benefits expense of $1.4 million, or 1.7%.  In 2020, bonus and commission expense increased $23.6 million, or 25.3%, driven by business volumes and revenue growth, and higher company performance.  Salary and wage expense increased $12.1 million, or 4.3%.  These increases were offset by a decrease in employee benefits expense of $1.7 million, or 2.1%.

Equipment expense decreased $7.3 million, or 8.5%, in 2021 compared to 2020, and increased $6.6 million, or 8.4%, from 2019 to 2020, respectively.  The decrease in 2021 was driven by lower software amortization related to a transition to cloud-based computing solutions.  The increase in 2020 compared to 2019 was driven by computer hardware and software expenses for the ongoing investments in digital channel and integrated platform solutions to support business growth and the continued modernization of core systems.

Marketing and business development expense increased $3.9 million, or 26.3%, in 2021 compared to 2020, but decreased $11.6 million, or 44.1%, in 2020 compared to 2019.  The increase in 2021 was driven by the timing of advertising and business development projects and higher travel expenses as compared to 2020.  The decrease in 2020 is driven by reduced travel and entertainment expenses and business development expense related to the COVID-19 pandemic.

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Processing fees expense increased $13.4 million, or 24.6%, in 2021 compared to 2020, and increased $2.0 million, or 3.9%, in 2020 compared to 2019.  The increases in 2021 and 2020 are primarily driven by the transition to cloud computing solutions and ongoing investments in digital channel and integrated platform solutions to support business growth and the continued modernization of core systems.

Other noninterest expense decreased $9.2 million, or 21.3%, in 2021 compared to 2020 and increased $16.2 million, or 59.8%, in 2020 compared to 2019.  The decrease in 2021 is driven by lower operational losses, partially offset by higher charitable contributions expense.  The increase in 2020 is primarily driven by higher operational losses and derivative expense.

Income Taxes

Income tax expense totaled $76.0 million, $52.4 million, and $42.4 million in 2021, 2020, and 2019 respectively. These amounts equate to effective tax rates of 17.7%, 15.5%, and 14.8% for 2021, 2020 and 2019, respectively. The increase in the effective tax rate from 2020 to 2021 is primarily attributable to a smaller portion of pre-tax income being earned from tax-exempt municipal securities and higher state and local income taxes.  The increase in the effective tax rate from 2019 to 2020 is primarily attributable to a smaller portion of pre-tax income being earned from tax-exempt municipal securities.

For further information on income taxes refer to Note 16, “Income Taxes,” in the Notes to the Consolidated Financial Statements.

Business Segments

The Company has strategically aligned its operations into the following three reportable segments: Commercial Banking, Institutional Banking, and Personal Banking (collectively, the Business Segments). Senior executive officers regularly evaluate Business Segment financial results produced by the Company’s internal reporting system in deciding how to allocate resources and assess performance for individual Business Segments.  Previously, the Company had the following four Business Segments:  Commercial Banking, Institutional Banking, Personal Banking, and Healthcare Services.  In the first quarter of 2020, the Company merged the Healthcare Services segment into the Institutional Banking segment to better reflect how the Company’s core businesses, products and services are currently being evaluated by management. The management accounting system assigns balance sheet and income statement items to each Business Segment using methodologies that are refined on an ongoing basis. For comparability purposes, amounts in all periods are based on methodologies in effect at December 31, 2021.  Previously reported results have been reclassified in this Form 10-K to conform to the Company’s current organizational structure.

