Burke & Herbert Financial Services (BHRB) - 2023 Q3 - Quarterly Report

Part I - Financial Information This part presents the unaudited consolidated financial statements and management's discussion and analysis for Burke & Herbert Financial Services Corp Item 1. Financial Statements This section presents the unaudited consolidated financial statements of Burke & Herbert Financial Services Corp. for the three and nine months ended September 30, 2023, and 2022, including balance sheets, income statements, comprehensive income, changes in shareholders' equity, and cash flows, along with detailed notes on significant accounting policies and financial instrument specifics Consolidated Balance Sheets The Consolidated Balance Sheets show the financial position of Burke & Herbert Financial Services Corp. as of September 30, 2023, and December 31, 2022, highlighting key asset, liability, and equity figures Metric (in thousands) | Metric (in thousands) | Sep 30, 2023 | Dec 31, 2022 | | :-------------------- | :----------- | :----------- | | Total Assets | $3,585,188 | $3,562,898 | | Total Deposits | $2,985,618 | $2,920,400 | | Borrowed Funds | $299,000 | $343,100 | | Total Shareholders' Equity | $270,819 | $273,453 | Consolidated Statements of Income The Consolidated Statements of Income detail the company's revenues, expenses, and net income for the three and nine months ended September 30, 2023, and 2022, showing a significant decrease in net income year-over-year Metric (in thousands) | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Total Interest Income | $37,272 | $29,265 | $108,716 | $80,059 | | Total Interest Expense | $14,383 | $2,585 | $37,261 | $4,277 | | Net Interest Income | $22,889 | $26,680 | $71,455 | $75,782 | | Provision for (Recapture of) Credit Losses | $235 | $(2,388) | $964 | $(7,564) | | Total Non-interest Income | $4,289 | $4,261 | $13,128 | $12,872 | | Total Non-interest Expense | $22,423 | $19,952 | $64,136 | $59,485 | | Income Before Income Taxes | $4,520 | $13,377 | $19,483 | $36,733 | | Income Tax Expense | $464 | $2,240 | $1,869 | $6,073 | | Net Income | $4,056 | $11,137 | $17,614 | $30,660 | | Basic EPS | $0.55 | $1.50 | $2.37 | $4.13 | | Diluted EPS | $0.55 | $1.49 | $2.35 | $4.11 | Consolidated Statements of Comprehensive Income (Loss) The Consolidated Statements of Comprehensive Income (Loss) show the net income and other comprehensive income (loss) components, primarily driven by unrealized gains/losses on securities and cash flow hedges, for the three and nine months ended September 30, 2023, and 2022 Metric (in thousands) | Metric (in thousands) | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net Income | $4,056 | $11,137 | $17,614 | $30,660 | | Unrealized gains (losses) on securities (net of tax) | $(20,285) | $(42,793) | $(8,322) | $(152,878) | | Reclassification adjustment for loss (gain) on securities (net of tax) | $0 | $33 | $88 | $(49) | | Reclassification adjustment for loss (gain) on fair value hedge (net of tax) | $(32) | $0 | $842 | $0 | | Unrealized holding gain (loss) on cash flow hedge (net of tax) | $(38) | $(654) | $(267) | $(1,519) | | Reclassification adjustment for losses (gains) included in net income (net of tax) | $373 | $58 | $995 | $(86) | | Total Other Comprehensive Income (Loss) | $(19,982) | $(43,356) | $(6,664) | $(154,532) | | Comprehensive Income (Loss) | $(15,926) | $(32,219) | $10,950 | $(123,872) | Consolidated Statements of Changes in Shareholders' Equity The Consolidated Statements of Changes in Shareholders' Equity reflect movements in common stock, additional paid-in capital, retained earnings, accumulated other comprehensive income (loss), and treasury stock for the three and nine months ended September 30, 2023, and 2022, including the impact of CECL adoption and dividend declarations Metric (in thousands) | Metric (in thousands) | Sep 30, 2023 | Dec 31, 2022 | | :-------------------- | :----------- | :----------- | | Total Shareholders' Equity | $270,819 | $273,453 | | Retained Earnings | $426,744 | $424,391 | | Accumulated Other Comprehensive Income (Loss) | $(146,159) | $(139,495) | | Impact of CECL Adoption (net of tax) | $(3,439) | N/A | | Cash Dividends Declared (9 months) | $(11,809) | $(11,807) | Consolidated Statements of Cash Flows The Consolidated Statements of Cash Flows provide a breakdown of cash generated from or used in operating, investing, and financing activities for the nine months ended September 30, 2023, and 2022, showing a decrease in cash and cash equivalents Metric (in thousands) | Metric (in thousands) | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------- | :-------------------------- | :-------------------------- | | Net Cash Flows Provided by Operating Activities | $32,335 | $48,650 | | Net Cash Flows (Used in) Investing Activities | $(50,086) | $(85,316) | | Net Cash Flows Provided by Financing Activities | $9,320 | $419 | | Increase (Decrease) in Cash and Cash Equivalents | $(8,431) | $(36,247) | | Cash and Cash Equivalents, End of Period | $41,864 | $41,116 | Note 1— Nature of Business Activities and Significant Accounting Policies This note outlines the company's organizational structure, primary market area, and significant accounting policies, including the