Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF FIRSTSUN
In this section, unless the context suggests otherwise, references to “we,” “us,” and “our” mean the combined business of FirstSun and its wholly-owned subsidiaries, Logia Portfolio Management, LLC and Sunflower Bank.
The following discussion is an analysis of our consolidated results of operations for the years ended December 31, 2021, 2020 and 2019, and financial condition for the years ended December 31, 2021 and 2020. This discussion and analysis should be read in conjunction with our consolidated financial statements and accompanying footnotes filed with this report in “Part II, Item 8. Financial Statements.” We have omitted discussion of 2019 results where it would be redundant to the discussion previously included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations of FirstSun” section of our Prospectus dated August 10, 2021, filed pursuant to Securities Act Rule 424(b)(3) under the Securities Act on August 12, 2021, relating to FirstSun’s Registration Statement on Form S-4 (File No. 333-258176), in connection with our proposed merger with Pioneer, which discussion is incorporated herein by reference. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.
Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements.
For additional information regarding our cautionary disclosures, See the “Cautionary Note Regarding Forward-Looking Statements” beginning on page 3 of this report.
General Overview
FirstSun, headquartered in Denver, Colorado, is the financial holding company for Sunflower Bank, which operates as Sunflower Bank, First National 1870 and Guardian Mortgage. We conduct a full service community banking and trust business through Sunflower Bank and Logia.
We offer a full range of relationship-focused services to meet our clients’ personal, business and wealth management financial objectives, with a branch network in Kansas, Colorado, New Mexico, Texas and Arizona and mortgage capabilities in 43 states.
Financial Highlights For 2021
We delivered strong financial results in 2021, which included:
•Net income of $43.2 million, $2.30 per diluted share
•Return on average assets of 0.79%
•Return on average equity of 8.37%
•Loan growth of 5.0% (excluding PPP loan balances (non-GAAP), 10.4%)
•Average deposit balance growth of 20.0%
Net income totaled $43.2 million, or $2.30 per diluted share, during 2021, compared to $47.6 million, or $2.58 per diluted share, in 2020. The return on average assets was 0.79% during 2021, compared to 1.02% in 2020, and the return on average equity was 8.37% during 2021, compared to 10.20% in 2020.
Pending Merger with Pioneer Bancshares, Inc.
On May 11, 2021, FirstSun and Pioneer Bancshares, Inc. (“Pioneer”) entered into an Agreement and Plan of Merger that provides for the merger of Pioneer with and into FirstSun. If the merger is completed, each share of Pioneer common stock will be converted into the right to receive 1.0443 shares of FirstSun common stock plus cash in lieu of any fractional shares. In September 2021, the Pioneer stockholders approved the merger. On March 7, 2022, we received the necessary regulatory approvals to complete the mergers, subject to applicable waiting periods. We expect to close the mergers on April 1, 2022, subject to customary closing conditions. In 2021, we incurred $3.1 million of expenses relating to the proposed transaction and anticipate additional expenses to be incurred in 2022.
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Pandemic Update
The COVID-19 pandemic has created economic and financial disruptions that adversely affected our operations during 2020 and to a lesser extent in 2021. Our historically diligent management of credit risk, diverse loan portfolios, and Southwest-based footprint has helped minimize any adverse impact to us. In addition, the combination of the vaccine rollout, government stimulus payments, and reduced spending during the pandemic are likely contributing factors mitigating the impact of the pandemic on our business, financial condition, results of operations, and our clients as of December 31, 2021. However, there are continuing concerns that indicate a slower return to pre-pandemic routines. Examples of these concerns relate to increases in new COVID-19 cases, hospitalizations and deaths leading to additional government imposed restrictions; refusals to receive the vaccine along with new strain concerns; supply chain issues remaining unresolved longer than anticipated; unemployment increases while consumer confidence and spending falls; and rising geopolitical tensions. Given the ongoing and dynamic nature of the circumstances surrounding the pandemic, it is difficult to predict the future adverse financial impact to us, although we expect to continue to be impacted by the pandemic in 2022.
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Financial Highlights
The following table sets forth certain financial highlights of FirstSun as of and for the years ended December 31,:
($ in thousands, except share and per share amounts) 2021 2020
Income Statement:
Taxable equivalent adjustment 5,755 6,490
Per Common Share Data:
Net income (basic) $ 2.36 $ 2.60
Net income (diluted) $ 2.30 $ 2.58
Cash dividends $ — $ —
Dividend payout ratio — % — %
Tangible common book value (Non-GAAP) $ 26.31 $ 24.18
Performance Ratios:
Return on average assets 0.79 % 1.02 %
Return on average stockholders' equity 8.37 % 10.20 %
Return on tangible common equity (Non-GAAP) 9.17 % 11.00 %
Return on average tangible common equity (Non-GAAP) 9.35 % 11.50 %
Net interest margin 3.00 % 3.10 %
Net charge-offs to average loans outstanding 0.09 % 0.11 %
Allowance for loan losses to loans 1.18 % 1.24 %
Nonperforming loans to total loans (2) 0.86 % 1.07 %
Balance Sheet:
Capital Ratios:
Total risk-based capital to risk-weighted assets 11.76 % 12.19 %
Tier 1 risk-based capital to risk-weighted assets 9.70 % 9.87 %
Common Equity Tier 1 (CET 1) to risk-weighted assets 9.70 % 9.87 %
Tier 1 leverage capital to average assets 8.24 % 8.53 %
Average equity to average assets 9.43 % 10.01 %
Tangible equity to tangible assets (non-GAAP) 8.58 % 8.95 %
Nonfinancial Data:
Full-time equivalent employees 1,042 1,059
Banking branches 53 56
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Non-GAAP Financial Measures and Reconciliations
The non-GAAP financial measures presented below are used by our management and our Board of Directors on a regular basis in addition to our GAAP results to facilitate the assessment of our financial performance. Management believes these non-GAAP financial measures enhance an investor’s understanding of our financial results by providing a meaningful basis for period-to-period comparisons, assisting in operating results analysis, and predicting future performance. This information supplements our GAAP reported results, and should not be viewed in isolation from, or as a substitute for, our GAAP results. Accordingly, this financial information should be read in conjunction with our consolidated financial statements and notes thereto for the year ended December 31, 2021, included elsewhere in this report. Non-GAAP financial measures exclude certain items that are included in the financial results presented in accordance with GAAP. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP. These non-GAAP measures are not necessarily comparable to similar measures that may be represented by other companies.
The following table presents GAAP to non-GAAP reconciliations as of and for the years ended December 31,:
($ in thousands, except share and per share amounts) 2021 2020
Loan growth excluding PPP loan balances:
Loan growth excluding PPP loan balances in $ $ 375,118 N/A
Loan growth excluding PPP loan balances 10.4 % N/A
Tangible common book value:
Less: Goodwill and other intangible assets
Total tangible stockholders' equity (non-GAAP) $ 482,738 $ 443,070
Tangible common book value (non-GAAP) $ 26.31 $ 24.18
Return on tangible common equity:
Add: Intangible amortization, net of tax 1,119 1,173
Tangible stockholders’ equity (non-GAAP) (see above) $ 482,738 $ 443,070
Return on tangible common equity 9.17 % 11.00 %
Return on average tangible common equity:
Tangible net income (non-GAAP) (see above) $ 44,283 $ 48,758
Total average stockholders' equity (GAAP) $ 515,773 $ 466,619
Less: Average goodwill and other intangible assets
Average other intangible assets (8,964) (9,597)
Total average tangible stockholders' equity (non-GAAP) $ 473,759 $ 423,972
Return on average tangible common equity 9.35 % 11.50 %
Net interest margin:
Taxable equivalent adjustment 5,755 6,490
Net interest income - FTE basis (non-GAAP) $ 160,988 $ 142,443
Net interest margin - FTE basis (non-GAAP) 3.11 % 3.25 %
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($ in thousands, except share and per share amounts) 2021 2020
Tangible common equity to tangible assets:
Less: Goodwill and other intangible assets
Tangible common equity (non-GAAP) (see above) $ 482,738 $ 443,070
Tangible equity to tangible assets (non-GAAP) 8.58 % 8.95 %
Comparison of fiscal years 2021 and 2020
Segments
Our operations are conducted through two operating segments: Banking and Mortgage Operations. We also allocate certain expenses to Corporate, which is not an operating segment. The operating segments have been determined based on the products and services we offer and reflect the manner in which our financial information is currently evaluated by management. Each of the operating segments is complementary to each other and because of the interrelationship of the segments, the information presented is not indicative of how the segments would perform if they operated as independent entities. For additional information on our segments, see Note 21- Segment Information included in our audited consolidated financial statements included elsewhere in this report.
Banking
Identifiable assets for our Banking segment grew by $0.6 billion to $5.1 billion at December 31, 2021 from $4.5 billion for the same period in 2020. The growth in identifiable assets was primarily driven by growth in cash and cash equivalents and our loan portfolio. Income (loss) before taxes increased $36.8 million to $34.8 million for the year ended December 31, 2021, from a loss of $2.0 million for the year ended December 31, 2020. The period over period increase was driven by a $20.1 million decrease in our provision for loan losses, decreasing from a $23.3 million provision in the year ended December 31, 2020 to a $3.2 million provision in the year ended December 31, 2021. This reduction in the provision was due to favorable changes to certain environmental factors as a result of improved economic conditions and the performance of our loan portfolio. Noninterest income increased $11.3 million to $35.4 million in the year ended December 31, 2021, compared to $24.1 million in the same period in 2020, primarily resulting from increases in trust and investment advisory fee income, treasury management service fees, customer accommodation interest rate swap fees and changes in fair value. Noninterest expense increased $15.0 million to $149.9 million for the year ended December 31, 2021 compared to $134.9 million for the year ended December 31, 2020. The increase in noninterest expense was primarily due to our continued growth, including increased salary and employee benefits associated with headcount increases from an expanding sales force, as well as our expanded operations in certain markets, including Arizona and Texas.
Mortgage Operations
Income before income taxes from our Mortgage Operations segment decreased to $25.4 million for the year ended December 31, 2021, compared to $63.8 million for the year ended December 31, 2020, due to a combination of factors including an $8.0 million decline in revenue related to mortgage servicing rights (“MSR”) capitalization and changes in fair value, net of hedging activity, and a $2.9 million increase in noninterest expense. The revenue decline related to our MSRs was primarily the result of changes in market interest rates and our corresponding hedging positions. Additionally, while total loan originations remained steady at $2.3 billion for both the years ended December 31, 2021 and 2020, overall gain on sale margins declined by $30.5 million to $63.5 million for the year ended December 31, 2021 from $94.0 million in the prior year. Noninterest expense for the year ended December 31, 2021 was $71.0 million, compared to $68.0 million for the year ended December 31, 2020. The $2.9 million increase was primarily due to the increased salary and employee benefits expense associated with higher headcount as we continue to invest in our workforce.
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Critical Accounting Estimates
Our consolidated financial statements are prepared based on the application of accounting policies in accordance with U.S. generally accepted accounting principles, and follow general practices within the banking industry.
Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. We have identified the determination of the allowance for loan losses and fair value measurements to be the accounting areas that require the use of critical accounting estimates as these policies require the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Changes in underlying factors, estimates, assumptions or judgements could have a material impact on our future financial condition and results of operations.
These critical accounting estimates and their application are reviewed at least annually by our audit committee. The following is a description of our critical accounting estimates and an explanation of the methods and assumptions underlying their application.
Allowance for Loan Losses - The allowance for loan losses is a valuation allowance for probable incurred credit losses and represents management's estimate of incurred losses in our loan portfolio as of the balance sheet date.
Management’s estimate of the allowance for loan losses includes both specific and general components. Management estimates the allowance balance required and necessary provision for loan losses expense using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, current economic conditions, and other factors which, in the opinion of management, deserve current recognition. Further information on the allowance for loan losses is presented within “Part II, Item 8. Financial Statements,” Notes 1 and 4 to the consolidated financial statements.
The allowance for loan losses may be materially affected by qualitative factors, especially during periods of economic uncertainty, for items not reflected in the loss calculation, but which are deemed appropriate by management's current assessment of the risks related to the loan portfolio and/or external factors. Such qualitative factors may include changes in our loan portfolio composition and credit concentrations, changes in the balances and/or trends in asset quality and/or loan credit performance, changes in lending underwriting standards, the effect of other external factors such as significant unique events or conditions, and actual change in economic conditions, real estate values, and/or other economic developments. The qualitative factors applied at December 31, 2021, and the importance and levels of the qualitative factors applied, may change in future periods depending on the level of changes to items such as the uncertainty of economic conditions and management's assessment of the level of credit risk within the loan portfolio as a result of such changes, compared to the amount of the allowance for loan losses currently calculated by management. The evaluation of qualitative factors is inherently imprecise and requires significant management judgment.
While management utilizes its best judgment and information available, the adequacy of the allowance for loan losses is determined by certain factors outside of our control, such as the performance of our portfolios, changes in the economic environment including economic uncertainty, changes in interest rates, and the view of the regulatory authorities toward classification of assets and the level of allowance for loan losses. Additionally, the level of the allowance for loan losses may fluctuate based on the balance and mix of the loan portfolio. If actual results differ significantly from our assumptions, our allowance for loan losses may not be sufficient to cover incurred losses in our loan portfolio, resulting in additions to our allowance for loan losses and an increase in the provision for loan losses.
Additionally, as an “emerging growth company” under Section 107 of the JOBS Act, we have not been required to adopt ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (CECL). As such, our allowance for loan losses may not be comparable to other public financial institutions that have adopted CECL.
Fair Value Measurements - We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures in accordance with Accounting Standards Codification ("ASC") 820 and ASC 825. We group our financial instruments at fair value in three levels based on the markets in which the instruments are traded and the reliability of the assumptions used to determine fair value, with Level 1 (quoted prices for identical assets in an active market) being considered the most reliable, and Level 3 having the most unobservable inputs and therefore being considered the least reliable. We base our fair values on the price that would be received from the sale of an asset in an orderly transaction between market participants at the measurement date. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
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Our AFS securities are measured at fair value on a recurring basis. Changes in the fair value of AFS securities, not related to credit loss, are recorded, net of tax, as accumulated other comprehensive income (AOCI) in stockholders' equity. We primarily use prices obtained from third-party pricing services to determine the fair value of our AFS securities. Various modeling techniques are used to determine pricing for our securities, including option pricing, discounted cash flow models, and similar techniques. The inputs to these models may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. All AFS securities are classified as Level 1 or Level 2 in the valuation hierarchy.
Our loans held-for-sale represent mortgage loans originated and intended for sale in the secondary market. These loans are recorded on a recurring fair value basis. The estimated fair value of these loans held-for-sale is generally based on sale, exchange, or dealer market prices and are classified within Level 2 of the valuation hierarchy.
Our mortgage servicing rights (MSRs) are measured at fair value on a recurring basis. We estimate the fair value of our MSRs using a process that utilizes a discounted cash flow model and analysis of current market data to arrive at the estimate. The cash flow assumptions and prepayment assumptions used in the model are based on numerous factors, with the key assumptions being mortgage prepayment speeds, discount rates and cost to service. The change of any of these key assumptions due to market conditions or other factors could materially affect the fair value of our MSR. We also utilize a third party consulting firm to assist us with the valuation. Because of the nature of the valuation inputs, we classify the valuation of our MSR as Level 3 in the valuation hierarchy.
Our derivative financial instruments are measured at fair value on a recurring basis. These derivative instruments are generally valued based on quoted prices for similar assets in an active market with inputs that are observable, exchange prices or dealer market prices and are classified within Level 2 of the valuation hierarchy. Further information on our derivative and hedging activities is presented in “Part II, Item 8. Financial Statements,” Notes 1 and 7 to the consolidated financial statements.
We did not have any other financial instruments that were measured at fair value on a recurring basis at December 31, 2021.
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Results of Operations
Comparison of fiscal years 2021 and 2020
The follow table sets forth our results of operations as of and for the years ended December 31,:
Diluted earnings per share $ 2.30 $ 2.58 $ 1.03
Net interest margin (FTE basis) 3.11 % 3.25 % 3.56 %
General
Our results of operations depend significantly on net interest income, which is the difference between interest income on interest-earning assets, consisting primarily of interest income on loans and investment securities and interest expense on interest-bearing liabilities, consisting primarily of deposits and borrowings. Our results of operations are also dependent on our generation of noninterest income, consisting primarily of income from mortgage banking services, service charges on deposit accounts, trust and investment advisory fees and credit and debit card fees. Other factors contributing to our results of operations include our provisions for loan losses, income taxes, and noninterest expenses, such as salaries and employee benefits, occupancy and equipment, amortization of intangible assets and other operating costs.
Net income for the year ended December 31, 2021 was $43.2 million, compared to $47.6 million for the year ended December 31, 2020. The $4.4 million decrease in net income for the year ended December 31, 2021, compared to 2020, was primarily due to a decrease in noninterest income of $24.1 million, due primarily to a decrease in income from mortgage banking services and an increase in noninterest expenses of $20.6 million, partially offset by a $39.4 million increase in net interest income after provision for loan losses.
Net Interest Income
Net interest income, representing interest income less interest expense, is a significant contributor to our revenues and earnings. We generate interest income from interest and dividends on interest-earning assets, which are principally comprised of loans and investment securities. We incur interest expense from interest owed or paid on interest-bearing liabilities, including interest-bearing deposits, FHLB advances and other borrowings. Net interest income and margin are shaped by the characteristics of the underlying products, including volume, term and structure of each product. We measure and monitor yields on our loans and other interest-earning assets, the costs of our deposits and other funding sources, our net interest spread and our net interest margin. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Net interest margin is calculated as the annualized net interest income divided by average interest-earning assets.
Interest earned on our loan portfolio is the largest component of our interest income. Our loan portfolios are presented at the principal amount outstanding net of deferred origination fees and unamortized discounts and premiums. Interest income is recognized based on the principal balance outstanding and the stated rate of the loan. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. Loans acquired through acquisition are initially recorded at fair value. Discounts or premiums created when the loans were recorded at their estimated fair values at acquisition are accreted over the remaining term of the loan as an adjustment to the related loan’s yield.
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Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of non-earning assets including nonperforming loans and OREO, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.
Our net interest income was $155.2 million for the year ended December 31, 2021, an increase of $19.3 million, or 14.2%, from 2020. This increase was primarily attributable to growth of $254.8 million in average total loans held-for-investment during 2021, driving an increase in interest income on loans of $13.8 million despite the negative impact of declining market interest rates on loan yields. Interest and fee income on PPP loans contributed $3.2 million of the overall increase in interest income on loans for the period. Interest income on investment securities decreased by $2.1 million for the year ended December 31, 2021, compared to 2020. Interest expense from interest-bearing deposits declined by $7.1 million driven by a 28 basis point reduction in the average rate on our interest-bearing deposits.
Average earning assets for the year ended December 31, 2021 were $5.2 billion, an increase of $0.8 billion, or 18.2%, compared to 2020. Total average loans, including loans held-for-sale, grew to $3.9 billion for the year ended December 31, 2021, an increase of $0.3 billion, compared to 2020. The growth in interest income on loans held-for-investment is due to growth in loan balances and a ten basis point increase in the yield on loans in the year ended December 31, 2021, compared to 2020. Interest income from investment securities declined period over period, due to a combination of a 32 basis point decrease in yield due to decreasing market interest rates, as well as a $23.2 million decrease in average balances, year over year.
Average interest-bearing liabilities increased $0.4 billion, or 11.7%, for the year ended December 31, 2021, compared to 2020. Average interest-bearing deposits increased $0.4 billion, or 13.4%, in the year ended December 31, 2021, compared to 2020 and was the primary driver of the growth in average interest-bearing liabilities. We also saw growth in noninterest-bearing deposits of $0.4 billion, or 40.8% for the year ended December 31, 2021, compared to 2020. In addition to growth in our overall commercial and consumer customer base, we saw deposit growth in the year ended December 31, 2021 as a result of funds our customers received from federal stimulus programs related to the COVID-19 pandemic.
Our net interest margin was 3.00% for the year ended December 31, 2021, compared to 3.10% for 2020, a decrease of ten basis points. While our total cost of funds declined by 27 basis points period over period, we also experienced a 31 basis point decline in yield from earning assets over the same period during 2021. Our earning asset yield was also negatively impacted by the $0.6 billion increase in interest bearing cash balances, compared to the prior year period, from the heightened level of overall liquidity in the marketplace.
The following tables set forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the periods presented. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated.
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As of and for the years ended December 31,:
Interest Earning Assets
Interest-bearing liabilities
Net interest margin (on an FTE basis) 3.11 % 3.25 % 3.56 %
(1) Includes nonaccrual loans
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Rate-Volume Analysis
The tables below present the effect of volume and rate changes on interest income and expense. Changes in volume are changes in the average balance multiplied by the previous period’s average rate. Changes in rate are changes in the average rate multiplied by the average balance from the previous period. The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate.
For the year ended December 31, For the year ended December 31,
(In thousands) Rate Volume Total Rate Volume Total
Interest Earning Assets
Interest-bearing liabilities
Provision for Loan Losses
We established an allowance for loan losses through a provision for loan losses charged as an expense in our consolidated statements of income. The provision for loan losses is the amount of expense that, based on our judgment, is required to maintain the allowance for loan losses at an adequate level to absorb probable losses incurred in the loan portfolio at the balance sheet date and that, in management’s judgment, is appropriate under GAAP. Our determination of the amount of the allowance for loan losses and corresponding provision for loan losses considers ongoing evaluations of the credit quality and level of credit risk inherent in our loan portfolio, levels of nonperforming loans and charge-offs, statistical trends and economic and other relevant factors. The allowance for loan losses is increased by the provision for loan losses and is decreased by charge-offs, net of recoveries on prior loan charge-offs.