Table 8

COMMERCIAL BANKING OPERATING RESULTS (in thousands)

For the year ended December 31, 2021, Commercial Banking net income increased $43.8 million, or 19.0%, to $274.7 million compared to the same period in 2020.  Net interest income increased $81.2 million, or 17.1%, for the year ended December 31, 2021, compared to the same period last year, primarily driven by strong loan growth, earning asset mix changes, and the Company’s participation in the PPP.  PPP loans averaged $802.4 million during 2021, and PPP income increased $12.4 million as compared to 2020.  Provision for credit losses decreased $103.9 million as compared to 2020.  The provision expense for 2020 was significantly impacted by the adoption of CECL,

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coupled with the impacts of the COVID-19 pandemic on the economic environment and reasonable and supportable economic forecasts.  The provision in 2021 represents substantial improvement in these forecasts.  Noninterest income decreased $107.7 million, or 56.8%, over the same period in 2020.  Investment securities gains, net decreased $117.0 million, primarily driven by the change in market valuation on the Company’s investment in TTCF. This decrease was partially offset by increases of $3.3 million in deposit service charges, $2.7 million in gains on sales of assets, and $2.5 million in bankcard fees. Noninterest expense increased $16.8 million, or 6.2%, as compared to the same period in 2020.  This increase was driven by an increase of $20.0 million in technology, service, and overhead expenses, $4.9 million in salaries and employee benefits expense, $1.8 million in marketing and business development expense, $1.6 million in processing fees, and $1.3 million in regulatory fees.  These increases were partially offset by a decrease of $12.9 million in operational losses as compared to 2020.

Table 9

INSTITUTIONAL BANKING OPERATING RESULTS (in thousands)

For the year ended December 31, 2021, Institutional Banking net income decreased $6.5 million, or 10.4%, compared to the same period last year.  Net interest income decreased $19.2 million, or 18.0%, compared to the same period last year, due to a decrease in funds transfer pricing driven by lower interest rates.  Noninterest income increased $18.5 million, or 7.3%, primarily due to increases of $27.5 million in fund services income, $5.8 million in corporate trust income, both recorded in trust and securities processing revenue, $0.9 million in bankcard fees and $0.8 million in other income. The increases in fund services income and corporate trust income are related to increased assets administered as compared to the prior year.  These increases were partially offset by decreases of $12.0 million in brokerage fees and $4.7 million in bond trading income.  The decrease in brokerage fees is primarily due to lower 12b-1 and money market revenue and the decline in bond trading income is due to decreased trading volumes.  Noninterest expense increased $5.4 million, or 1.9%, primarily driven by increases of $4.7 million in technology, service, and overhead expenses and $4.5 million in processing fees.  These increases were partially offset by decreases of $2.8 million in salary and employee benefits expense, and $1.3 million in equipment expense.

Table 10

PERSONAL BANKING OPERATING RESULTS (in thousands)

For the year ended December 31, 2021, Personal Banking net income increased $29.3 million as compared to the same period last year.  Net interest income increased $22.3 million, or 14.9%, compared to the same period last year due to increased loan balances.  Provision for credit losses decreased $6.4 million.  The provision expense for 2020 was significantly impacted by the adoption of CECL, coupled with the impacts of the COVID-19 pandemic on

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the economic environment and reasonable and supportable economic forecasts.  The provision in 2021 represents substantial improvements in these forecasts.  Noninterest income decreased $3.9 million, or 3.3%, primarily driven by a decrease of $3.8 million in trust income and $1.3 million in equity earnings on alternative investments. Both decreases are related to the sale of PCM in the first quarter of 2021.  These decreases were partially offset by an increase of $0.6 million in bankcard fees driven by higher interchange income. Noninterest expense decreased $10.6 million, or 4.0%, primarily due to decreases of $7.5 million in salary and employee benefits, $2.6 million in operational losses, and $2.2 million in legal and consulting expense.  These decreases were partially offset by an increase of $1.8 million in marketing and business development expense.

Balance Sheet Analysis

Loans and Loans Held For Sale

Loans represent the Company’s largest source of interest income.  Loan balances held for investment increased by $1.1 billion, or 6.6%, in 2021.  This increase was primarily driven by an increase of $374.5 million, or 19.3%, in consumer real estate loans, $358.6 million, or 6.1%, in commercial real estate loans, $196.0 million, or 2.8%, in commercial loans, and $91.4 million, or 47.9% in lease and other loans.

Commercial & industrial loans and commercial real estate loans continue to represent the largest segments of the Company’s loan portfolio, comprising approximately 42.3% and 36.5%, respectively, of total loans and loans held for sale at the end of 2021 and 43.8% and 36.7%, respectively, of total loans and loans held for sale at the end of 2020.