adoption of new accounting standards like CECL and ASU 2022-01, and the pending merger with Summit Financial Group, Inc - Burke & Herbert Financial Services Corp. became the holding company for Burke & Herbert Bank & Trust Company on October 1, 2022, and elected to be a financial holding company in September 2023. The Bank operates 23 branches in Northern Virginia and commercial loan offices in Fredericksburg, Loudoun County, Richmond, VA, and Bethesda, MD[389][361][596][597] - On August 24, 2023, the Company entered into an Agreement and Plan of Reorganization and Plan of Merger with Summit Financial Group, Inc. (Summit). Summit shareholders will receive 0.5043 shares of Burke & Herbert common stock for each Summit common stock share. The merger is subject to shareholder and regulatory approvals[362][75] - The Company adopted ASU 2016-13 (CECL) and ASU 2022-02 on January 1, 2023. CECL replaced the incurred loss methodology with an expected loss methodology for financial assets measured at amortized cost and off-balance sheet credit exposures. The adoption resulted in a cumulative-effect adjustment that increased the allowance for credit losses for loans by $4.1 million and for unfunded commitments by $274.8 thousand, decreasing retained earnings by $3.4 million (net of deferred taxes)[395][419][369][421] Nature of operations The Company operates as a financial holding company, with its primary business conducted through Burke & Herbert Bank & Trust Company, offering a range of banking products and services across Northern Virginia and surrounding areas - The Bank's primary market area includes northern Virginia, with 23 branches and commercial loan offices in Fredericksburg, Loudoun County, Richmond, Virginia, and Bethesda, Maryland. Deposit products include checking, savings, and term certificates, while the loan portfolio comprises commercial and consumer loans, largely secured by real estate[361] Pending Merger with Summit Financial Group, Inc. Burke & Herbert Financial Services Corp. is in the process of merging with Summit Financial Group, Inc., a transaction that will result in Summit merging into Burke & Herbert, and Summit Community Bank, Inc. merging into Burke & Herbert Bank & Trust Company - The merger agreement, entered on August 24, 2023, stipulates that Summit shareholders will receive 0.5043 shares of Burke & Herbert common stock for each share they own. The completion of the mergers is contingent upon requisite approvals from both companies' stockholders and regulatory bodies[75][362] Basis of Presentation The consolidated financial statements are prepared in accordance with GAAP for interim reporting and SEC regulations, with all significant intercompany transactions eliminated. Management's estimates and assumptions are integral to the reported amounts - The financial statements are prepared in accordance with GAAP for interim financial reporting and SEC regulations, with all significant intercompany accounts and transactions eliminated. Management's estimates and assumptions affect reported asset, liability, revenue, and expense amounts, and actual results may differ[363][393][415] Adoption of new accounting standards The Company adopted ASU 2022-01 (Derivatives and Hedging) and ASU 2016-13 (CECL) on January 1, 2023, with CECL significantly changing the methodology for credit loss measurement and eliminating TDR accounting guidance - ASU 2022-01 (Derivatives and Hedging) was adopted on January 1, 2023, with no material impact. ASU 2016-13 (CECL) was also adopted on January 1, 2023, replacing the incurred loss methodology with an expected loss model for financial assets at amortized cost and off-balance sheet credit exposures[366][395] - The adoption of CECL resulted in a cumulative-effect adjustment that increased the allowance for credit losses for loans by $4.1 million and for unfunded commitments by $274.8 thousand, leading to a $3.4 million decrease in retained earnings (net of deferred taxes)[419][421] - ASU 2022-02 (Troubled Debt Restructurings and Vintage Disclosures) was adopted prospectively on January 1, 2023, eliminating TDR accounting guidance and enhancing disclosures for loan refinancings/restructurings when borrowers face financial difficulty[369] Allowance for Credit Losses The Allowance for Credit Losses (ACL) is determined using the CECL methodology, which estimates expected credit losses over the life of financial assets, including loans and off-balance sheet exposures, considering historical experience, current conditions, and future forecasts - The ACL for expected credit losses is determined based on a quantitative assessment of collectively and individually evaluated loans, incorporating a qualitative component for risk factors not fully captured by the CECL model[401][505] - For collectively evaluated loans, the Company uses a Weighted Average Remaining Maturity (WARM) methodology, segmenting the portfolio by federal call codes and utilizing macroeconomic variable loss drivers for a two-year forecast period, reverting to historical average loss rates thereafter[426][478] - Individually evaluated loans, such as non-accrual loans, are assessed based on collateral value, observable market price, or present value of expected future cash