We had a provision for loan losses of $3.0 million for the year ended December 31, 2021, compared to a provision for loan losses of $23.1 million for 2020. The increase in our provision for loan losses during 2020 was primarily due to changes in certain environmental factors that resulted from uncertainty surrounding the COVID-19 pandemic, as well as an increase in loan balances. The decrease in provision recorded during 2021 was primarily due to favorable changes to certain environmental factors as a result of improved economic conditions, partially offset by a $375.1 million increase in loan balances, excluding PPP loan balances during the year ended December 31, 2021.
For a further discussion of the allowance for loan losses, refer to the “Allowance for Loan Losses” section of this financial review.
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Noninterest Income
The following table presents noninterest income for the years ended December 31,:
Our noninterest income decreased $24.1 million to $124.2 million for the year ended December 31, 2021 from $148.4 million for 2020, primarily due to a decrease in income from mortgage banking services.
Service charges on deposit accounts includes overdraft and non-sufficient funds charges, treasury management services provided to our business customers, and other maintenance fees on deposit accounts. For the year ended December 31, 2021, service charges on deposit accounts increased $2.9 million, compared to 2020, primarily due to increased treasury management service fee income which increased by $2.0 million, compared to the prior year.
Credit and debit card fees represent interchange income from credit and debit card activity and referral fees earned from processing fees on card transactions at our business customers. Credit and debit card fees increased $1.6 million for the year ended December 31, 2021 compared to 2020, due primarily to increased card transaction volumes.
Trust and investment advisory fees represent fees we receive in connection with our investment advisory and custodial management services of investment accounts. Trust and investment advisory fees increased by $2.6 million for the year ended December 31, 2021 compared to 2020. The increase is primarily due to our September 2020 acquisition of certain customer relationships of a trust and wealth advisory business based in Arizona which added revenues from late 2020 throughout 2021.
For the year ended December 31, 2021, income from mortgage banking services decreased $35.8 million compared to 2020 primarily due to a decline in revenue related to net gain on sales and fees from loan originations, including fair value changes in the held-for-sale portfolio and hedging activity, which decreased $30.5 million for the year ended December 31, 2021 compared to 2020. Loan originations remained relatively flat at $2.3 billion for the years ended December 31, 2021 and 2020, however, gain on sale margins declined in 2021 as compared to 2020. We retain servicing rights on the majority of mortgage loans that we sell, driving the increase in servicing income of $2.7 million from $9.8 million in 2020 to $12.5 million in 2021. MSR capitalization and changes in fair value, net of derivative activity, declined $8.0 million in the year ended December 31, 2021, compared to 2020. The revenue decline related to our MSRs was primarily the result of changes in market interest rates, mortgage spreads and our corresponding hedge positions. We recognize fair value adjustments to our MSR asset, which includes changes in assumptions to the valuation model and pay-offs and pay-downs of the MSR portfolio. We also maintain a hedging strategy to manage a portion of the risk associated with changes in the fair value of our MSR portfolio. Changes in fair value of the derivative instruments used to economically hedge the MSRs are also included as a component of income from mortgage banking services.
The components of mortgage banking income were as follows for the years ended December 31,:
Other noninterest income increased $4.6 million for the year ended December 31, 2021 compared to 2020 primarily due to certain loan-related fee income streams such as loan syndication fee income and customer accommodation interest rate swap fees and changes in fair value as well as unused credit line fees. An increase in gains on other real estate sales of $0.6 million also contributed to the increased other noninterest income.
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Noninterest Expense
The following table presents noninterest expense for the years ended December 31,:
Merger related expenses 3,085 — —
Our noninterest expense increased $20.6 million to $224.6 million for the year ended December 31, 2021, from $204.1 million for 2020, primarily due to increases of $11.9 million in salary and employee benefits expense and $5.8 million in other expenses in the year ended December 31, 2021.
The increase in our salary and employee benefits expense for the year ended December 31, 2021, compared to 2020, was driven by the increase in commissions paid to our mortgage loan officers related to increased mortgage origination activity earlier in the year as well as an increase in headcount associated with expanding our presence in certain markets, including in Texas and Arizona.
We incurred merger related expenses of $3.1 million for the year ended December 31, 2021, related to our proposed merger with Pioneer. We had no merger related expenses in 2020.
Other noninterest expenses increased $5.8 million for the year ended December 31, 2021, compared to 2020. This increase was primarily caused by a $1.3 million increase in data processing expenses related to an increase in volume and enhanced products and services for our customers and a $1.2 million increase in FDIC insurance costs as the Small Bank FDIC Assessment Credit was fully utilized in 2020.
Income Taxes
We had income tax expense for the year ended December 31, 2021 of $8.7 million, compared to $9.6 million in 2020. The decrease in income tax expense was primarily due to our decreased income during 2021. Our effective tax rate was 16.7% for the year ended December 31, 2021, compared to 16.8% in 2020.
Financial Condition
Balance Sheet
Our total assets were $5.7 billion at December 31, 2021, compared to $5.0 billion at December 31, 2020. Our total loans held-for-investment, net of deferred fees, costs, premiums and discounts were $4.0 billion at December 31, 2021, an increase of $190.8 million from 2020.
Investment Securities
Our securities portfolio is used to make various term investments, maintain a source of liquidity and serve as collateral for certain types of deposits and borrowings. We manage our investment portfolio according to written investment policies approved by our board of directors. Investment in our securities portfolio may change over time based on our funding needs and interest rate risk management objectives. Our liquidity levels take into account anticipated future cash flows and other available sources of funds, and are maintained at levels that we believe are appropriate to provide the necessary flexibility to meet our anticipated funding requirements.
Our investment securities portfolio consists of securities classified as available-for-sale and held-to-maturity. There were no trading securities in our investment portfolio as of December 31, 2021 and 2020. All available-for sale securities are carried at fair value and may be used for liquidity purposes should management consider it to be in our best interest.
Our securities available-for-sale increased by $103.9 million to $572.5 million at December 31, 2021. During 2021, the securities held-to-maturity paid down resulting in a decrease of $14.2 million to $18.0 million.
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The following table is a summary of our investment portfolio as of December 31,:
(In thousands) Carrying Amount % of Portfolio Carrying Amount % of Portfolio
Available-for-sale:
U.S. treasury $ 35,185 6.1 % $ — — %
Obligations of states and political subdivisions 3,789 0.7 % 3,435 0.7 %
Held-to-maturity:
Obligations of states and political subdivisions 716 4.0 % 730 2.3 %
The following tables show the weighted average yield to average life of each category of investment securities as of December 31, 2021:
Available-for-sale:
U.S. treasury $ — — % $ — — % $ 35,185 1.29 % $ — — %
Held-to-maturity:
Obligations of states and political subdivisions — — % 716 1.55 % — — % — — %
Collateralized mortgage obligations 706 (1.61) % 5,835 2.09 % — — % — — %
We had no securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.
Loans
Our loan portfolio represents a broad range of borrowers primarily in our markets in Kansas, Colorado, New Mexico, Texas, and Arizona, comprised of commercial, commercial real estate, residential real estate and consumer financing loans. We have a diversified portfolio across a variety of industries, and the portfolio is generally centered in the states in which we have branch offices.
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Total loans, net of deferred origination fees, as of December 31, 2021 and 2020 were $4.0 billion and $3.8 billion, respectively. The commercial loan portfolio included PPP loans outstanding of $66.7 million and $251.1 million at December 31, 2021 and 2020, respectively.
The following table sets forth the composition of our loan portfolio, as of December 31,:
(In thousands) Amount % of total loans Amount % of total loans
Commercial loans include commercial and industrial loans to commercial and agricultural customers for use in normal business operations to finance working capital needs, equipment and inventory purchases, and other expansion projects. Commercial and industrial loans also include our specialty lending verticals such as public finance offerings to our charter school and municipal based customers, asset based lending and structured finance products as well as our healthcare, SBA and other small business lending products. These loans are made primarily in our market areas and are underwritten on the basis of the borrower’s ability to service the debt from revenue, and are generally extended under our normal credit standards, controls and monitoring systems.
Commercial real estate loans include owner occupied and non-owner occupied commercial real estate mortgage loans to operating commercial and agricultural businesses, and include both loans for long-term financing of land and buildings and loans made for the initial development or construction of a commercial real estate project.
Residential real estate loans represent loans to consumers collateralized by a mortgage on a residence and include purchase money, refinancing, secondary mortgages, and home equity loans and lines of credit.
Consumer loans include direct consumer installment loans, credit card accounts, overdrafts and other revolving loans.
The CARES Act created the PPP to provide certain small businesses with liquidity to support their operations during the COVID-19 pandemic. Under the PPP, eligible small businesses could apply to an SBA-approved lender for a loan that does not require collateral or personal guarantees. Entities were required to meet certain eligibility requirements to receive PPP loans, and they must maintain specified levels of payroll and employment to have the loans forgiven. The conditions are subject to audit by the U.S. government, but entities that borrowed less than $2.0 million (together with any affiliates) will be deemed to have made the required certification concerning the necessity of the loan in good faith. However, the SBA does reserve the right to audit any PPP borrower. While the PPP program ended on May 31, 2021, we are now focused on assisting our customers through the loan forgiveness process.
PPP loans issued prior to June 5, 2020 mature in two years unless otherwise modified and loans issued after June 5, 2020 mature in five years. However, PPP loans are eligible for forgiveness (in full or in part, including any accrued interest) under certain conditions. All borrowers are required to retain the supporting documents for six years. For loans (or parts of loans) that are forgiven, the lender will collect the forgiven amount from the U.S. government. The average amount of each of our originated PPP loans was approximately $0.2 million at each of December 31, 2021 and 2020.
The PPP loans have a 1% fixed interest rate and produced an annualized yield for the year ended December 31, 2021 of 5.18%, due to the amortization of net deferred loan fees and the accelerated recognition of loan fees in conjunction with loan forgiveness occurring prior to a scheduled maturity. At December 31, 2021, the remaining amount of unamortized net deferred loan fees on our PPP loans was $1.7 million. Our PPP loans are included in the commercial loans category.
Maturities and Sensitivity of Loans to Changes in Interest Rates
The information in the following tables is based on the contractual maturities of individual loans, including loans that may be subject to renewal at their contractual maturity. Renewal of these loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because
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borrowers have the right to prepay obligations with or without prepayment penalties. The following tables summarize the loan maturity distribution by type and related interest rate characteristics as of December 31, 2021:
Loans maturing with:
Fixed interest rates
Floating or adjustable interest rates
Allowance for Loan Losses
We maintain the allowance for loan losses at a level we believe is sufficient to absorb probable incurred losses in our loan portfolio given the conditions at the time. Events that are not within our control, such as changes in economic factors, could change subsequent to the reporting date and could cause increases or decreases to the allowance. The amount of the allowance is affected by loan charge-offs, which decrease the allowance; recoveries on loans previously charged off, which increase the allowance; and the provision for loan losses charged to earnings, which increases the allowance.
In determining the provision for loan losses, management monitors fluctuations in the allowance resulting from actual charge-offs and recoveries and reviews the size and composition of the loan portfolio in light of current and anticipated economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events change.
