Burke & Herbert Financial Services (BHRB) - 2025 Q1 - Quarterly Report

Part I - Financial Information This part presents the unaudited consolidated financial statements and management's discussion and analysis for the quarter ended March 31, 2025 Item 1. Financial Statements This section presents the unaudited consolidated financial statements of Burke & Herbert Financial Services Corp. for the quarter ended March 31, 2025, including balance sheets, income statements, comprehensive income, changes in shareholders' equity, and cash flows, along with detailed notes explaining the company's business activities, significant accounting policies, and specific financial line items Consolidated Balance Sheets This section provides a snapshot of the company's financial position, detailing assets, liabilities, and shareholders' equity as of March 31, 2025, and December 31, 2024 Consolidated Balance Sheets (in thousands) | Metric | March 31, 2025 (Unaudited) | December 31, 2024 (Audited) | | :-------------------------------- | :--------------------------- | :-------------------------- | | Assets | | | | Cash and cash equivalents | $148,846 | $135,314 | | Securities available-for-sale | $1,436,869 | $1,432,371 | | Net loans | $5,579,754 | $5,604,196 | | Total Assets | $7,838,090 | $7,812,185 | | Liabilities | | | | Total deposits | $6,541,871 | $6,515,239 | | Short-term borrowings | $300,000 | $365,000 | | Total Liabilities | $7,080,090 | $7,082,028 | | Shareholders' Equity | | | | Total Shareholders' Equity | $758,000 | $730,157 | - Total Assets increased by $25.9 million to $7.84 billion as of March 31, 2025, from $7.81 billion at December 31, 2024, primarily driven by an increase in cash and cash equivalents and total deposits, partially offset by a decrease in net loans and short-term borrowings[10][253] Consolidated Statements of Income This section presents the company's financial performance, including income, expenses, and net income for the three months ended March 31, 2025, and 2024 Consolidated Statements of Income (in thousands) | Metric (in thousands) | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Total interest income | $110,786 | $38,745 | | Total interest expense | $37,799 | $16,614 | | Net interest income | $72,987 | $22,131 | | Total provision (recapture) for credit losses | $501 | $(670) | | Total non-interest income | $10,023 | $4,254 | | Total non-interest expense | $49,664 | $21,165 | | Income before income taxes | $32,845 | $5,890 | | Net income | $27,201 | $5,212 | | Net income applicable to common shares | $26,976 | $5,212 | | Basic EPS | $1.80 | $0.70 | | Diluted EPS | $1.80 | $0.69 | - Net income applicable to common shares significantly increased by $21.8 million to $27.0 million for the three months ended March 31, 2025, compared to $5.2 million in the prior year, primarily due to the impact of the Merger with Summit Financial Group, Inc[12][225] Consolidated Statements of Comprehensive Income (Loss) This section details comprehensive income, including net income and other comprehensive income (loss) components, for the three months ended March 31, 2025, and 2024 Consolidated Statements of Comprehensive Income (Loss) (in thousands) | Metric (in thousands) | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net income | $27,201 | $5,212 | | Total other comprehensive income (loss) | $7,696 | $2,540 | | Comprehensive income (loss) | $34,897 | $7,752 | - Total other comprehensive income (loss) increased to $7.7 million for the three months ended March 31, 2025, from $2.5 million in the prior year, driven by unrealized gains on securities, net of tax[14] Consolidated Statements of Changes in Shareholders' Equity This section outlines changes in shareholders' equity, including net income, other comprehensive income, and dividends, for the period ended March 31, 2025 Consolidated Statements of Changes in Shareholders' Equity (in thousands) | Metric (in thousands) | Balance December 31, 2024 | Balance March 31, 2025 | | :-------------------------------- | :------------------------ | :--------------------- | | Total Shareholders' Equity | $730,157 | $758,000 | | Net income | $27,201 | | | Other comprehensive income (loss) | $7,696 | | | Common stock cash dividends, declared | $(8,237) | | | Preferred stock cash dividends, declared | $(225) | | | Share-based compensation expense, net | $1,408 | | - Total Shareholders' Equity increased by $27.8 million from $730.2 million at December 31, 2024, to $758.0 million at March 31, 2025, primarily due to net income and other comprehensive income, partially offset by cash dividends[17][289] Consolidated Statements of Cash Flows This section presents cash flows from operating, investing, and financing activities for the periods presented Consolidated Statements of Cash Flows (in thousands) | Metric (in thousands) | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net cash flows provided by operating activities | $37,647 | $7,089 | | Net cash flows provided by (used in) investing activities | $22,605 | $(70,617) | | Net cash flows provided by (used in) financing activities | $(46,720) | $73,107 | | Increase in cash and cash equivalents | $13,532 | $9,579 | | Cash and cash equivalents, End of period | $148,846 | $54,077 | - Net cash provided by operating activities significantly increased to $37.6 million for the three months ended March 31, 2025, from $7.1 million in the prior year[20][22] - Investing activities shifted from a net outflow of $70.6 million to a net inflow of $22.6 million, while financing activities changed from a net inflow of $73.1 million to a net outflow of $46.7 million[20][22] Notes to the Consolidated Financial Statements This section provides detailed explanations and disclosures supporting the consolidated financial statements Note 1— Nature of Business Activities and Significant Accounting Policies This note outlines the company's structure as a financial holding company for Burke & Herbert Bank & Trust Company, its regulatory oversight, primary market areas, and product offerings. It also details the significant merger with Summit Financial Group, Inc. in May 2024, which expanded its operations and market presence, and discusses the basis of financial statement presentation and newly issued accounting standards - Burke & Herbert Financial Services Corp. operates as a financial holding company, with its primary operations conducted through Burke & Herbert Bank & Trust Company, regulated by the Federal Reserve and Virginia BFI[24][25] - The company completed a merger with Summit Financial Group, Inc. on May 3, 2024, significantly expanding its market area to include northern Virginia and West Virginia, with over 77 branches across multiple states[26][27][28] - The merger involved an exchange of 0.5043 shares of Burke & Herbert