Commercial loans represent the largest percent of total loans.  Commercial loans at December 31, 2021 have increased $196.0 million, or 2.8%, as compared to December 31, 2020, to 42.3% of total loans.  Commercial loans represented 43.8% of total loans at December 31, 2020.  The Company’s commercial loan balances have been impacted by the Company’s participation in the PPP.  PPP loans totaled $136.5 million and $1.3 billion as of December 31, 2021 and December 31, 2020, respectively.

As a percentage of total loans, commercial real estate comprises 36.5% of total loans compared to 36.7% in 2020.  Commercial real estate loans increased $358.6 million, or 6.1%, compared to 2020.  Generally, these loans are made for investment and real estate development or working capital and business expansion purposes and are primarily secured by real estate with a maximum loan-to-value of 80%.  Most of these properties are non-owner occupied and have guarantees as additional security.

Consumer real estate loans increased $374.5 million, or 19.3%, and represented 13.5% of total loans. Specialty lending loans increased $11.1 million, or 2.2%, and represented 3.0% of total loans as of December 31, 2021.

For further information on loan portfolio segments refer to Note 3, “Loans and Allowance for Credit Losses,” in the Notes to the Consolidated Financial Statements.

Nonaccrual, past due and restructured loans are discussed under “Quantitative and Qualitative Disclosure about Market Risk – Credit Risk Management” in Item 7A of this report.

Investment Securities

The Company’s investment portfolio contains trading, available-for-sale (AFS), and held-to-maturity (HTM) securities as well as FRB stock, Federal Home Loan Bank (FHLB) stock, and other miscellaneous investments.  Investment securities totaled $13.8 billion as of December 31, 2021 and $10.6 billion as of December 31, 2020 and comprised 33.8% and 34.0% of the Company’s earning assets, respectively, as of those dates.

The Company’s AFS securities portfolio comprised 86.7% of the Company’s investment securities portfolio at December 31, 2021, compared to 87.4% at December 31, 2020.  The Company’s AFS securities portfolio provides liquidity as a result of the composition and average life of the underlying securities.  This liquidity can be used to fund loan growth or to offset the outflow of traditional funding sources.  The average life of the AFS securities portfolio decreased from 70.1 months at December 31, 2020 to 67.6 months at December 31, 2021. In addition to providing a potential source of liquidity, the AFS securities portfolio can be used as a tool to manage interest rate

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sensitivity.  The Company’s goal in the management of its AFS securities portfolio is to maximize return within the Company’s parameters of liquidity goals, interest rate risk and credit risk.

Management expects collateral pledging requirements for public funds, loan demand, and deposit funding to be the primary factors impacting changes in the level of AFS securities.  There were $10.2 billion of AFS securities pledged to secure U.S. Government deposits, other public deposits, certain trust deposits, derivative transactions, and repurchase agreements at December 31, 2021.  Of this amount, securities with a market value of $171.2 million at December 31, 2021 were pledged at the Federal Reserve Discount Window but were unencumbered as of that date.

The Company’s HTM securities portfolio consists of private placement bonds, which are issued primarily to refinance existing revenue bonds in the healthcare and education sectors, and mortgage-backed securities.  The Company’s private placement bond portfolio totaled $1.1 billion as of December 31, 2021, an increase of $70.3 million, or 7.0%, from December 31, 2020.  The Company’s HTM mortgage-backed securities portfolio totaled $396.1 million as of December 31, 2021. The average life of the HTM portfolio was 5.2 years at December 31, 2021, compared to 6.1 years at December 31, 2020.