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The following table presents, by loan type, the changes in the allowance for loan losses for the years ended December 31,:
Loan charge-offs:
Residential real estate (42) (39) (272)
Recoveries of loans previously charged-off:
Allowance for loan losses to total loans 1.18 % 1.24 % 0.92 %
Ratio of net charge-offs to average loans outstanding 0.09 % 0.11 % 0.13 %
The following table presents net charge-offs (recoveries) to average loans outstanding by loan category for the years ended December 31,:
Commercial real estate 0.03 % 0.03 % — %
Residential real estate — % (0.01) % 0.02 %
Allocation of Allowance for Loan Losses
The following table presents the allocation of the allowance for loan losses by category and the percentage of the allocation of the allowance for loan losses by category to total loans listed as of December 31,:
Nonperforming Assets
We have established policies and procedures to guide us in originating, monitoring and maintaining the credit quality of our loan portfolio. These policies and procedures are expected to be followed by our bankers and underwriters and exceptions to these policies require elevated levels of approval and are reported to our board of directors.
Nonperforming assets include all loans categorized as nonaccrual, loans identified as a troubled debt restructuring (“TDR”), accrual loans greater than 90 days past due, and other real estate owned and other repossessed assets. The accrual of interest on loans is discontinued, or the loan is placed on nonaccrual, when the full collection of principal and interest is in doubt. We do not generally accrue interest on loans that are 90 days or more past due. When a loan is placed on nonaccrual, previously accrued but unpaid interest is reversed and charged against interest income and future accruals of
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interest are discontinued. Payments by borrowers for loans on nonaccrual are applied to loan principal. Loans are returned to accrual status when, in our judgment, the borrower’s ability to satisfy principal and interest obligations under the loan agreement has improved sufficiently to reasonably assure recovery of principal and the borrower has demonstrated a sustained period of repayment performance. In general, we require a minimum of six consecutive months of timely payments in accordance with the contractual terms before returning a loan to accrual status.
A loan is identified as a TDR, when we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession to the borrower. The concessions may be granted in various forms including interest rate reductions, principal forgiveness, extension of maturity date, waiver or deferral of payments and other actions intended to minimize potential losses. A loan that has been restructured in a TDR may not be disclosed as a TDR in years subsequent to the restructuring if certain conditions are met. Generally, a nonaccrual loan that is restructured remains on nonaccrual status for a period of no less than six months to demonstrate that the borrower can meet the restructured terms. However, the borrower’s performance prior to the restructuring or other significant events at the time of restructuring may be considered in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status after a shorter performance period. If the borrower’s performance under the new terms is not reasonably assured, the loan remains classified as a nonaccrual loan.
The CARES Act, as extended by certain provisions of the Consolidated Appropriations Act, 2021, permitted banks to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 that may otherwise be characterized as a TDR and suspended any determination related thereto if (i) the borrower was not more than 30 days past due as of December 31, 2019, (ii) the modifications were related to COVID-19, and (iii) the modification occurred between March 1, 2020 and January 1, 2022. Federal bank regulatory authorities also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19.
As of December 31, 2021 and 2020, $0.8 million and $51.8 million, respectively, of restructured loans were exempt from the accounting guidance for TDRs as a result of loans which are included in the COVID-19 related loan payment deferral total.
The following table sets forth our nonperforming assets as of December 31,:
Nonaccrual loans:
Accrual loans greater than 90 days past due 1,061 777
Other real estate owned and foreclosed assets, net 5,487 3,354
Nonaccrual loans to total loans 0.68 % 0.92 %
Nonperforming loans to total loans (1) 0.86 % 1.07 %
Nonperforming assets to total assets (1) 0.71 % 0.89 %
Allowance for loan losses to nonaccrual loans 173.99 % 135.51 %
Total nonperforming assets were $40.3 million as of December 31, 2021, compared to $44.4 million at 2020.
Deposits
Deposits represent our primary source of funds. We are focused on growing our core deposits through relationship-based banking with our business and consumer clients. Total deposits increased to $4.9 billion at December 31, 2021, compared to $4.2 billion at December 31, 2020. Deposit growth over this period occurred across all of the states in our footprint including Kansas, New Mexico and Colorado, as well as in our newer markets in Arizona and Texas. In addition, government stimulus efforts in response to the COVID-19 pandemic have contributed to a portion of our deposit growth for both commercial and consumer clients. Noninterest-bearing demand deposits increased on average by $0.4 billion from
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December 31, 2020 to December 31, 2021, primarily driven by our growth in our commercial deposit base. Our certificates of deposit have decreased on average by $0.1 billion from 2020 to 2021 primarily due to the low interest rate environment.
The following table sets forth the average balance amounts and the average rates paid on deposits held by us for the years ended December 31,:
Noninterest-bearing demand deposit accounts $ 1,376,968 — % $ 978,092 — %
Interest-bearing deposit accounts:
The following table sets forth the average balance amounts and the average rates paid on deposits by customer type held by us for the years ended December 31,:
Maturities of certificates of deposit of $250,000 or more outstanding are summarized as follows as of December 31,:
Over three months through twelve months 43,922 57,457
Over twelve months through three years 13,490 17,713
The following table sets forth the portion of the Bank's time deposits, by account, that are in excess of the FDIC insurance limit, by remaining time until maturity, as of December 31,:
Three months or less $ 11,214
Over three months through twelve months 42,198
Over twelve months through three years 13,460
Over three years 2,518
As of December 31, 2021 and 2020, approximately $2.5 billion and $1.7 billion, respectively, of our deposit portfolio was uninsured. The uninsured amounts are estimates based on the methodologies and assumptions used for the Bank's regulatory reporting requirements.
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Liquidity
Liquidity refers to our ability to maintain cash flow that is adequate to fund operations, support asset growth, maintain reserve requirements and meet present and future obligations of deposit withdrawals, lending obligations and other contractual obligations.
FirstSun (Parent Company)
FirstSun has routine funding requirements consisting primarily of operating expenses, debt service, and funds used for acquisitions. FirstSun can obtain funding to meet its obligations from dividends collected from its subsidiaries, primarily the Bank, and through the issuance of varying forms of debt. At December 31, 2021, FirstSun has cash and cash equivalents of $11.1 million and debt outstanding of $74.6 million. Management believes FirstSun has the ability to generate and obtain adequate amounts of liquidity to meet its requirements in the short-term and the long-term.
Federal banking laws regulate the amount of dividends that may be paid by banking subsidiaries without prior approval. The Bank may declare dividends without prior regulatory approval that do not exceed the total of retained net income for the current year combined with its retained net income for the preceding two years, subject to maintenance of minimum capital requirements. Prior regulatory approval to pay dividends was not required in 2020 or 2021 and is not currently required. At December 31, 2021, the Bank could pay dividends to FirstSun of approximately $100.0 million without prior regulatory approval.
Bank
The Bank’s liquidity management policy and our asset and liability management policy, or ALM policy, provides the framework that we use to seek to maintain adequate liquidity and sources of available liquidity at levels that will enable us to meet all reasonably foreseeable short-term, long-term and strategic liquidity demands. Our Asset and Liability Management Committee, or ALCO, is responsible for oversight of our liquidity risk management activities in accordance with the provisions of our ALM Policy and applicable bank regulatory capital and liquidity laws and regulations. Our liquidity risk management process includes (i) ongoing analysis and monitoring of our funding requirements under various economic and interest rate scenarios, (ii) review and monitoring of lenders, depositors, brokers and other liability holders to ensure appropriate diversification of funding sources and (iii) liquidity contingency planning to address liquidity needs in the event of unforeseen market disruption, including appropriate allocation of funds to a liquid portfolio of marketable securities and investments. We continuously monitor our liquidity position in order for our assets and liabilities to be managed in a manner that we believe will meet our immediate and long-term funding requirements. We seek to manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our stockholders. We also monitor our liquidity requirements in light of interest rate trends, changes in the economy, and the scheduled maturity and interest rate sensitivity of our securities and loan portfolios and deposits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control when we make investment decisions. Net deposit inflows and outflows, however, are far less predictable and are not subject to the same degree of certainty.
Our liquidity position is supported by management of our liquid assets and liabilities and access to alternative sources of funds. Our short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers and capital expenditures. These liquidity requirements are met primarily through our deposits, FHLB advances and the principal and interest payments we receive on loans and investment securities. Cash, interest-bearing deposits in third party banks, securities available for sale and maturing or prepaying balances in our investment and loan portfolios are our most liquid assets. Other sources of liquidity that are available to us include the sale of loans we hold for investment, the ability to acquire additional national market non-core deposits, borrowings through the Federal Reserve’s discount window and the issuance of debt or equity securities.
At December 31, 2021, our liquid assets, which consist of cash and amounts due from banks and interest-bearing deposits in other financial institutions, amounted to $583.0 million, or 10.3% of total assets, compared to $144.9 million, or 2.9% of total assets, at December 31, 2020. The increase in our liquid assets was primarily due to an increase in cash held at the Federal Reserve. Our available-for-sale securities at December 31, 2021 were $572.5 million, or 10.1% of total assets, compared to $468.6 million, or 9.4% of total assets, at December 31, 2020. Investment securities with an aggregate carrying value of $465.7 million and $437.2 million at December 31, 2021 and December 31, 2020, respectively, were pledged to secure public deposits and repurchase agreements. The increase in our pledged securities was due to increases in public funds and repurchase agreements.
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The liability portion of our balance sheet serves as a primary source of liquidity. We plan to meet our future cash needs primarily through the generation of deposits. Customer deposits have historically provided a sizeable source of relatively stable and low-cost funds. At December 31, 2021, customer deposits, excluding brokered deposits and certificates of deposit greater than $250,000, were 113.2% of net loans, compared with 98.8% at December 31, 2020. For additional information related to our deposits, see Deposits section above. We are also a member of the FHLB, from which we can borrow for leverage or liquidity purposes. The FHLB requires that securities and qualifying loans be pledged to secure any advances. At December 31, 2021, we had $40.0 million in advances from the FHLB and a remaining credit availability of $505.0 million. In addition, we maintain a $8.5 million line with the Federal Reserve Bank’s discount window that is secured by certain loans from our loan portfolio.
Management believes the Bank has the ability to generate and obtain adequate amounts of liquidity to meet its requirements in the short-term and the long-term.
Capital
Stockholders’ equity at December 31, 2021 was $524.0 million, compared to $485.8 million at 2020, an increase of $38.3 million, or 7.9%. The increase was primarily driven by net income in 2021.
Capital Adequacy
We are subject to various regulatory capital requirements administered by the federal banking agencies. Management routinely analyzes our capital to ensure an optimized capital structure. For further information on capital adequacy see Note 17 - Regulatory Capital Matters to the consolidated financial statements.
Material Contractual Obligations, Commitments, and Contingent Liabilities
We have entered into contractual obligations in the normal course of business that involve elements of credit risk, interest rate risk and liquidity risk.
The following table summarizes our material contractual obligations as of December 31, 2021. Further discussion of each obligation or commitment is included in the referenced note to the consolidated financial statements.