common stock for each Summit common stock share, totaling approximately 7.4 million shares, and conversion of Summit preferred stock into Burke & Herbert preferred stock[29] - Newly issued accounting standards, ASU 2024-03 and ASU 2023-06, are not expected to have a material impact on the company's consolidated financial statements[34][35] Note 2— Securities This note provides a detailed breakdown of the company's available-for-sale (AFS) securities portfolio, including amortized cost, fair value, and unrealized gains/losses. It highlights that unrealized losses are primarily due to interest rate fluctuations rather than credit deterioration, and the company does not intend to sell these securities before recovery of amortized cost. It also details restricted stock holdings AFS Securities (in thousands) | Metric (in thousands) | March 31, 2025 | December 31, 2024 | | :-------------------------------- | :------------------- | :------------------- | | Total AFS Securities (Amortized Cost) | $1,546,361 | $1,549,589 | | Total AFS Securities (Fair Value) | $1,436,869 | $1,432,371 | | Gross Unrealized Gains | $1,492 | $1,658 | | Gross Unrealized Losses | $110,984 | $118,876 | - Unrealized losses on AFS securities decreased by $7.9 million from $118.9 million at December 31, 2024, to $111.0 million at March 31, 2025, primarily attributed to market interest rate fluctuations, not credit deterioration[37][42][45][255] AFS Securities by Maturity (in thousands) | Maturity | Amortized Cost (March 31, 2025) | | :------------------- | :------------------------------ | | One Year or Less | $94,717 | | One to Five Years | $515,452 | | Five to Ten Years | $558,838 | | After Ten Years | $377,354 | | Total | $1,546,361 | - The company holds restricted stock, primarily FHLB and Federal Reserve Bank stock, totaling $35.1 million at March 31, 2025, carried at cost and not considered impaired[52] Note 3— Loans This note details the composition of the company's loan portfolio by segment, including commercial real estate, owner-occupied commercial real estate, acquisition, construction & development, commercial & industrial, single family residential, and consumer non-real estate and other. It also outlines the specific risks associated with each loan category Loan Portfolio Segment (in thousands) | Loan Portfolio Segment (in thousands) | March 31, 2025 | December 31, 2024 | | :------------------------------------ | :------------- | :---------------- | | Commercial real estate | $2,809,573 | $2,637,802 | | Owner-occupied commercial real estate | $589,889 | $614,362 | | Acquisition, construction & development | $322,963 | $465,537 | | Commercial & industrial | $613,219 | $613,085 | | Single family residential (1-4 units) | $1,161,406 | $1,173,749 | | Consumer non-real estate and other | $150,457 | $167,701 | | Loans, gross | $5,647,507 | $5,672,236 | | Allowance for credit losses | $(67,753) | $(68,040) | | Loans, net | $5,579,754 | $5,604,196 | - The loan portfolio, net of ACL, decreased by $24.4 million from $5.60 billion at December 31, 2024, to $5.58 billion at March 31, 2025, primarily due to the exiting of loans not aligning with the company's desired risk profile[55][262] - Commercial real estate loans constitute the largest segment, representing 49.7% of the gross loan portfolio at March 31, 2025[55][193] Note 4— Allowance for Credit Losses This note details the company's Allowance for Credit Losses (ACL) methodology under CECL, including collective and individual loan evaluations, qualitative adjustments, and activity in the ACL. It also provides aging of past due loans, credit quality indicators, and information on collateral-dependent loans and purchased credit deteriorated loans - The company adopted the CECL methodology on January 1, 2023, calculating ACL quarterly using the Weighted Average Remaining Maturity (WARM) method for collectively evaluated loans and specific reserve analysis for individually evaluated loans[56][57][58] Allowance for Credit Losses Activity (in thousands) | Metric (in thousands) | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Balance, beginning of period | $68,040 | $25,301 | | Provision for (recapture of) credit losses | $900 | $(670) | | Charge-offs | $(1,424) | $(30) | | Recoveries | $237 | $5 | | Balance, end of period | $67,753 | $24,606 | - Total past due loans (30-89 days and 90+ days past due) increased from $68.3 million at December 31, 2024, to $122.1 million at March 31, 2025, with a notable increase in 90+ days past due loans still accruing[62][267] - The ACL as a percentage of gross loans was 1.20% at March 31, 2025, up from 1.16% at March 31, 2024, reflecting an increase in expected losses under the CECL model[272][273] Note 5— Deposits This note provides details on the company's deposit base, including time deposits exceeding FDIC insurance limits, brokered time deposits, and CDARS program deposits. It also outlines the remaining maturities of time deposits - Aggregate time deposits exceeding the FDIC insurance limit were $292.3 million at March 31, 2025, an increase from $284.4 million at December 31, 2024[79] - Brokered time deposits, which are fully insured, totaled $246.9 million at March 31, 2025, slightly up from $244.8 million at December 31, 2024[79] Remaining Maturity of Time Deposits (as of March 31, 2025, in thousands) | Remaining Maturity (as of March 31, 2025) | Amount (in thousands) | | :---------------------------------------- | :-------------------- | | Remaining nine months ending, Dec 31, 2025 | $987,610 | | 2026 | $215,992 | | 2027 | $41,828 | | 2028 | $8,744 | | 2029 | $6,057 | | Thereafter | $6,922 | | Total | $1,267,153 | Note 6— Borrowed Funds This note details the company's short-term and long-term borrowings, including interest rates, maturities, and available lines of credit. It highlights the subordinated debentures and trust preferred securities assumed as part of the Merger, which qualify as Tier 2 and Tier 1 capital, respectively - Short-term borrowings decreased by $65.0 million to $300.0 million at March 31, 2025, from $365.0 million at December 31, 2024, with an interest rate of 4.42% at March 31, 2025[82] - The company has $4.1 billion in unused borrowing capacity from secured lines of credit with the Federal Reserve Bank of Richmond and FHLB of Atlanta, and unsecured federal funds lines[83][84] - As part of the Merger, Burke & Herbert assumed $75.0 million and $30.0 million in subordinated debentures, fair valued at $61.5 million and $29.8 million respectively, which qualify as Tier 2 capital[86][87] - The company also assumed subordinated debentures owed to unconsolidated subsidiary trusts totaling $17.1 million at March 31, 2025, which qualify as Tier 1 capital[88][10] Note 7— Leased Property This note details the company's lessor