The securities portfolio generates the Company’s second largest component of interest income.  The AFS, HTM, and Other securities portfolios achieved an average yield on a tax-equivalent basis of 2.16% for 2021, compared to 2.45% in 2020.  Securities available for sale had a net unrealized gain of $153.9 million at year-end, compared to a net unrealized gain of $412.0 million the preceding year. This market value change primarily reflects the impact of a larger portfolio size, shorter average life, and declining mark interest rates as of December 31, 2021, compared to December 31, 2020.  These amounts are reflected, on an after-tax basis, in the Company’s Accumulated other comprehensive income (loss) in shareholders’ equity, as an unrealized gain of $118.5 million at year-end 2021, compared to an unrealized gain of $314.5 million for 2020. The AFS securities portfolio contains securities that have unrealized losses (see the table of these securities in Note 4, “Securities,” in the Notes to the Consolidated Financial Statements).  The unrealized losses in the Company’s investments were caused by changes in interest rates, and not from a decline in credit of the underlying issuers.  The U.S. Treasury, U.S. Agency, and GSE mortgage-backed securities are all considered to be agency-backed securities with no risk of loss as they are either explicitly or implicitly guaranteed by the U.S. government. The changes in fair value in the agency-backed portfolios are solely driven by change in interest rates caused by changing economic conditions. The Company has no knowledge of any underlying credit issues and the cash flows underlying the debt securities have not changed and are not expected to be impacted by changes in interest rates.  As of December 31, 2021, the Company does not believe the decline in value in these portfolios is related to credit impairments and instead is due to declining interest rates.  The Company does not have the intent to sell these securities and does not believe it is more likely than not that the Company will be required to sell these securities before a recovery of amortized cost.  As of December 31, 2021, there is no ACL related to the Company’s available-for-sale securities as the decline in fair value did not result from credit issues.

Included in Tables 11 and 12 are analyses of the fair value and average yield (tax-equivalent basis) of securities available for sale and securities held to maturity.

Table 11

SECURITIES AVAILABLE FOR SALE (in thousands)

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Table 12

SECURITIES HELD TO MATURITY (in thousands)

The table below provides detailed information for Other securities at December 31, 2021 and 2020:

Table 13

OTHER SECURITIES (in thousands)

Equity securities with readily determinable fair values are generally traded on an exchange and market prices are readily available.  Equity securities with readily determinable fair values includes the Company’s investment in TTCF, which had a fair value of $12.5 million as of December 31, 2021 and $106.9 million as of December 31, 2020.  During 2021, the Company sold a portion of this investment with a value of $79.0 million. Equity securities without readily determinable fair values are generally carried at cost less impairment.  Equity securities without readily determinable fair values also include PCM alternative investments in hedge funds and private equity funds, which are accounted for as equity-method investments.  During the first quarter of 2021, the Company sold its membership interest in PCM.  Unrealized gains or losses on equity securities with and without readily determinable fair values are recognized in the Investment Securities gains, net line of the Company’s Consolidated Statements of Income.

For further information on the Company’s investment securities, refer to Note 4, “Securities,” in the Notes to the Consolidated Financial Statements.

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Other Earning Assets

Federal funds transactions essentially are overnight loans between financial institutions, which allow for either the daily investment of excess funds or the daily borrowing of another institution’s funds in order to meet short-term liquidity needs.  The net borrowed position was $12.6 million at December 31, 2021 compared to $65.6 million at December 31, 2020.

The Bank buys and sells federal funds as agent for non-affiliated banks.  Because the transactions are pursuant to agency arrangements, these transactions do not appear on the balance sheet and averaged $394.7 million in 2021 and $362.5 million in 2020.

At December 31, 2021, the Company held securities purchased under agreements to resell of $1.2 billion compared to $1.7 billion at December 31, 2020.  The Company uses these instruments as short-term secured investments, in lieu of selling federal funds, or to acquire securities required for collateral purposes.  Balances will fluctuate based on the Company’s liquidity and investment decisions as well as the Company’s correspondent bank borrowing levels.  These investments averaged $1.2 billion in 2021 and $1.1 billion in 2020.

The Company also maintains an active securities trading inventory.  The average holdings in the securities trading inventory in 2021 were $23.5 million, compared to $37.1 million in 2020, and were recorded at fair market value.  As discussed in “Quantitative and Qualitative Disclosures About Market Risk – Trading Account” in Part II, Item 7A, the Company offsets the trading account securities by the sale of exchange-traded financial futures contracts, with both the trading account and futures contracts marked to market daily.