Deposits:
Securities sold under agreements to repurchase 10 92,093 92,093 — — —
Short-term debt:
FHLB LOC 11 — — — — —
Long-term debt:
We are party to various derivative contracts as a means to manage the balance sheet and our related exposure to changes in interest rates, to manage our residential real estate loan origination and sale activity, and to provide derivative contracts to our clients. Since the derivative liabilities recorded on the balance sheet change frequently and do not represent the amounts that may ultimately be paid under these contracts, these liabilities are not included in the table of contractual obligations presented above. Further discussion of derivative instruments is included in Note 7 - Derivative Financial Instruments to the consolidated financial statements.
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In the normal course of business, various legal actions and proceedings are pending against us and our affiliates which are incidental to the business in which they are engaged. Further discussion of contingent liabilities is included in Note 22 - Commitments and Contingencies to the consolidated financial statements.
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, commercial letters of credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contractual or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments. Further discussion of contingent liabilities is included in Note 22 - Commitments and Contingencies to the consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of reduced earnings and/or declines in the net market value of the balance sheet due to changes in market rates. Our primary market risk is interest rate risk which impacts our net interest income, fee income related to interest sensitive activities such as mortgage origination and servicing income and loan and deposit demand.
We are subject to interest rate risk due to:
•the maturity or repricing of assets and liabilities at different times or for different amounts;
•differences in short-term and long-term market interest rate changes; and
•the remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change.
Our Asset Liability Committee, or ALCO, which is composed of our executive officers and certain other members of management, monitors interest rate risk on an ongoing basis in accordance with policies approved by our board of directors. The ALCO reviews interest rate positions and considers the impact projected interest rate scenarios have on earnings, liquidity, business strategies and other factors. However, management has the latitude to change interest rate positions within certain limits if, in management’s judgment, the change will enhance profitability or minimize risk.
To assess and manage interest rate risk, sensitivity analysis is used to determine the impact on earnings and the net market value of the balance sheet across various interest rate scenarios, balance sheet trends, and strategies.
Management uses a simulation model to analyze the sensitivity of net interest income to changes in interest rates across various interest rate scenarios, which seeks to demonstrate the level of interest rate risk inherent in the existing balance sheet. The analysis holds the current balance sheet values constant and does not take into account management intervention. In addition, we assume certain correlation rates, often referred to as a “deposit beta,” for interest-bearing deposits, wherein the rates paid to customers change relative to changes in benchmark interest rates. The effect on net interest income over a 12-month time horizon due to hypothetical changes in market interest rates is presented in the table below. In this interest rate shock simulation, as of the periods presented, interest rates have been adjusted by instantaneous parallel changes rather than in a ramp simulation, which applies interest rate changes over time. All rates, short-term and long-term, are changed by the same amount (e.g. plus or minus 100 basis points) resulting in the shape of the yield curve remaining unchanged.
Base — % — % — % — %
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Item 8. Financial Statements
Index to Consolidated Financial Statements
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID: 173) 75
Consolidated Balance Sheets 76
Consolidated Statements of Income and Comprehensive Income 77
Consolidated Statements of Stockholders' Equity 78
Consolidated Statements of Cash Flows 79
Notes to Consolidated Financial Statements 81
Note 2 - Securities 93
Note 3 - Loans 95
Note 4 - Mortgage Servicing Rights 101
Note 5 - Premises and Equipment 102
Note 6 - Core Deposits and Other Intangible Assets 102
Note 7 - Derivative Financial Instruments 104
Note 8 - Prepaid expenses and other assets 106
Note 9 - Deposits 106
Note 10 - Securities Sold Under Agreements to Repurchase 107
Note 12 - Accrued Expenses and Other Liabilities 110
Note 13 - Earnings Per Share 111
Note 14 - Stockholders' Equity 111
Note 15 - Income Taxes 113
Note 16 - Other noninterest expenses 115
Note 17 - Regulatory Capital Matters 115
Note 18 - Transactions with Related Parties 117
Note 19 - Fair Value Measurements 117
Note 20 - Parent Company Only Condensed Financial Information 121
Note 21 - Segment Information 123
Note 22 - Commitments and Contingencies 127
Note 23 - Revenue from Contracts with Customers 129
Note 24 - Subsequent Events 130
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and the Board of Directors of FirstSun Capital Bancorp and Subsidiaries
Denver, Colorado
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of FirstSun Capital Bancorp and Subsidiaries (the "Company") as of December 31, 2021 and 2020, the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Crowe LLP
Crowe LLP
We have served as the Company's auditor since 2014.
Dallas, Texas
March 25, 2022
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FIRSTSUN CAPITAL BANCORP
and Subsidiaries
Consolidated Balance Sheets
As of December 31,
(In thousands, except par and share amounts) 2021 2020
Assets
Mortgage servicing rights, at fair value 47,392 29,144
Other real estate owned and foreclosed assets, net 5,487 3,354
Core deposits and other intangible assets, net 8,250 9,667
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Securities sold under agreements to repurchase 92,093 115,372
Accrued expenses and other liabilities 83,908 99,384
Commitments and contingencies (Note 22)
Stockholders’ equity:
Accumulated other comprehensive income, net 1,664 9,119
The accompanying notes are an integral part of these consolidated financial statements.
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FIRSTSUN CAPITAL BANCORP
and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
For the years ended December 31,
Interest income:
Interest and fee income on loans:
Interest and dividend income on securities:
Interest expense:
Interest expense on securities sold under agreements to repurchase 59 157 728
Noninterest income:
Gain on sales of available-for-sale securities, net — 153 1,583
Gain on other real estate owned and foreclosed assets activity, net 766 148 303
Noninterest expense:
Merger related expenses 3,085 — —
Other comprehensive income:
Income tax effect on other comprehensive income 2,415 (2,352) (4,022)
Earnings per share:
The accompanying notes are an integral part of these consolidated financial statements.
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FIRSTSUN CAPITAL BANCORP
and Subsidiaries
Consolidated Statements of Stockholders’ Equity
For the years ended December 31,
Issuance of treasury stock (100 shares) — — — 3 — — 3
Share-based compensation, net of forfeitures — — 2,114 — — — 2,114
Issuance of treasury stock (100 shares) — — — 2 — — 2
Share-based compensation, net of forfeitures — — 2,335 — — — 2,335
Other comprehensive income — — — — — 7,261 7,261
Issuance of common stock on restricted stock grants 24,629 — 812 — — — 812
Share-based compensation, net of forfeitures — — 1,730 — — — 1,730
Other comprehensive loss — — — — — (7,455) (7,455)
The accompanying notes are an integral part of these consolidated financial statements.
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FIRSTSUN CAPITAL BANCORP
and Subsidiaries
Consolidated Statements of Cash Flows
For the years ended December 31,
Cash flows from operating activities:
Adjustments to reconcile income to net cash provided by operating activities:
Net accretion of discount on acquired loans (1,142) (3,766) (4,175)
Net change in deferred loan origination fees and costs 617 8,811 2,682
Amortization of core deposits and other intangible assets 1,417 1,485 1,896
Net amortization (accretion) of lease marks — 83 (6)
Amortization of software implementation costs 1,063 1,028 1,036
Accretion of fair value premium on acquired deposits (45) (151) (288)
Amortization of fair value discount on subordinated debt 256 258 261
Amortization of issuance costs on subordinated debt 93 45 —
Amortization of fair value discount on convertible notes payable 746 752 761
Accretion of fair value premium on Federal Home Loan Bank advances — (165) (57)
Impairment of premises and equipment — 678 —
Impairment of other real estate owned and foreclosed assets 217 418 1,076
Federal Home Loan Bank stock dividends (407) (468) (311)
Decrease in fair value of mortgage servicing rights 5,606 22,280 11,930
Net gain on sales of available-for-sale securities — (153) (1,583)
Net loss (gain) on sales of loans held-for-investment 701 1,180 (511)
Net loss on disposal of premises and equipment 76 519 207
Net gain on bank-owned life insurance — — (464)
Changes in operating assets and liabilities:
Net cash provided by (used in) operating activities $ 113,109 $ (547) $ 3,897
The accompanying notes are an integral part of these consolidated financial statements.
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FIRSTSUN CAPITAL BANCORP
and Subsidiaries
Consolidated Statements of Cash Flows (continued)
For the year ended December 31,
Cash flows from operating activities: (previous page) $ 113,109 $ (547) $ 3,897
Cash flows from investing activities:
Net cash paid for acquisitions — (7,019) —
Proceeds from maturities of held-to-maturity securities 13,835 24,433 18,084
Proceeds from the sale of premises and equipment 5 2,945 1,757
Proceeds from bank-owned life insurance — — 1,337
Purchases of restricted equity securities (57) (8,704) (12,157)
Purchase of other investments (686) (155) (82)
Proceeds from the sale or redemption of other investments 519 1 10
Cash flows from financing activities:
Proceeds from Federal Home Loan Bank advances — — 871,000
Proceeds from Subordinated debt — 39,067 —
Proceeds from issuance of common stock, net of issuance costs (456) — 1,268
Issuance of treasury stock — (31) 358
Supplemental disclosures of cash flow information:
Non-cash investing and financing activities:
Other assets transferred to Premises and equipment $ 170 $ — $ —
The accompanying notes are an integral part of these consolidated financial statements.
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FIRSTSUN CAPITAL BANCORP and Subsidiaries
Notes to Consolidated Financial Statements
($ in thousands, except share and per share amounts)
NOTE 1 - Basis of Presentation, Description of Business and Summary of Significant Accounting Policies
a.Principles of Consolidation - The consolidated financial statements include the accounts of FirstSun Capital Bancorp (“FirstSun” or “Parent Company”) and its wholly-owned subsidiaries, Sunflower Bank, N.A. (the “Bank”) and Logia Portfolio Management, LLC, and have been prepared using U.S. generally accepted accounting principles (“U.S. GAAP”) and prevailing practices in the banking industry.All significant intercompany balances and transactions have been eliminated. These entities are collectively referred to as “our”, “us”, “we”, or “the Company”.
b.Nature of Operations - The Bank is headquartered in Denver, Colorado, and primarily operates throughout Kansas, Colorado, New Mexico, Texas and Arizona providing a full range of commercial and consumer banking and financial services to small and medium-sized companies. Its primary deposit products are checking, savings and term certificate accounts. Its primary wealth management and trust products are personal trust and agency accounts, employee benefit and retirement related trust and agency accounts, investment management and advisory agency accounts, and foundation and endowment trust and agency accounts. Its primary lending products are residential mortgage, commercial and consumer loans. Substantially all loans are secured by specific items of collateral, including business assets, consumer assets, and commercial and residential real estate. Commercial loans are generally expected to be repaid from the borrower’s cash flow from operations.
c.Business Combination - On May 11, 2021, FirstSun and Pioneer Bancshares, Inc. (“Pioneer”) entered into an Agreement and Plan of Merger that provides for the merger of Pioneer with and into FirstSun, with FirstSun as the surviving entity (the “merger”). If the merger is completed, each share of Pioneer common stock will be converted into the right to receive 1.0443 shares of FirstSun common stock plus cash in lieu of any fractional shares. In September 2021, the Pioneer stockholders approved the merger. On March 7, 2022, we received the necessary regulatory approvals to complete the mergers, subject to applicable waiting periods. We expect to close the mergers on April 1, 2022, subject to the satisfaction of other customary closing conditions. Pioneer currently operates from its headquarters in Austin, Texas and has banking offices located primarily in the Austin, Houston, San Antonio, and Dallas metro areas. As of December 31, 2021 Pioneer reported assets of $1.6 billion, total loans of $0.9 billion, and deposits of $1.2 billion.
d.Subsequent Events - We evaluate events occurring subsequent to the balance sheet date to determine whether the events required recognition or disclosure in the financial statements. If conditions of a subsequent event existed as of the balance sheet date, depending on materiality, the effects may be required to be recognized and disclosed in the financial statements. If conditions of a subsequent event arose after the balance sheet date, the effects are not required to be recognized in the financial statements, but depending on materiality, may need to be disclosed in the financial statements.
e.Use of Estimates - The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
These estimates are based on historical experience and on various assumptions about the future that are believed to be reasonable based on all available information. Our reported financial position or results of operations may be materially different under changed conditions or when using different estimates and assumptions, particularly with respect to significant accounting policies. In the event that estimates or assumptions prove to differ from actual results, adjustments are made in subsequent periods to reflect more current information.