and lessee arrangements for leased properties. It provides lease income from operating leases, remaining maturities of lease receivables, and information on right-of-use assets and lease liabilities for both operating and finance leases Operating Lease Income (in thousands) | Metric (in thousands) | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Operating lease income | $693 | $575 | | Total lease income | $693 | $575 | Lease Assets and Liabilities (in thousands) | Lease Type (in thousands) | March 31, 2025 | December 31, 2024 | | :-------------------------------- | :------------- | :---------------- | | Operating leases (Right-of-use assets) | $12,520 | $13,203 | | Finance leases (Right-of-use assets) | $3,241 | $3,312 | | Operating leases (Lease liabilities) | $12,960 | $13,586 | | Finance leases (Lease liabilities) | $3,563 | $3,620 | - Total lease cost for the three months ended March 31, 2025, was $932 thousand, an increase from $733 thousand in the prior year, with operating lease costs being the largest component[94] Note 8— Regulatory Capital Matters This note details the company's and the Bank's compliance with regulatory capital requirements under the Basel III Framework and 'prompt corrective action' regulations. It presents actual and required capital amounts and ratios, confirming the Bank's 'well capitalized' status - As of March 31, 2025, both the Company and the Bank meet all capital adequacy requirements and the Bank is categorized as 'well capitalized' under regulatory frameworks[97][98] Capital Ratios (Consolidated) | Capital Ratio (Consolidated) | March 31, 2025 (Actual) | Minimum Required (Basel III) | | :------------------------------------ | :------------------------ | :--------------------------- | | Total Capital to risk weighted assets | 14.79% | ≥ 10.5% | | Tier 1 (Core) Capital to risk weighted assets | 12.20% | ≥ 8.5% | | Common Tier 1 (CET 1) to risk-weighted assets | 11.77% | ≥ 7.0% | | Tier 1 (Core) Capital to average assets (leverage ratio) | 10.12% | ≥ 4.0% | - Approximately $265.7 million of retained earnings was available for dividend declaration as of March 31, 2025, consistent with the company's capital plan and banking regulations[99] Note 9— Derivatives This note describes the company's use of interest rate swap agreements for asset liability management, including those designated as cash flow hedges and those not designated as hedges (economic hedges for customer loans). It provides fair values of derivative instruments and their impact on comprehensive income and the income statement - The company uses interest rate swaps to manage interest rate risk, with derivatives designated as cash flow hedges recorded in AOCI and reclassified to interest expense/income[100][101][103] - Derivatives not designated as hedges, primarily back-to-back interest rate swaps for customer loans, are reported at fair value with changes recorded in other non-interest expense, summing to zero due to offsetting terms[104] Derivative Instruments Fair Value (in thousands) | Derivative Type (in thousands) | March 31, 2025 (Fair Value) | December 31, 2024 (Fair Value) | | :------------------------------------ | :---------------------------- | :----------------------------- | | Interest rate swaps (cash flow hedges, assets) | $514 | $1,368 | | Interest rate swaps (cash flow hedges, liabilities) | $219 | $165 | | Interest rate swaps (customer loans, assets) | $1,591 | $1,823 | | Interest rate swaps (customer loans, liabilities) | $1,591 | $1,823 | - The company estimates an additional $360 thousand will be reclassified as a reduction to interest expense from cash flow hedges over the next twelve months[103] Note 10— Commitments and Contingencies This note outlines the company's off-balance sheet financial instruments, including commitments to extend credit and commercial letters of credit, which involve credit and liquidity risks. It also details the allowance for credit losses on unfunded commitments and confirms no material litigation Commitments (in thousands) | Commitment Type (in thousands) | March 31, 2025 | December 31, 2024 | | :------------------------------------ | :------------- | :---------------- | | Commitments to extend credit | $1,021,447 | $969,317 | | Commercial letters of credit | $30,303 | $13,333 | - The allowance for credit losses on unfunded commitments totaled $3.6 million at March 31, 2025, down from $4.0 million at December 31, 2024, following a recapture of $398.8 thousand for the three months ended March 31, 2025[113] - Management believes that liabilities from currently pending or threatened litigation will not be material to the company's financial position[114] Note 11— Fair Value Measurements This note defines fair value measurement levels (Level 1, 2, 3) and describes the valuation techniques used for various financial instruments, including investment securities, equity investments, derivatives, and loans held-for-sale, measured on a recurring basis. It also covers non-recurring fair value measurements for collateral-dependent loans and other real estate owned - Fair value measurements are categorized into Level 1 (quoted prices in active markets), Level 2 (significant other observable inputs), and Level 3 (significant unobservable inputs)[115][116] Financial Assets Measured at Fair Value (in thousands) | Financial Asset (in thousands) | Level 1 (March 31, 2025) | Level 2 (March 31, 2025) | Level 3 (March 31, 2025) | Total (March 31, 2025) | | :------------------------------------ | :----------------------- | :----------------------- | :----------------------- | :--------------------- | | Total investment securities AFS | $151,793 | $1,285,076 | $— | $1,436,869 | | Loans held-for-sale, at fair value | $— | $1,302 | $— | $1,302 | | Equity investments | $— | $12,258 | $— | $12,258 | | Derivatives (assets) | $— | $2,105 | $— | $2,105 | | Derivatives (liabilities) | $— | $1,810 | $— | $1,810 | - Collateral-dependent loans and other real estate owned are measured at fair value on a non-recurring basis, primarily using Level 3 inputs based on collateral appraisals and management adjustments for liquidity and selling costs[125][126][127][128] Note 12— Accumulated Other Comprehensive Income (Loss) This note details the changes in accumulated other comprehensive income (loss) by component, including unrealized gains/losses on available-for-sale securities and gains/losses on cash flow hedges, net of tax Accumulated Other Comprehensive Income (in thousands) | Component (in thousands) | Beginning Balance (Dec 31, 2024) | Ending Balance (Mar 31, 2025) | | :------------------------------------ | :------------------------------- | :---------------------------- | | Gains and Losses on Cash Flow Hedges | $911 | $951 | | Unrealized Gains and Losses on AFS Securities | $(92,055) | $(84,399) | | Defined Benefit Pension Items | $(4,576) | $(4,576) | | Total Accumulated Other Comprehensive Income | $(95,720) | $(88,024) | - Accumulated other comprehensive income (loss) improved from $(95.7) million at December 31, 2024, to $(88.0) million at March 31, 2025, primarily due to net unrealized gains on available-for-sale securities[131][289] Reclassification Adjustments (in thousands) | Reclassification (in thousands) | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :------------------------------------ | :-------------------------------- | :-------------------------------- | | Cash flow hedges, net of tax | $330 | $(353) | | AFS securities, net of tax | $32 | $32 | | Total reclassifications, net of tax | $362 | $(321) | Note 13— Other Operating Expense This note itemizes the components of 'Other operating expense' from the Consolidated Statements of Income, highlighting significant increases in various categories for the three months ended March 31, 2025, compared to the prior year, largely due to the Merger Other Operating Expense (in thousands) | Expense Category (in thousands) | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :------------------------------------ | :-------------------------------- | :-------------------------------- | | FDIC & other regulatory assessments | $914 | $516 | | IT related | $417 | $550 | | ATM, card, & network expense | $1,132 | $551 | | Core deposit intangible amortization | $4,298 | $— | | Other | $5,390 | $1,448 | | Total | $15,458 | $6,463 | - Total other operating expense increased by $8.99 million, or 139.2%, to $15.5 million for the three months ended March 31, 2025, compared to $6.5 million in the prior year, primarily driven by the Merger[134][251] - Merger-related expenses were zero for the three months ended March 31, 2025, compared to $663 thousand in the prior year, included in consultant fees, audit fees, legal expense, donation, and other line items[134] Note 14— Share-Based Compensation This note describes the company's share-based incentive plans (2019 SIP and 2023 SIP) and the 2023 Employee Stock Purchase Plan (ESPP), detailing the types of awards (RSUs, SARs), vesting conditions, and compensation expense recognized. It also provides a summary of RSU and SAR activity - Total share-based compensation cost charged against income was $1.3 million for the three months ended March 31, 2025, up from $590.5 thousand in the prior year[136] - The 2023 Stock Incentive Plan (SIP) authorized 250,000 shares, with 324,887 shares available for issuance as of March 31, 2025, including recycled shares from the 2019 SIP[139] RSU Activity | RSU Activity | Shares | Weighted-Average Grant-Date Fair Value | | :-------------------------- | :----- | :------------------------------------- | | Non-vested at December 31, 2024 | 134,202 | $57.67 | | Granted | 77,441 | $58.49 | | Vested | (9,360) | $54.78 | | Non-vested at March 31, 2025 | 202,283 | $58.12 | - As of March 31, 2025, there was $8.4 million of total unrecognized compensation costs related to non-vested RSUs and $508.1 thousand for non-vested SARs, expected to be recognized over weighted average periods of 1.57 years and 2.38 years, respectively[144][149] Note 15— Earnings Per Share This note provides the calculation of basic and diluted earnings per share (EPS) for common shares, detailing the weighted average number of shares used in the computation Earnings Per Share | Metric | Three Months Ended March 31, 2025 | Three Months Ended March 31, 2024 | | :------------------------------------ | :-------------------------------- | :-------------------------------- | | Net income applicable to common shares (in thousands) | $26,976 | $5,212 | | Weighted average number of shares (basic) | 14,976,483 | 7,433,481 | | Weighted average dilutive shares | 15,026,376 | 7,527,489 | | Basic earnings per common share | $1.80 | $0.70 | | Diluted earnings per common share | $1.80 | $0.69 | - Basic and diluted EPS significantly increased to $1.80 for the three months ended March 31, 2025, from $0.70 and $0.69 respectively in the prior year, reflecting higher net income and an increased weighted average number of shares[152] Note 16— Business Combination This note details the acquisition method accounting for the Merger with Summit Financial Group, Inc. on May 3, 2024. It outlines the total consideration paid, the fair values of assets acquired and liabilities assumed, and the resulting goodwill recognized - The Merger with Summit Financial Group, Inc. was completed on May 3, 2024, and accounted for using the acquisition method, with assets and liabilities recorded at fair value[153][155] - Total aggregate consideration for the Merger was approximately 7,405,772 shares of Burke & Herbert common stock and preferred stock, with a fully diluted transaction value of $397.4 million[154][160] - Goodwill of $32.8 million was recognized in connection with the acquisition, primarily representing synergies and cost savings, and is not amortized but subject to annual impairment testing[155][160] - The fair value of intangible assets related to core deposits was $68.8 million at acquisition, to be amortized over an estimated weighted average life of 7 years[156] Note 17— Goodwill and Other Intangible Assets This note provides details on the changes in goodwill and other intangible assets, specifically the core deposit intangible, for the three months ended March 31, 2025. It outlines the amortization schedule for the core deposit intangible Goodwill (in thousands) | Metric (in thousands) | Three Months Ended March 31, 2025 | | :------------------------------------ | :-------------------------------- | | Beginning of period (Goodwill) | $32,783 | | Goodwill adjustment | $59 | | End of period (Goodwill) | $32,842 | - The core deposit intangible, valued at $68.8 million at acquisition, is being amortized on an accelerated basis over its 7-year estimated useful life, with $4.3 million amortization expense for the three months ended March 31, 2025[163][164] Estimated Amortization (in thousands) | Estimated Amortization (in thousands) | | :------------------------------------ | | Remaining nine months ending, Dec 31, 2025 | $11,255 | | 2026 | $13,097 | | 2027 | $10,641 | | 2028 | $8,186 | | 2029 | $5,730 | | Thereafter | $4,093 | | Total | $53,002 | Note 18— Segment Information This note clarifies that the company operates in a single reportable operating segment, 'Community Banking,' as its financial performance is evaluated on a company-wide basis by the chief operating decision maker, despite monitoring various product and service revenue streams - The company operates in one reportable segment: Community Banking, with performance evaluated on a company-wide basis by the Chief Executive Officer[166] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides a comprehensive discussion and analysis of the company's financial condition and results of operations, highlighting the significant impact of the Merger with Summit Financial Group, Inc. It covers an overview of the business, critical accounting policies, financial performance, asset quality, liquidity, and capital management, offering insights into key drivers and trends Overview This section provides an overview of the company, its market, products, and the Merger's impact on operations - Burke & Herbert Financial Services Corp. is a financial holding company operating through Burke & Herbert Bank & Trust Company, which became a Federal Reserve System member on December 31, 2024[171] - The Bank's primary market area includes northern Virginia and West Virginia, with over 77 branches across multiple states, offering diverse deposit and loan products[172] Key Metrics (as of March 31, 2025) | Metric (as of March 31, 2025) | Amount (in billions) | | :------------------------------------ | :------------------- | | Total consolidated assets | $7.8 | | Gross loans | $5.6 | | Total deposits | $6.5 | | Total shareholders' equity | $758.0 million | | Full-time employees | 814 | - The Merger with Summit Financial Group, Inc. on May 3, 2024, significantly expanded the company's operations and is a key factor in the current financial results[175][176] Critical Accounting Policies and Estimates This section discusses critical accounting policies and estimates, including goodwill, ACL, and income taxes - The company identifies business combination and goodwill, allowance for credit losses (ACL), and income taxes as critical accounting areas requiring subjective judgments and estimates[179] - Goodwill from acquisitions is reviewed annually for impairment, with fair value determinations relying on significant estimates like projected cash flows and discount rates[180][181] - The ACL is estimated quarterly using an internally developed CECL model, which forecasts lifetime expected credit losses based on historical experience, current conditions, and macroeconomic variables (e.g., unemployment rates, real estate prices)[183][184][186] - Income tax expense, deferred tax assets/liabilities, and unrecognized tax benefits involve complex calculations and management judgments, with a valuation allowance recognized if deferred tax assets are unlikely to be realized[188][189] Non-GAAP Financial Measures This section explains the use of non-GAAP financial measures to supplement GAAP information for performance assessment - The company presents non-GAAP financial measures to provide additional useful information for assessing financial condition and operating performance, emphasizing that these are not substitutes for GAAP measures[191] Commercial Real Estate Sector Concentration This section analyzes the company's commercial real estate exposure, risks, and market conditions - The commercial real estate (CRE) sector faces challenges from rising interest rates and vacancies, but recent federal and private sector return-to-office mandates and decreasing interest rates could potentially improve the market[192] Loan Portfolio Segment (as of March 31, 2025) | Loan Portfolio Segment (as of March 31, 2025) | Amortized Cost (in thousands) | Percentage of Total Gross Loans | | :-------------------------------------------- | :---------------------------- | :------------------------------ | | Commercial real estate | $2,809,573 | 49.7% | | Owner-occupied commercial real estate | $589,889 | 10.4% | | Acquisition, construction & development | $322,963 | 5.7% | | Total CRE exposure (including owner-occupied and A,C&D) | $3,722,425 | 65.8% | - The Bank's total CRE exposure (including owner-occupied and acquisition, construction & development) was $3.7 billion, representing 65.8% of total gross loans and 47.4% of total assets at March 31, 2025[192] - The largest concentration of CRE loans is in Virginia (approximately 46.8%), and the Bank's overall exposure to 'Office Building / Condo' collateral type is 15.9% of total CRE loans[195][201] Liquidity Management This section describes the company's liquidity management, including funding sources, uses, and regulatory oversight - Liquidity management involves maintaining the ability to convert assets to cash and raise funds to meet customer demands, with assessments performed quarterly by the Asset/Liability Committee (ALCO) and reported to the Board[202][203] - Primary liquidity sources include unencumbered AFS securities, loan payments, and maturing investment securities, while liabilities provide liquidity through deposits and FHLB/other borrowings[205][206] - The company's primary source of liquidity for operating needs is dividends from the Bank, which are subject to regulatory restrictions and capital plan approvals[207] - Management believes current liquidity sources are adequate for requirements and planned growth[208] Capital This section outlines the company's and Bank's compliance with Basel III regulatory capital requirements - The company and the Bank are subject to Basel III regulatory capital requirements, including minimum CET 1, Tier 1, and Total Capital ratios, along with a capital conservation buffer[210][211] - As of March 31, 2025, and December 31, 2024, the Bank complied with all regulatory capital standards and was categorized as 'well capitalized' under 'prompt corrective action' regulations[214] Effects of Inflation This section discusses inflation's impact on financial results, particularly interest rate management - Inflation's most significant impact on financial results is the company's ability to manage interest rate changes, as most assets and liabilities are monetary[216] - Management aims to maintain a balanced position between rate-sensitive assets and liabilities to minimize the impact of interest rate fluctuations on net interest income, though this is challenging in rapidly changing rate environments[216] Key Factors Affecting Financial Performance This section identifies internal and external factors influencing financial performance, including economic conditions - Internal factors affecting financial performance include effective capital and liquidity management, controlling costs related to strategic priorities, managing credit and interest rate risk, adapting to regulatory changes, and managing operational risks[218] - External factors include economic conditions (inflation, interest rates, political conflicts), actions by federal agencies (Federal Reserve, U.S. Treasury), competitive landscape changes, and impacts of governmental policy and climate change[218] Selected Financial Data This section presents key financial data and performance ratios for comparative overview of financial health Selected Financial Data (in