Interest-bearing due from banks totaled $8.8 billion as of December 31, 2021 compared to $3.1 billion as of December 31, 2020 and includes amounts due from the FRB and interest-bearing accounts held at other financial institutions.  The amount due from the FRB averaged $4.0 billion and $1.2 billion during the years ended December 31, 2021 and 2020, respectively.  The increase in the FRB balance from 2020 to 2021 is primarily due to an increase in deposit balances as a result of the Company’s participation in the PPP.  The interest-bearing accounts held at other financial institutions totaled $41.2 million and $43.1 million at December 31, 2021 and 2020, respectively.

Deposits and Borrowed Funds

Deposits represent the Company’s primary funding source for its asset base.  In addition to the core deposits garnered by the Company’s retail branch structure, the Company continues to focus on its cash management services, as well as its asset management and mutual fund servicing businesses in order to attract and retain additional core deposits.  Deposits totaled $35.6 billion at December 31, 2021 and $27.1 billion at December 31, 2020, an increase of $8.5 billion, or 31.6%. Deposits averaged $28.9 billion in 2021, and $23.2 billion in 2020.

Noninterest-bearing demand deposits averaged $11.3 billion in 2021 and $7.8 billion in 2020.  These deposits represented 38.9% of average deposits in 2021, compared to 33.8% in 2020.  The Company’s large commercial customer base provides a significant source of noninterest-bearing deposits.  Many of these commercial accounts do not earn interest; however, they receive an earnings credit to offset the cost of other services provided by the Company.

Table 14

MATURITIES OF UNINSURED TIME DEPOSITS (in thousands)

As of December 31, 2021, there were $27.4 billion of uninsured deposits, as compared to $19.7 billion as of December 31, 2020.

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Table 15

ANALYSIS OF AVERAGE DEPOSITS (in thousands)

Capital Resources and Liquidity

The Company places a significant emphasis on the maintenance of a strong capital position, which it believes promotes investor confidence, provides access to funding sources under favorable terms, and enhances the Company’s ability to capitalize on business growth and acquisition opportunities.  Higher levels of liquidity, however, bear corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets, and higher expenses for extended liability maturities.  The Company manages capital for each subsidiary based upon the subsidiary’s respective risks and growth opportunities as well as regulatory requirements.

Total shareholders’ equity increased $128.5 million, or 4.3% to $3.1 billion at December 31, 2021 as compared to December 31, 2020.

The Board authorized, at its April 27, 2021, April 28, 2020, and April 23, 2019 meetings, the repurchase of up to two million shares of the Company’s common stock during the twelve months following each meeting (each a Repurchase Authorization).  During 2021 and 2020, the Company acquired 67,671 shares and 1,208,623 shares, respectively, of its common stock pursuant to the applicable Repurchase Authorization. During March 2020, the Company entered into an agreement with Bank of America Merrill Lynch (BAML) to repurchase an aggregate of $30.0 million of the Company’s common stock through an accelerated share repurchase agreement (ASR). Under the ASR, the Company repurchased a total of 653,498 shares, which was completed during the second quarter of 2020. The ASR was entered into pursuant to the April 23, 2019 Repurchase Authorization.  The Company has not made any repurchase of its securities other than pursuant to the Repurchase Authorizations.

Risk-based capital guidelines established by regulatory agencies set minimum capital standards based on the level of risk associated with a financial institution’s assets.  The Company has implemented the Basel III regulatory capital rules adopted by the FRB.  Basel III capital rules include a minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a minimum tier 1 risk-based capital ratio of 6%.  A financial institution’s total capital is also required to equal at least 8% of risk-weighted assets.

The risk-based capital guidelines indicate the specific risk weightings by type of asset.  Certain off-balance sheet items (such as standby letters of credit and binding loan commitments) are multiplied by credit conversion factors to translate them into balance sheet equivalents before assigning them specific risk weightings.  The Company is also required to maintain a leverage ratio equal to or greater than 4%.  The leverage ratio is tier 1 core capital to total average assets less goodwill and intangibles.  The Company's capital position as of December 31, 2021 is summarized in the table below and exceeded regulatory requirements.