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f.Concentration of Credit Risk - We have a significant concentration in residential real estate and commercial loans within Kansas, Colorado, New Mexico, Texas, and Arizona. When necessary, we perform credit evaluations on our customers' financial condition and often request additional guarantees and forms of collateral from our customers. These financial evaluations require significant judgment and are based on a variety of factors including, but not limited to, current economic trends, historical payment patterns, and bad debt write-off experience. Declines in the local or statewide economies could have an adverse impact on our financial condition. Adverse developments affecting real estate values in one or more of our markets could increase our credit risk associated with our loan portfolio. Additionally, if loans are not repaid according to their terms, the collateral securing the loans, in those cases where real estate serves as the primary collateral, may not have value equal to the amounts owed under the loan. We did not exceed regulatory concentration monitoring levels as of December 31, 2021 or 2020.
g.Reclassifications - Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior years net income or stockholders’ equity.
h.Fair Value Measurement - Fair value is determined in accordance with Accounting Standards Codification (ASC) Topic 820, Fair Value Measurement. ASC Topic 820 establishes a fair value hierarchy which requires the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 describes three levels of inputs that may be used to measure fair value:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
Level 3: Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own beliefs about the assumptions that market participants would use in pricing the assets or liabilities.
i.Cash and Cash Equivalents - Cash and cash equivalents include cash, cash items in process of collection, deposits with other financial institutions and federal funds sold. For purposes of the consolidated statements of cash flows, we consider all federal funds sold and interest-bearing deposits at other financial institutions to be cash and cash equivalents, all with original maturities of less than 90 days. Cash held at depository institutions at times may be in excess of the Federal Deposit Insurance Corporation (FDIC) insurance limit. Cash deposits are with reputable financial institutions and we do not anticipate realizing any losses from these cash deposits. As of December 31, 2021 and 2020, we have complied with all regulatory cash reserve and clearing requirements.Cash and cash equivalents were as follows as of December 31,:
Cash on hand and noninterest bearing accounts 51,441 55,983
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j.Securities - The Bank classifies debt securities as either available-for-sale or held-to-maturity. Held-to-maturity securities are those which the Bank has the positive intent and ability to hold to maturity. All other debt securities are classified as available-for-sale.
Held-to-maturity securities are recorded at amortized cost. Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders’ equity (accumulated other comprehensive income/loss) until realized. Realized gains and losses on securities classified as available-for-sale are included in earnings and recorded on trade date. The specific identification method is used to determine the cost of the securities sold.
Purchased premiums and discounts on debt securities are amortized/accreted into interest income using the yield-to-maturity method based upon the remaining contractual maturity of the asset, adjusted for any expected prepayments.
Management evaluates debt securities for other-than-temporary impairment (OTTI) on at least a quarterly basis, and more frequently when warranted by economic or market conditions. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the difference between amortized cost and fair value is recognized as an impairment through earnings. A decline in the market value of any security below cost that is deemed other than temporary due to the losses being credit and not due to other factors is charged to income, resulting in the establishment of a new cost basis for the security. Amortization and accretion of purchase premium and discount is then discontinued. Continuance of accrual of interest is determined on an individual basis. For debt securities that do not meet the aforementioned OTTI criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement, and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Equity securities are carried at fair value, with changes in fair values reported in net income. Equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment. Equity securities are included as a component of "prepaid expenses and other assets" in our consolidated balance sheets.
k.Loans Held-for-sale - Mortgage loans originated and intended for sale in the secondary market are classified as loans held-for-sale and recorded at fair value. Most of these loans are sold with servicing rights retained. The changes in fair value of loans held-for-sale are measured and recorded in income from mortgage banking services. Loan origination fees are recorded in the period of origination.
l.Loans Receivable - Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are reported at the principal balance outstanding, net of purchase premiums and discounts, deferred loan fees and costs, and an allowance for loan losses.
Interest on loans receivable is accrued and credited to income based upon the principal amount outstanding using primarily a simple interest calculation. Loan origination fees and related direct loan origination costs for a given loan are offset and only the net amount is deferred and amortized and recognized in interest income over the life of the loan using the level yield method without anticipating prepayments. The accrual of interest income on loans is discontinued when, in management’s judgment, the interest is uncollectible in the normal course of business, and a loan is moved to nonaccrual status in accordance with the Bank’s policy, typically after 90 or 120 days of non-payment, as follows: interest income on consumer, commercial real estate and commercial loans is typically discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection; interest income on residential real estate loans is typically discontinued at the time the loan is 120 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest in full is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
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When discontinued, all unpaid interest is reversed. Interest is included in income after the date the loan is placed on nonaccrual status only after all principal has been paid or when the loan is returned to accrual status. The loan is returned to accrual status only when the borrower has brought all past-due principal and interest payments current and, in the opinion of management, has demonstrated the ability to make future payments of principal and interest as scheduled.
Acquired Loans - Acquired loans are recorded at fair value as of the acquisition date and classified as either purchased performing or purchased credit impaired (PCI) loans.
For purchased performing loans, we follow the provisions of ASC Topic 310-20, Receivables - Nonrefundable Fees and Other Costs. The difference between the fair value and unpaid principal balance on a purchased performing loan as of the acquisition date is accreted or amortized to interest income over the estimated life of the loan. We may aggregate purchased performing loans into different pools based on common risk characteristics such as risk rating, underlying collateral, type of interest rate (fixed or adjustable), types of amortization, and other similar factors. A purchased performing loan pool is accounted for as a single asset with a single interest rate, cumulative loss rate, and cash flow expectation. A loan will be removed from a pool of loans only if the loan is sold, foreclosed, or assets are received in full satisfaction of the loan. If an individual loan is removed from a pool of loans, the difference between its relative carrying amount and its cash, fair value of the collateral, or other assets received will be recognized in income immediately as interest income on loans and would not affect the effective yield used to recognize the accretable yield on the remaining loan pool.
For PCI loans, we follow the provisions of ASC Topic 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality. PCI loans reflect credit deterioration since origination such that it is probable at acquisition that we will be unable to collect all contractually required payments. PCI loans are initially recorded at estimated fair value measured as the present value of all cash flows expected to be received, discounted at an appropriately risk-weighted discount rate. Initial cash flow expectations incorporate significant assumptions regarding prepayment rates, frequency of default, and loss severity. The excess of cash flows expected to be collected over a loan’s carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the loan using the effective yield method. The accretable yield may change due to changes in the timing and amounts of expected cash flows. Expected cash flows for PCI loans are reviewed quarterly. If, at acquisition, the PCI loans are collateral dependent and acquired primarily for the rewards of ownership of the underlying collateral, or if cash flows to be collected cannot be reasonably estimated, accrual of income is not recorded. The excess of the undiscounted contractual balances due over the cash flows expected to be collected on a PCI loan is considered to be the nonaccretable difference. The nonaccretable difference represents our estimate of the credit losses expected to occur and is considered in determining the fair value of the loans as of the acquisition date. Subsequent to the acquisition date, any increases in expected cash flows over those expected as of the acquisition date are adjusted through an increase to the accretable yield on a prospective basis. Any subsequent decreases in expected cash flows attributable to credit deterioration are recognized by recording a provision for loan losses which is charged against earnings. PCI loans acquired are subject to our internal and external credit review and monitoring controls. Our PCI loan portfolio may also include revolving lines of credit with funded and unfunded commitments. Loan balances outstanding at the time of acquisition are accounted for under ASC Topic 310-30. Any additional advances on these commitments subsequent to the acquisition date are accounted for under ASC Topic 310-20.
m.Allowance for Loan Losses - The allowance for loan losses is a valuation allowance for probable incurred credit losses and is based upon management’s estimate of the amount required to maintain an adequate allowance which reflects the risks in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required and necessary provision for loan losses expense using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, current economic conditions, and other factors which, in the opinion of management, deserve current recognition. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (“TDR”s) and classified as impaired.
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Management also considers loan impairment in its analysis of the allowance. We consider a loan to be impaired when management believes it is probable that it will be unable to collect all principal and interest due according to the contractual terms of the loan. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at: the present value of estimated future cash flows discounted using the loan’s effective interest rate; the loan’s observable market price; or at the fair value of collateral if repayment is expected primarily from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
TDRs occur when a borrower is experiencing financial difficulty and a concession is granted; such as below market interest rate for the remaining original life of the loan, extension of maturity date, release of collateral, reduction of principal amount or reduction of accrued interest. TDRs are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, we determine the amount of reserve in accordance with the accounting policy for the allowance for loan losses on loans individually identified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio type and is based on the actual loss history experienced by us. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio type. These economic factors include, but are not limited to, consideration of the following: levels of, and trends in delinquencies, impaired loans, nonaccrual, and adversely classified loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; changes in the quality of the loan review system; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; effects of changes in credit concentrations; and the effects of other external factors such as competition and legal and/or regulatory requirements on the level of estimated credits losses in the Bank’s portfolio.
Loan credit quality and the adequacy of the allowance are also subject to periodic examination by regulatory agencies. Such agencies may require adjustments to the allowance based upon their judgments about information available at the time of their examination.
The Bank’s loan portfolio types are Commercial, Commercial Real Estate, Residential Real Estate, and Consumer loans. The Bank has a diversified portfolio across a variety of industries, and the portfolio is generally centered in the states in which the Bank has offices.