thousands, except per share data) | Metric (in thousands, except per share data) | March 31, 2025 | March 31, 2024 | | :------------------------------------------- | :------------- | :------------- | | Total assets | $7,838,090 | $3,696,390 | | Net loans | $5,579,754 | $2,093,549 | | Total deposits | $6,541,871 | $2,990,113 | | Total shareholders' equity | $758,000 | $319,308 | | Net income applicable to common shares | $26,976 | $5,212 | | Basic net income per common share | $1.80 | $0.70 | | Diluted net income per common share | $1.80 | $0.69 | | Dividends declared per common share | $0.53 | $0.53 | | Book value per common share | $49.90 | $42.92 | Performance Ratios | Performance Ratios | March 31, 2025 | March 31, 2024 | | :------------------------------------------- | :------------- | :------------- | | Return on average assets | 1.41% | 0.58% | | Return on average equity | 14.57% | 6.67% | | Net interest margin | 4.18% | 2.68% | | Efficiency ratio | 59.83% | 80.22% | | Common equity tier 1 (CET 1) capital to risk-weighted assets | 11.77% | 16.56% | | Non-performing loans as a percentage of total loans | 1.15% | 1.26% | Results of Operations for the Three Months Ended March 31, 2025, and March 31, 2024 This section analyzes operational performance, detailing changes in net income, interest, and non-interest items General Net income applicable to common shares increased significantly due to the Merger, driving substantial increases in net interest income, non-interest income, and non-interest expense, while credit provision expense also increased - Net income applicable to common shares increased by $21.8 million to $27.0 million for the three months ended March 31, 2025, compared to $5.2 million in the prior year, primarily due to the Merger[225] - Net interest income increased by $50.9 million to $73.0 million, and total non-interest income increased by $5.8 million (135.6%) to $10.0 million, both driven by the Merger[226][228] - Total non-interest expense increased by $28.5 million (134.7%) to $49.7 million, also primarily due to the Merger[229] - The company recorded a credit provision expense of $0.5 million for the three months ended March 31, 2025, compared to a provision recapture of $0.7 million in the prior year[227] Net Interest Income and Net Interest Margin Net interest income and net interest margin saw substantial increases, primarily driven by the Merger, which led to higher interest-earning assets, increased rates, and significant accretion income. The tax-adjusted net interest margin rose to 4.18% from 2.68% year-over-year - Net interest income increased to $73.0 million for the three months ended March 31, 2025, from $22.1 million in the prior year, driven by higher interest-earning assets, rates, and $11.4 million in accretion income from acquired loans and borrowings[232] - The tax-adjusted net interest margin increased to 4.18% for the three months ended March 31, 2025, from 2.68% in the prior year, primarily due to the Merger and acquisition of higher-yielding assets[233] - The yield on the taxable loan portfolio increased to 6.96% (from 5.41%) and the tax-adjusted yield on the total investment securities portfolio increased to 3.85% (from 3.43%), both due to the Merger[234][235] - Interest expense on interest-bearing deposits increased to 2.53% (from 2.41%) due to the Merger, while the yield on short-term borrowings decreased to 3.88% (from 4.82%) due to lower market rates[236][237] Interest Income Total interest income surged by 185.9% to $110.8 million, primarily due to the Merger and the acquisition of additional interest-earning assets, with significant increases in both loan and securities interest income - Total interest income increased by $72.1 million (185.9%) to $110.8 million for the three months ended March 31, 2025, compared to $38.7 million in the prior year, driven by the Merger[247] - Interest income on loans increased by $69.0 million, and interest income on securities increased by $2.5 million[247] Interest Expense Total interest expense increased to $37.8 million, mainly due to the Merger and the assumption of additional interest-bearing liabilities, including a new $2.7 million in subordinated debt interest - Total interest expense increased to $37.8 million for the three months ended March 31, 2025, from $16.6 million in the prior year, primarily due to the Merger and assumed interest-bearing liabilities[248] - Interest expense on interest-bearing deposits increased by $18.9 million, and interest on subordinated debt acquired in the Merger was $2.7 million[248] Provision for (Recapture of) Credit Losses The company recorded a provision for credit losses of $0.5 million, a shift from a $0.7 million recapture in the prior year, driven by increased expected losses in the loan portfolio - Provision for credit losses was $0.5 million for the three months ended March 31, 2025, compared to a provision recapture of $0.7 million in the prior year, due to additional credit loss expense on loans[249] Non-interest Income Non-interest income increased by 135.6% to $10.0 million, with all categories showing growth, primarily driven by the Merger and the resulting expansion of the customer base and accounts Non-interest Income (in thousands) | Category (in thousands) | March 31, 2025 | March 31, 2024 | Increase (Decrease) | Percent Change | | :------------------------------------ | :------------- | :------------- | :------------------ | :------------- | | Fiduciary and wealth management | $2,443 | $1,419 | $1,024 | 72.2% | | Service charges and fees | $2,089 | $655 | $1,434 | 218.9% | | Bank debit and other card revenue | $2,884 | $1,132 | $1,752 | 154.8% | | Other non-interest income | $1,413 | $501 | $912 | 182.0% | | Total | $10,023 | $4,254 | $5,769 | 135.6% | - The largest increases were in bank debit and other card revenue ($1.8 million) and service charges and fees ($1.4 million), both attributed to the Merger and increased customer base[250] Non-interest Expense Non-interest expense increased by 134.7% to $49.7 million, with all categories experiencing growth, primarily as a direct result of the Merger Non-interest Expense (in thousands) | Category (in thousands) | March 31, 2025 | March 31, 2024 | Increase (Decrease) | Percent Change | | :------------------------------------ | :------------- | :------------- | :------------------ | :------------- | | Salaries and wages | $20,941 | $9,518 | $11,423 | 120.0% | | Pensions and other employee benefits | $5,136 | $2,365 | $2,771 | 117.2% | | Occupancy | $4,045 | $1,538 | $2,507 | 163.0% | | Equipment rentals, depreciation and maintenance | $4,084 | $1,281 | $2,803 | 218.8% | | Other | $15,458 | $6,463 | $8,995 | 139.2% | | Total | $49,664 | $21,165 | $28,499 | 134.7% | - All categories of non-interest expense increased, with