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Table 16

RISK-BASED CAPITAL (in thousands)

This table computes risk-based capital in accordance with current regulatory guidelines.  These guidelines as of December 31, 2021, excluded net unrealized gains or losses on securities available for sale from the computation of regulatory capital and the related risk-based capital ratios.

For further discussion of regulatory capital requirements, see Note 10, “Regulatory Requirements” within the Notes to Consolidated Financial Statements under Item 8.

Repurchase agreements are transactions involving the exchange of investment funds by the customer for securities by the Company, under an agreement to repurchase the same issues at an agreed-upon price and date.  Securities sold under agreements to repurchase and federal funds purchased totaled $3.2 billion at December 31, 2021, and $2.3 billion at December 31, 2020. Repurchase agreements and federal funds purchased averaged $2.6 billion in 2021 and $2.0 billion in 2020.  The Company enters into these transactions with its downstream correspondent banks, commercial customers, and various trust, mutual fund, and local government relationships.

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The Company is a member bank with the FHLB of Des Moines, and through this relationship, the Company owns $10.0 million of FHLB stock and has access to additional liquidity and funding sources through FHLB advances.  The Company’s borrowing capacity is dependent upon the amount of collateral the Company places at the FHLB.  Based on the collateral pledged, the Company had $1.6 billion of borrowing capacity at the FHLB at December 31, 2021.  The Company had no outstanding advances at FHLB Des Moines as of December 31, 2021.

To enhance general working capital needs, the Company has a revolving line of credit with Wells Fargo Bank, N.A. which allows the Company to borrow up to $30.0 million for general working capital purposes. The interest rate applied to borrowed balances will be at the Company’s option, either 1.25% above LIBOR or 1.75% below the prime rate on the date of an advance. The Company pays a 0.4% unused commitment fee for unused portions of the line of credit. The Company had no advances outstanding at December 31, 2021.

Long-term debt totaled $271.5 million at December 31, 2021, compared to $269.6 million at December 31, 2020.  In September 2020, the Company issued $200.0 million in aggregate subordinated notes due in September 2030.  The Company received $197.7 million, after deducting underwriting discounts and commissions and offering expenses, and used the proceeds from the offering for general corporate purposes, including, among other uses, contributing Tier 1 capital into the Bank. The subordinated notes were issued with a fixed-to-fixed rate of 3.70% and an effective rate of 3.93%, due to issuance costs, with an interest rate reset date of September 2025.  The remainder of the Company’s long-term debt was assumed from the acquisition of Marquette and consists of debt obligations payable to four unconsolidated trusts (Marquette Capital Trust I, Marquette Capital Trust II, Marquette Capital Trust III, and Marquette Capital Trust IV) that previously issued trust preferred securities.  These long-term debt obligations had an aggregate contractual balance of $103.1 million and had a carrying value of $73.2 million at December 31, 2021 and $71.7 million at December 31, 2020.  Interest rates on trust preferred securities are tied to the three-month LIBOR with spreads ranging from 133 basis points to 160 basis points and reset quarterly. The trust preferred securities have maturity dates ranging from January 2036 to September 2036.  For further information on long-term debt refer to Note 9, “Borrowed Funds,” in the Notes to the Consolidated Financial Statements.

The Company has material off-balance sheet arrangements in the form of loan commitments, commercial and standby letters of credit, futures contracts and forward exchange contracts, which have maturity dates rather than payment due dates.  These commitments and contingent liabilities are not required to be recorded on the Company’s balance sheet.  Since commitments associated with letters of credit and lending and financing arrangements may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.  See Table 17 below, as well as Note 15, “Commitments, Contingencies and Guarantees” in the Notes to Consolidated Financial Statements under Item 8 for detailed information and further discussion of these arrangements.  Management does not anticipate any material losses from its off-balance sheet arrangements.