Commercial loans include commercial and industrial loans to commercial and agricultural customers for use in normal business operations to finance working capital needs, equipment and inventory purchases, and other expansion projects. These loans are made primarily in the Bank’s market areas, are underwritten on the basis of the borrower’s ability to service the debt from revenue, and extended under the Bank’s normal credit standards, controls, and monitoring systems. Collateral is often represented by liens on accounts receivable, inventory, equipment, and other forms of general non-real estate business assets. The Bank often obtains some form of credit enhancement through a personal guaranty of the borrower, principals and/or others. The global cash flow capability of commercial loan customers is generally evaluated both at underwriting and during the life of the loan. Commercial loans may involve increased risk due to the expectation that repayments for such loans generally come from the operation of the business activity and those operations may be unsuccessful. A disruption in the operating cash flows from a business, sometimes influenced by events not under the control of the borrower such as changing business environment, changes in regulations and political climate, unexpected natural events, or competition could also impact the borrower’s capacity to repay the loan. Assets collateralizing commercial loans may also decline in value more quickly than anticipated. Commercial loans require increased underwriting and monitoring to offset these risks, for which the Bank’s systems have been designed to provide.
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Commercial Real Estate loans include owner occupied and non-owner occupied commercial real estate mortgage loans to operating commercial and agricultural businesses, and include both loans for long term financing of land and buildings and loans made for the initial development or construction of a commercial real estate project. Commercial Real Estate loans are repaid by cash flow generated by business operations, revenues generated from other business of the borrower, or from other long term financing sources upon completion of development or construction. Commercial Real Estate loans are collateralized by well-managed property with adequate margins and may also include credit enhancements through guarantees from responsible parties and collateralization by other assets. The performance of Commercial Real Estate loans may be impacted by negative changes in the real estate market and the underlying collateral value, weakened economic conditions, changing regulations and political climate, unexpected natural events, and other external factors. Commercial Real Estate loans require specialized underwriting and monitoring to offset these risks, which the Bank’s systems have been designed to provide.
Residential Real Estate loans represent loans to consumers collateralized by a mortgage on a residence and include purchase money, refinancing, secondary mortgages, and home equity loans and lines of credit. Residential Real Estate loans also include purchased mortgage loan pools serviced by others. General overall economic conditions, and individual economic conditions such as job loss, divorce, illness or personal bankruptcy, may impact the performance of Residential Real Estate borrowers. The credit quality of Residential Real Estate loans is monitored primarily on the basis of payment delinquency.
Consumer loans include direct consumer installment loans, credit card accounts, overdrafts and other revolving loans. Consumer loans are underwritten using factors such as the borrower’s income and debt levels, credit history, and the value of available collateral. General overall economic conditions, and individual economic conditions such as job loss, divorce, illness or personal bankruptcy, may impact the performance of Consumer loan borrowers. In case of default, collateral on a Consumer loan may be difficult or expensive to locate and acquire, and collection efforts may not warrant substantial actions other than obtaining a deficiency judgment. The credit quality of Consumer loans is monitored primarily on the basis of payment delinquency.
The Bank utilizes an internal loan risk rating system as a means of underwriting, monitoring credit quality, and identifying both problem and potential problem loans. The Bank’s credit risk management policies, procedures and practices promote sound lending standards and prudent management of credit risks, providing for sound underwriting, appropriate ongoing monitoring and review, and adherence to policy and regulatory requirements.
n.Mortgage Servicing Rights (MSRs) - MSRs arise from contractual agreements between us and investors in mortgage loans. Pursuant to ASC Topic 860-50, Servicing Assets and Liabilities, we record MSR assets when we sell loans on a servicing-retained basis, at the time of a securitization that qualifies and meets requirements for sale accounting or through the acquisition or assumption of the right to service a financial asset. Under these contracts, we perform loan servicing functions in exchange for fees and other remuneration.
Our MSRs are initially recorded and subsequently measured at fair value. The fair value of the MSRs is based upon the present value of the expected future net cash flows related to servicing these loans. We receive a base servicing fee, generally ranging from 0.25% to 0.50% annually on the remaining outstanding principal balances of the loans. The servicing fees are collected from investors. We determine the fair value of the MSRs by the use of a discounted cash flow model that incorporates prepayment speeds, delinquencies, discount rate, ancillary revenues and other assumptions (including costs to service) that management believes are consistent with the assumptions other market participants use in valuing MSRs. The nature of the loans underlying the MSRs affects the assumptions used in the cash flow models. We obtain third party valuations quarterly to assess the reasonableness of the fair value calculated by the cash flow model. Changes in the fair value of MSRs are charged or credited to income from mortgage banking services, net.
As a part of our mortgage servicing responsibilities, we advance funds when the borrower fails to meet contractual payments (e.g. principal, interest, property taxes, and insurance). We also advance funds to maintain, report, and market foreclosed real estate properties on behalf of investors. These advances are collectively known as servicer related advances. Such advances are recovered from borrowers for reinstated and performing loans and from investors for foreclosed loans. We record a valuation allowance on outstanding servicer advances when we determine that based on all available information, it is probable that a loss has been incurred, and that all contractual amounts due will not be recovered.
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o.Premises and Equipment - Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line or declining balance method depending upon the type of asset with useful lives ranging from three to 39 years.
Maintenance and repair costs are charged to expense as incurred. Major betterments are considered individually and are capitalized or expensed depending on facts and circumstances.
p.Other Real Estate Owned and Foreclosed Assets - Assets acquired through, or in lieu of, foreclosure or repossession or otherwise are being held for disposal or to be sold are adjusted upon transfer to fair value less estimated costs to sell, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Subsequent to foreclosure/repossession, management periodically performs valuations, and an allowance for losses is established by a charge against earnings if the carrying value of a property exceeds the fair value less estimated costs to sell. Revenue and expenses from operation and changes in the valuation allowance are included in other noninterest expense on the consolidated statements of income and comprehensive income.
q.Bank-owned Life Insurance (BOLI) - We have purchased life insurance policies on certain key current and former executives as a method to offset the cost of employee benefit plans. We record BOLI at the estimated contractual amount that would be realized if the life insurance policy is surrendered prior to maturity or death of the insured, which is the cash surrender value adjusted for other charges and amounts due that are probable at settlement. Changes in the net cash surrender value of the policies, as well as insurance proceeds received, are recorded in noninterest income and are not subject to income taxes.
r.Restricted Equity Securities - Restricted equity securities consist of capital stock of the Federal Home Loan Bank of Topeka (FHLB) and the Federal Reserve Bank of Kansas City (FRB). Such stock is not readily marketable, and accordingly, is carried at cost. Members of the FHLB are required to own a certain amount of stock based on the level of borrowings and other factors. As a national banking association, the Bank is required to own stock of its regional FRB. FRB and FHLB stock are periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Restricted equity securities consisted of the following:
Total restricted equity securities $ 16,239 $ 23,175
s.Goodwill - The excess purchase price of acquired businesses over the fair value of identifiable assets acquired and liabilities assumed is recognized as goodwill. Goodwill is evaluated for impairment on an annual basis, or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. Our evaluation may consist of performing a qualitative assessment of impairment to determine whether any further quantitative testing for impairment is necessary. Factors considered in the qualitative assessment include general economic conditions, conditions of the industry and markets in which we operate, regulatory developments, cost factors, and our overall financial performance. We performed our most recent annual goodwill impairment test as of December 31, 2021 and concluded that no impairment existed. No impairment losses have been recognized during the years ended December 31, 2021, 2020 and 2019.
t.Core Deposits and Other Intangible Assets - Core deposits related to the depositor relationship of customers acquired from an acquisition are recognized in the value of core deposits. Our core deposits were valued based on the expected future benefit or earnings capacity attributable to the acquired deposits. These assets have been assigned a 10 year life from the date of acquisition. Other intangible assets include the trade names of First National 1870 and Guardian Mortgage. These trade names provide a source of market recognition to attract potential clients/relationships and retain existing customers. Management has indicated that portions of the business will utilize these trade names into perpetuity; therefore, these trade names have been classified as indefinite-lived assets. Further, we acquired certain customer relationships relating to wealth management. These customer relationships were assigned an amortization period of 16 years. During 2020, the Company acquired
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additional customer relationships relating to wealth advisory services from a financial institution. These customer relationships were assigned an amortization period of 10 years. Further information on the asset purchase is presented in Note 6 - Core Deposits and Other Intangible Assets. Two non-competition agreements were put in place for certain employees. These agreements were fully amortized in 2019.
u.Impairment of Long-lived Assets - Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When events or changes in circumstances indicate an asset may not be recoverable, we estimate the future cash flows expected to result from the use of the asset. If impairment is indicated, an adjustment is made to reduce the carrying amount based on the difference between the future cash flows expected and the carrying amount of the asset. There were no impairments of long-lived assets recognized in 2021 and 2019. During 2020, we approved the closure of six bank branches resulting in the impairment of $678 of long-lived assets.
v.Transfers of Financial Assets - Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
w.Loan Commitments and Related Financial Instruments - Financial instruments include off-balance sheet credit instruments, such as commitments to make loans, commercial letters of credit, and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
x.Derivative Instruments and Hedging Activities - ASC Topic 815, Derivatives and Hedging (ASC Topic 815), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain our objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
As required by ASC Topic 815, we record all derivatives on the consolidated balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain of our risks, even though hedge accounting does not apply or we do not elect not to apply hedge accounting. We do not have any cash flow or foreign currency hedges.
In accordance with the fair value measurement guidance in ASU Topic 2011-04, Fair Value Measurement (Topic 820), we made an accounting policy election to measure the credit risk of our derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.
In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. The Alternative Reference Rates Committee ("ARRC") has proposed that the SOFR replace USD-LIBOR. We have material contracts that are indexed to USD-LIBOR. Industry organizations are currently working on the transition plan. We are currently monitoring this activity and our portfolio as well as evaluating the risks involved. Under this guidance, SOFR will be an eligible benchmark interest rate for our hedging strategies. Also effective December 31, 2021, we are no longer issuing debt indexed to USD-LIBOR.
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Risk Management Objective of Using Derivatives
Banking Activities -We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our assets and liabilities and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to our loan portfolio. The initial and subsequent changes in value, as well as the offsetting gain or loss of banking derivative financial instruments that qualify as fair value hedges, and any fees income generated are recorded as a component of interest and fee income on loans in our consolidated statements of income and comprehensive income.
Mortgage Banking Activities - Our mortgage bankers enter into interest rate lock commitments (IRLC) with prospective borrowers. An IRLC represents an agreement to purchase loans from a third-party originator or an agreement to extend credit to a mortgage applicant, whereby the interest rate is set prior to funding. The loan commitment binds us (subject to the loan approval process) to fund the loan at the specified rate, regardless of whether interest rates have changed between the commitment date and the loan funding date. Outstanding interest rate lock commitments are subject to interest rate risk and related price risk during the period from the date of the commitment through the loan funding date or expiration date. The borrower is not obligated to obtain the loan, thus we are subject to fallout risk related to IRLCs, which is realized if approved borrowers choose not to close on the loans within the terms of the IRLC. Our interest rate exposure on these derivative loan commitments is hedged with forward sales of mortgage-based securities as described below. Our IRLCs are carried at fair value in accordance with ASC Topic 815,and recorded at fair value in prepaid expenses and other assets on our consolidated balance sheets. ASC Topic 815 clarifies that the expected net future cash flows related to the associated servicing of a loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The estimated fair values of IRLCs are based on the fair value of the related mortgage loans which is based upon observable market data. The initial and subsequent changes in value of IRLCs are recorded as a component of income from mortgage banking services, net, in our consolidated statements of income and comprehensive income.