salaries and wages rising by $11.4 million and 'Other' expenses by $9.0 million, primarily due to the Merger[251] Income Tax Expense Income tax expense increased by $5.0 million to $5.6 million, driven by higher net income and additional state taxes incurred in the expanded market area post-Merger, resulting in an effective tax rate of 17.2% - Income tax expense increased by $5.0 million to $5.6 million for the three months ended March 31, 2025, from $0.7 million in the prior year[252] - The effective tax rate for the three months ended March 31, 2025, was 17.2%, up from 11.5% in the prior year, due to increased net income and additional state taxes post-Merger[252] Analysis of Financial Condition for the Period Ended March 31, 2025, and December 31, 2024 This section analyzes financial condition, including assets, liabilities, and equity, highlighting key changes and trends Assets Total assets increased slightly to $7.84 billion, while net loans decreased by $24.4 million. Deposits increased by $26.6 million, and short-term borrowings decreased by $65.0 million - Total assets increased by $25.9 million to $7.84 billion as of March 31, 2025, from $7.81 billion at December 31, 2024[253] - Net loans decreased by $24.4 million to $5.58 billion, while total deposits increased by $26.6 million to $6.54 billion[253] - Short-term borrowings decreased by $65.0 million to $300.0 million, and subordinated debt increased to $113.3 million[253] Investment Securities The investment portfolio, primarily AFS securities, serves as a liquidity source and interest rate risk management tool. Unrealized losses decreased by $7.7 million, attributed to market movements and interest rate changes, not credit factors, with the company having sufficient liquidity to avoid selling at a loss - The investment portfolio, classified as AFS, provides liquidity and helps manage interest rate risk[254][255] - Unrealized losses on AFS securities decreased by $7.7 million during the three months ended March 31, 2025, from December 31, 2024, primarily due to increases in interest rates and market movements, not credit deterioration[255][256] - The company has sufficient liquidity and does not believe it would be necessary to sell investment securities at a loss[257] Investment Securities (in thousands) | Metric (in thousands) | March 31, 2025 | December 31, 2024 | | :-------------------------------- | :------------------- | :------------------- | | Total AFS Securities (Amortized Cost) | $1,546,361 | $1,549,589 | | Total AFS Securities (Fair Value) | $1,436,869 | $1,432,371 | | Gross Unrealized Losses | $110,984 | $118,876 | Lending Activities The loan portfolio, primarily commercial real estate, decreased by $24.7 million, mainly due to the exiting of loans that do not align with the company's risk profile. The maturity distribution shows a significant portion of loans maturing within one to five years - The loan portfolio, excluding ACL, decreased by $24.7 million to $5.58 billion at March 31, 2025, primarily due to exiting loans not aligning with the company's desired risk profile[262] Loan Portfolio Segment (in thousands) | Loan Portfolio Segment (in thousands) | March 31, 2025 | December 31, 2024 | | :------------------------------------ | :------------- | :---------------- | | Commercial real estate | $2,809,573 | $2,637,802 | | Single family residential (1-4 units) | $1,161,406 | $1,173,749 | | Total Loans, gross | $5,647,507 | $5,672,236 | Loan Maturity (as of March 31, 2025, in thousands) | Loan Maturity (as of March 31, 2025) | Fixed Rates (in thousands) | Adjustable Rates (in thousands) | Total (in thousands) | | :----------------------------------- | :------------------------- | :------------------------------ | :------------------- | | Within One Year | $348,102 | $599,095 | $947,197 | | One Year to Five Years | $1,428,282 | $645,123 | $2,073,405 | | Five Years to 15 Years | $493,861 | $665,011 | $1,158,872 | | After 15 Years | $501,033 | $967,000 | $1,468,033 | | Total Loans | $2,771,278 | $2,876,229 | $5,647,507 | Asset Quality Asset quality remained relatively stable, though non-accrual loans and 90-day past due loans increased. Non-performing assets rose to $67.4 million. The ACL increased to $67.8 million, with a provision expense of $0.9 million, reflecting increased expected losses - Non-accrual loan balance increased by $5.6 million, and loans 90 days past due and still accruing increased by $20.8 million from December 31, 2024[267] Non-Performing Assets (in thousands) | Non-Performing Assets (in thousands) | March 31, 2025 | December 31, 2024 | | :----------------------------------- | :------------- | :---------------- | | Non-accrual loans | $41,431 | $35,871 | | 90 days past due and still accruing | $23,325 | $2,497 | | Total non-performing loans | $64,756 | $38,368 | | Other real estate owned | $2,625 | $2,783 | | Total non-performing assets | $67,381 | $41,151 | - The company recorded a provision expense of $0.9 million on loans for the three months ended March 31, 2025, compared to a recapture of $0.7 million in the prior year, due to increased expected losses under the CECL model[271] - The ACL as a percentage of gross loans was 1.20% at March 31, 2025, and the ACL as a percentage of non-performing loans was 104.63%[272][273] Derivative Financial Instruments The company uses interest rate swap agreements to manage interest rate risk, recognizing them at fair value on the balance sheet - The company utilizes interest rate swap agreements as part of its asset/liability management strategy to manage interest rate risk, recognizing them at fair value on the Consolidated Balance Sheets[278] Off-Balance Sheet Arrangements The company engages in off-balance sheet arrangements like credit commitments and letters of credit, which carry credit and interest rate risks, but has no other material off-balance sheet arrangements - Off-balance sheet arrangements include commitments to extend credit and standby letters of credit, which involve credit and interest rate risk[279] - The company has no other material off-balance sheet arrangements that would significantly impact its financial condition[279] Funding Activities Deposits are the primary funding source, supplemented by borrowings to meet liquidity needs. The company has substantial unused borrowing capacity of $4.1 billion through various credit lines - Deposits are the primary source of funds, complemented by borrowings for liquidity and temporary funding[280] - The company has $4.1 billion in unused borrowing capacity through credit lines with FHLB of Atlanta, Federal Reserve Borrower-In-Custody Program, and correspondent banking relationships[282] Borrowing Type (in thousands) | Borrowing Type (in thousands) | March 31, 2025 | December 31, 2024 | | :------------------------------------ | :------------- | :---------------- | | Short-term borrowings | $300,000 | $365,000 | | Subordinated debentures, net | $96,212 | $94,872 | | Subordinated debentures owed to unconsolidated subsidiary trusts | $17,077 | $17,013 | | Total long-term debt | $113,289 | $111,885 | Deposits Total deposits increased slightly by $26.6 million, driven by a focus on gathering deposits across commercial and retail businesses. Brokered time deposits remained stable, and the company has no material deposit concentration risk - Total deposits increased by $26.6 million from December 31, 2024, to March 31, 2025, primarily due to a focus on gathering deposits[284] Deposit Category (in thousands) | Deposit Category (in thousands) | March 31, 2025 | December 31, 2024 | | :------------------------------------ | :------------- | :---------------- | | Demand, non-interest-bearing | $1,382,427 | $1,379,940 | | Demand, interest-bearing | $2,224,844 | $2,223,540 | | Money market and savings | $1,667,447 | $1,658,480 | | Brokered deposits | $246,902 | $244,802 | | Time deposits, other | $1,020,251 | $1,008,477 | | Total deposits | $6,541,871 | $6,515,239 | - Brokered time deposits totaled $246.9 million at March 31, 2025, and the company has no material deposit concentration risk[284][286] Time Deposits Exceeding FDIC Limit (in thousands) | Time Deposits Exceeding FDIC Limit (in thousands) | March 31, 2025 | | :------------------------------------------------ | :------------- | | Due within 3 months or less | $149,818 | | Due after 3 months and within 6 months | $103,935 | | Due after 6 months and within 12 months | $29,570 | | Due after 12 months | $8,933 | | Total uninsured, time deposits | $292,256 | Shareholders' Equity Total shareholders' equity increased by $27.8 million to $758.0 million, primarily due to increased earnings, while accumulated other comprehensive income (loss) improved by $7.7 million - Total shareholders' equity increased by $27.8 million to $758.0 million at March 31, 2025, from $730.2 million at December 31, 2024, mostly due to an increase in earnings[289] - Accumulated other comprehensive income (loss) improved by $7.7 million, from $(95.7) million to $(88.0) million[289] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section discusses the company's market risk, primarily interest rate risk, and its management strategies. It details how the company monitors and mitigates exposure to interest rate fluctuations through asset-liability management, interest rate sensitivity analysis, and economic value of equity (EVE) modeling - Market risk primarily stems from interest rate risk inherent in lending, investment, and deposit-taking activities, actively monitored and managed by the ALCO[290] - The company's objective is to minimize the adverse impact of interest rate changes on net interest income and capital, relying on its asset-liability structure and various tools like gap analysis and interest rate simulations[291][296][297] Percentage Change in Earnings (March 31, 2025) | Change in Interest Rates (in Basis Points) | Percentage Change in Earnings (March 31, 2025) | | :----------------------------------------- | :--------------------------------------------- | | 200 | (1.7)% | | 100 | (0.6)% | | (100) | (0.5)% | | (200) | (1.4)% | | (300) | (1.8)% | Percentage Change in EVE (March 31, 2025) | Change in Interest Rates (in Basis Points) | Percentage Change in EVE (March 31, 2025) | | :----------------------------------------- | :---------------------------------------- | | 200 | (8.4)% | | 100 | (3.7)% | | (100) | 2.8% | | (200) | 3.2% | | (300) | 1.9% | Item 4. Controls and Procedures Management, including the CEO and CFO, evaluated the effectiveness of disclosure controls and procedures as of March 31, 2025, concluding they are designed and operating effectively. No material changes to internal control over financial reporting occurred during the quarter - Disclosure controls and procedures were evaluated as effective by management, including the CEO and CFO, as of March 31, 2025[303] - No material changes in internal control over financial reporting occurred during the quarter ended March 31, 2025[304] Part II - Other Information This part provides additional information including legal proceedings, risk factors, equity sales, and exhibits Item 1. Legal Proceedings The company is involved in routine legal claims and proceedings but is not currently party to any material legal proceedings, and management believes any liabilities will not have a material adverse effect on its financial position - The company is not party to any material legal proceedings, and management believes any liabilities from current or threatened litigation will not have a material adverse effect on its financial position[306] Item 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in the company's Form 10-K for the year ended December 31, 2024 - No material changes to the risk factors disclosed in the Form 10-K for the year ended December 31, 2024, have occurred[307] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The company's Board authorized a $50.0 million share repurchase program on April 25, 2025. During the quarter ended March 31, 2025, no shares were purchased under any repurchase program, though some shares were acquired from employees for tax withholding - On April 25, 2025, the Board authorized a share repurchase program for up to $50.0 million of common stock[308] Share Purchases | Period | Total number of shares purchased | Average price paid per share | | :-------------------- | :------------------------------- | :--------------------------- | | January 1 - 31, 2025 | 2,829 | $62.18 | | February 1 - 28, 2025 | — | — | | March 1 - 31, 2025 | — | — | - Shares purchased during January 2025 were transferred from employees to satisfy minimum tax withholding obligations related to restricted stock units, not under a repurchase program[308][309] Item 3. Defaults Upon Senior Securities There were no defaults upon senior securities during the period - None[310] Item 4. Mine Safety Disclosures This item is not applicable to the company - Not Applicable[311] Item 5. Other Information No directors or officers adopted or terminated Rule 10b5-1 or non-Rule 10b5-1 trading arrangements during the three months ended March 31, 2025 - No directors or officers adopted or terminated Rule 10b5-1 or non-Rule 10b5-1 trading arrangements during the three months ended March 31, 2025[312] Item 6. Exhibits This section lists the exhibits filed with the Form 10-Q, including corporate governance documents, certifications, and financial statements formatted in Inline XBRL - Key exhibits include Articles of Incorporation, Bylaws, CEO/CFO certifications (302 and 906), and financial statements formatted in Inline XBRL[313]