Table 17

COMMITMENTS, MATERIAL CASH REQUIREMENTS AND OFF-BALANCE SHEET ARRANGEMENTS (in thousands)

The table below details the commitments, material cash requirements, and off-balance sheet arrangements for the Company as of December 31, 2021 and includes principal payments only.  The Company has no capital leases or long-term purchase obligations.

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As of December 31, 2021, the Company’s total liabilities for unrecognized tax benefits were $8.8 million.  The Company cannot reasonably estimate the settlement of these liabilities.  Therefore, these liabilities have been excluded from the table above.  See Note 16, “Income Taxes,” in the Notes to the Consolidated Financial Statements for information regarding the liabilities associated with unrecognized tax benefits.

For further discussion of capital and liquidity, see the “Quantitative and Qualitative Disclosures about Market Risk – Liquidity Risk” in Item 7A of this report.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).  The preparation of these Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period.  On an on-going basis, management evaluates its estimates and judgments, including those related to customers and suppliers, allowance for credit losses, bad debts, investments, financing operations, long-lived assets, taxes, other contingencies and litigation.  Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which have formed the basis for making such judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Under different assumptions or conditions, actual results may differ from the recorded estimates.

Management believes that the Company’s critical accounting policies and estimates are those relating to the allowance for credit losses.

Allowance for Credit Losses

The Company’s ACL represents management’s judgment of the total expected losses included in the Company’s assets held at amortized cost. The Company’s process for recording the ACL is based on the evaluation of the Company’s lifetime historical loss experience, management’s understanding of the credit quality inherent in the loan portfolio, and the impact of the current economic environment, coupled with reasonable and supportable economic forecasts.

A mathematical calculation of an estimate is made to assist in determining the adequacy and reasonableness of management’s recorded ACL.  To develop the estimate, the Company follows the guidelines in ASC Topic 326, Financial Instruments – Credit Losses.  The estimate reserves for assets held at amortized cost, which include the Company’s loan and held-to-maturity security portfolios.

The estimation process involves the consideration of quantitative and qualitative factors relevant to the specific segmentation of loans.  These factors have been established over decades of financial institution experience and include economic observation and loan loss characteristics.  This process is designed to produce a lifetime estimate of the losses, at a reporting date, that is based on evaluation of historical loss experience, current economic

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conditions, reasonable and supportable forecasts, and the qualitative framework outlined by the Office of the Comptroller of the Currency in the published 2020 Interagency Policy Statement.  This process allows management to take a holistic view of the recorded ACL reserve and ensure that all significant and pertinent information is considered in its estimate.

The Company considers a variety of factors to ensure the safety and soundness of its estimate including a strong internal control framework, extensive methodology documentation, credit underwriting standards which encompass the Company’s desired risk profile, model validation, and ratio analysis.  If the Company’s total ACL estimate, as determined in accordance with the approved ACL methodology, is either outside a reasonable range based on review of economic indicators or by comparison of historical ratio analysis, the ACL estimate is an outlier and management will investigate the underlying reason(s).  Based on that investigation, issues or factors that previously had not been considered may be identified in the estimation process, which may warrant adjustments to estimated credit losses.

The ending result of this process is a recorded consolidated ACL that represents management’s best estimate of the total expected losses included in the loan and held-to-maturity security portfolios considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument.  While management utilizes its best judgment and information available, the ultimate adequacy of the ACL is dependent upon a variety of factors beyond the Company’s control, including the performance of its portfolios, the economy, and changes in interest rates. As such, significant downturns in circumstances relating to loan quality and economic conditions could result in a requirement for additional allowance.  Likewise, an upturn in loan quality and improved economic conditions may allow a reduction in the required allowance. In either instance, unanticipated changes could have a significant impact on the Company’s Provision for credit losses and ACL reported in its Consolidated Income Statements and Consolidated Balance Sheets, respectively.

For more information on loan portfolio segments, the Company’s ACL methodology, and management’s assumptions in estimating the ACL, refer to the section captioned “Allowance for Credit Losses” within Note 3, “Loans and Allowance for Credit Losses,” in the Notes to the Consolidated Financial Statements.