We actively manage the risk profiles of our IRLCs and mortgage loans held-for-sale on a daily basis. To manage the price risk associated with IRLCs, we enter into forward sales of mortgage-backed securities (MBS) in an amount equal to the portion of the IRLC expected to close, assuming no change in mortgage interest rates. In addition, to manage the interest rate risk associated with mortgage loans held-for-sale, we enter into forward sales of MBS to deliver mortgage loans to third party investors. The estimated fair values of forward sales of MBS and forward sales commitments are based on exchange prices or the dealer market price. The initial and subsequent changes in value on forward sales of MBS and forward sales commitments are a component of income from mortgage banking services, net, in our consolidated statements of income and comprehensive income.
We also occasionally enter into contracts with other mortgage bankers to purchase residential mortgage loans at a future date, which we refer to as Loan Purchase Commitments (LPCs). LPCs are accounted for as derivatives under ASC Topic 815 and recorded at fair value in prepaid expenses and other assets on our consolidated balance sheets. Subsequent changes in LPCs are recorded as a charge or credit to income from mortgage banking services, net, in our consolidated statements of income and comprehensive income.
We utilize derivative instruments to help manage the fair value changes in our MSRs. These derivative instruments are intended to economically hedge certain risks related to our MSRs. As such, these derivative instruments are not designated as accounting hedges. These derivatives may include To Be Announced (TBA) MBS, interest rate swaps, and options contracts and are valued based on quoted prices for similar assets in an active market with inputs that are observable. These derivative products are accounted for and recorded at fair value in prepaid expenses and other assets or accrued expenses and other liabilities on our consolidated balance sheets. Subsequent changes are recorded to income from mortgage banking services, net, in our consolidated statements of income and comprehensive income.
y.Revenue Recognition - Noninterest income within the scope of ASC Topic 606 is recognized by us when performance obligations, under the terms of the contract, are satisfied. This income is measured as the amount of
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consideration expected to be received in exchange for the providing of services. The majority of our applicable noninterest income continues to be recognized at the time when services are provided to our customers. Further information is presented in Note23 - Revenue from Contracts with Customers.
z.Advertising - Advertising costs are expensed as incurred and recorded within other noninterest expense.
aa.Earnings Per Share - Basic and diluted earnings per share are computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during each period.
ab.Share-Based Compensation - Compensation cost is recognized for stock options issued to employees, based on the fair value of these awards at the date of the grant. A Black-Scholes model is utilized to estimate the fair value of stock options.
Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. We recognize forfeitures as they occur.
ac.Retirement Plan - We have an employee savings plan and trust (the Plan) which qualifies under Section 401(k) of the Internal Revenue Service Code. The Bank’s Trust and Wealth Management department is the Trustee. Substantially all of our full-time employees are eligible to participate in the Plan. Eligible employees may contribute up to 100% of their compensation subject to certain limits based on federal tax laws. Additional contributions are allowed per the Internal Revenue Service Code for participants who have attained age 50 before the end of the Plan year. We make a matching contribution for each eligible participant equal to 100% of the participant’s elective deferrals which does not exceed 6% of the participant’s compensation. Participants are immediately vested in the matching contribution. Matching contributions to the Plan charged to salary and employee benefits amounted to $4,912, $4,351 and $3,390 in 2021, 2020 and 2019, respectively.
ad.Income Taxes - The Company files a consolidated federal income tax return. Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards; deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred tax assets and liabilities for subsequent changes in tax rates are recognized in income in the period that includes the tax rate changes.
We recognize the financial effects of a tax position only when we believe it can “more likely than not” support the position upon a tax examination by the relevant taxing authority, with a tax examination being presumed to occur. We are no longer subject to examination by taxing authorities for years before 2018. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
ae.Comprehensive income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale, which is also recognized as a separate component of equity.
af.Loss Contingencies - Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on these consolidated financial statements.
ag.Risks and Uncertainties - In the normal course of business, companies in the banking and mortgage industries encounter certain economic and regulatory risks. Economic risks include prepayment risk, market risk, interest rate risk, and credit risk. We are subject to interest rate risk to the extent that in a rising interest rate environment, we may experience a decrease in loan production, as well as decreases in the value of mortgage loans held-for-sale and in commitments to originate loans, which may adversely impact our earnings. Credit risk is the risk of default that may result from the borrowers’ inability or unwillingness to make contractually required payments.
We generally sell loans to investors without recourse; therefore, the investors have assumed the risk of loss or default by the borrower. However, we are usually required by these investors to make certain standard representations and warranties relating to credit information, loan documentation, and collateral. To the extent that
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we do not comply with such representations, or there are early payment defaults, we may be required to repurchase the loans or indemnify these investors for any losses from borrower defaults. In addition, if loans pay off within a specified time frame, we may be required to refund a portion of the sales proceeds to the investors. We established reserves for potential losses related to these representations and warranties which is recorded within accrued expenses and other liabilities. In assessing the adequacy of the reserve, we evaluate various factors including actual write-offs during the period, historical loss experience, known delinquent and other problem loans, and economic trends and conditions in the industry. Further information is presented in Note 22 - Commitments and Contingencies.
ah.Equity - Treasury stock is carried at cost
Dividend Restriction - Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Parent Company or by the Parent Company to stockholders.
ai.Adoption of New Accounting Standards - As an “emerging growth company” under Section 107 of the JOBS Act, we can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Therefore, we can delay the adoption of certain accounting standards until those standards would otherwise apply to non-public business entities. We intend to take advantage of the benefits of this extended transition period for an “emerging growth company” for as long as it is available to us. For standards that we have delayed adoption, we may lack comparability to other companies who have adopted such standards.
Guidance on Non-TDR Loan Modifications due to COVID-19 – The Consolidated Appropriations Act, 2021 (“CAA”), which was signed into law on December 27, 2020, extends certain provisions of the CARES Act. Section 4013 of the CARES Act provided temporary relief from TDR accounting and is amended by Division N, Section 540 of the CAA, by extending the end date from December 31, 2020, to the earlier of January 1, 2022, or 60 days after the date on which the COVID-19 national emergency terminates. In response, the OCC updated its two-page reference guide, “TDR Designation and COVID-19 Loan Modifications,” to conform to the extended TDR provisions. In accordance with such guidance, we are offering short-term modifications made in response to COVID-19 to borrowers who are current and otherwise not past due. These include short-term (180 days or less) modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Our non-TDR loan modifications are immaterial to the consolidated financial statements at December 31, 2021.
aj.Recent Accounting Pronouncements - In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), amending existing guidance. The guidance is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet and disclosure of key information about leasing arrangements. The principal change required by the guidance relates to lessee accounting. Under the new guidance for operating leases (with the exception of short-term leases), a lessee is required to (1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position, (2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis, and (3) classify all cash payments within operating activities in the statement of cash flows. The guidance also changes disclosure requirements related to leasing activities, and requires certain qualitative disclosures along with specific quantitative disclosures. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and ASC 606, Revenue from Contracts with Customers. The guidance and related subsequent pronouncements are effective for us for fiscal years beginning after December 15, 2021. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and Lessors may not apply a full retrospective transition approach. We have evaluated contracts, performed present value calculations and we anticipate recording a right of use asset of approximately $30.0 million and a lease liability of approximately $35.0 million in our December 31, 2022 consolidated balance sheet when adopted under the modified retrospective approach. The Company does not expect the adoption of this guidance will be material to our Consolidated Statement of Income and Comprehensive Income.
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In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). This guidance replaces the existing incurred loss model for estimating allowances with a current expected credit losses (CECL) model with respect to most financial assets measured at amortized cost and certain other instruments, including loan receivables, held to maturity debt securities and off-balance sheet credit exposures such as loan commitments, standby letters of credit, financial guarantees, and other similar instruments. In addition, the guidance requires credit losses relating to available for sale debt securities to be recorded through an allowance for credit losses rather than a reduction of the carrying amount, and also changes the accounting for purchased credit-impaired debt securities and loans. The guidance retains many of the disclosure requirements in current U.S. GAAP and expands certain disclosure requirements. The guidance provides transition rules for: debt securities with OTTI; existing purchased credit impaired assets; and all other assets within the scope of CECL. For us, the guidance is effective for fiscal years beginning after December 15, 2022. While early adoption is currently permitted, we plan to adopt this standard on January 1, 2023. The guidance allows for a modified retrospective approach and we expect to recognize a one-time cumulative effect adjustment through retained earnings as of the beginning of the first reporting period in which the new standard is effective for us. We continue to work with a software provider on the application and implementation of the new accounting guidance. The integration of our data with the software provider is substantially complete. Management anticipates model development, with the assistance of the software provider, will begin in early calendar year 2022 and will take several months to complete. We continue to believe that the adoption of the standard will result in an overall increase in the allowance for loan losses to cover credit losses over the estimated life of the financial assets. However, the magnitude of the increase of our allowance for loan losses at the adoption date will depend upon the nature and characteristics of the portfolio, as well as macroeconomic conditions and forecasts at that time.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This guidance eases the potential burden in accounting for reference rate reform. The amendments are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. The new guidance provides the following optional expedients that reduce costs and complexity of accounting for reference rate reform: Simplify accounting analysis for contract modifications; Allow hedging relationships to continue without de-designation if there are qualifying changes in critical terms of an existing hedging relationship due to reference rate reform; Allow change in the systematic and rational method used to recognize in earnings the components excluded from the assessment of hedge effectiveness; Allow a change in the designated benchmark interest rate to a different eligible benchmark interest rate in a fair value hedging relationship; Allow the shortcut method for a fair value hedging relationship to continue for the remainder of the hedging relationship; Simplify the assessment of hedge effectiveness and provide temporary optional expedients for cash flow hedging relationships affected by reference rate reform; and allow a one-time election to sell or transfer debt securities classified as held-to-maturity that reference a rate affected by reference rate reform and are classified as held-to-maturity before January 1, 2020. The amendments are effective for all entities from the beginning of an interim period that includes the issuance date of the ASU. An entity may elect to apply the amendments prospectively through December 31, 2022. We have identified all LIBOR exposure and are working to communicate and revise any contracts as necessary. The adoption of this standard is not expected to have a material effect on our operating results or financial condition.
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NOTE 2 - Securities
The amortized cost, gross unrealized gains and losses, and fair values of available-for-sale and held-to-maturity debt securities by type follows as of December 31,:
Available-for-sale:
Obligations of states and political subdivisions 3,979 — (190) 3,789
Held-to-maturity:
Obligations of states and political subdivisions $ 716 $ 25 $ — $ 741
Available-for-sale:
Obligations of states and political subdivisions 3,427 8 — 3,435
Held-to-maturity:
Obligations of states and political subdivisions 730 41 — 771
As of December 31, 2021 and 2020, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.