flows. For collateral-dependent loans, the ACL is measured based on the fair value of the collateral[403][430][451] - The ACL on off-balance sheet credit exposures (e.g., unfunded commitments) is estimated quarterly using the same CECL methodology as the loan portfolio and is included in accrued interest and other liabilities[404] - The Company elected to exclude accrued interest from the amortized cost basis for ACL determination and reverses interest income directly for uncollectible accrued interest receivable[405][422] Note 2— Securities This note details the Company's securities portfolio, primarily available-for-sale (AFS) debt securities, their fair values, unrealized gains/losses, and the impairment evaluation process under CECL, concluding no credit-related impairment for AFS securities as of September 30, 2023 Securities Available-for-Sale (in thousands): | Category | Amortized Cost (Sep 30, 2023) | Fair Value (Sep 30, 2023) | Amortized Cost (Dec 31, 2022) | Fair Value (Dec 31, 2022) | | :-------------------------------- | :---------------------------- | :------------------------ | :---------------------------- | :------------------------ | | U.S. Treasuries and government agencies | $197,310 | $172,982 | $198,154 | $174,993 | | Obligations of states and municipalities | $536,885 | $429,479 | $550,590 | $453,907 | | Residential mortgage backed - agency | $47,494 | $41,836 | $57,883 | $53,061 | | Residential mortgage backed - non-agency | $307,763 | $282,108 | $365,983 | $339,295 | | Commercial mortgage backed - agency | $36,874 | $35,539 | $61,810 | $59,933 | | Commercial mortgage backed - non-agency | $181,844 | $173,344 | $191,709 | $183,299 | | Asset-backed | $82,811 | $81,172 | $101,791 | $98,626 | | Other | $9,500 | $7,935 | $9,500 | $8,643 | | Total | $1,400,481 | $1,224,395 | $1,537,420 | $1,371,757 | Gross Unrealized Losses on AFS Securities (in thousands): | Category | Less Than Twelve Months (Fair Value) | Less Than Twelve Months (Gross Unrealized Losses) | More Than Twelve Months (Fair Value) | More Than Twelve Months (Gross Unrealized Losses) | Total Unrealized Losses (Sep 30, 2023) | | :-------------------------------- | :----------------------------------- | :---------------------------------------- | :----------------------------------- | :---------------------------------------- | :------------------------------------- | | U.S. Treasuries and government agencies | $0 | $0 | $172,982 | $24,328 | $24,328 | | Obligations of states and municipalities | $1,708 | $125 | $424,139 | $107,288 | $107,413 | | Residential mortgage backed - agency | $37 | $1 | $41,798 | $5,657 | $5,658 | | Residential mortgage backed - non-agency | $12,875 | $542 | $268,477 | $25,117 | $25,659 | | Commercial mortgage backed - agency | $249 | $2 | $34,725 | $1,353 | $1,355 | | Commercial mortgage backed - non-agency | $13,671 | $103 | $158,968 | $8,397 | $8,500 | | Asset-backed | $13,080 | $47 | $58,198 | $1,603 | $1,650 | | Other | $6,252 | $1,249 | $1,683 | $316 | $1,565 | | Total | $47,872 | $2,069 | $1,160,970 | $174,059 | $176,128 | - The Company concluded that unrealized losses on AFS securities at September 30, 2023, were primarily due to changes in interest rates and market volatility, not credit deterioration. No ACL was recorded for AFS securities, as the Company does not intend to sell them and is not required to sell them before recovery of amortized cost[438][464][466][467][468][469] - Restricted stock, primarily FHLB stock, totaled $7.2 million at September 30, 2023, and $16.4 million at December 31, 2022. These investments are carried at cost and are not considered impaired[470] Note 3— Loans This note details the composition of the Company's loan portfolio by segment, outlining the associated risks and the impact of the CECL methodology adoption on loan accounting Loan Balances by Portfolio Segment (in thousands): | Loan Segment | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :----------- | :----------- | | Commercial real estate | $1,260,653 | $1,109,315 | | Owner-occupied commercial real estate | $123,496 | $127,114 | | Acquisition, construction & development | $96,535 | $94,450 | | Commercial & industrial | $61,571 | $53,514 | | Single family residential (1-4 units) | $525,558 | $499,362 | | Consumer non-real estate and other | $2,803 | $3,466 | | Loans, gross | $2,070,616 | $1,887,221 | | Allowance for credit losses | $(26,111) | $(21,039) | | Loans, net | $2,044,505 | $1,866,182 | - The Company's loan portfolio segments include commercial real estate, owner-occupied commercial real estate, acquisition, construction & development, commercial & industrial, single family residential (1-4 units), and consumer non-real estate and other. Each segment carries distinct risks related to interest rates, collateral market conditions, and general economic conditions[445][446][447][471][472][473][474][475] - The CECL methodology was adopted on January 1, 2023, for financial assets measured at amortized cost, including loan receivables. All information as of September 30, 2023, is presented in accordance with ASC 326, while prior period information follows previous GAAP[449] Note 4— Allowance for Credit Losses This note details the activity in the Allowance for Credit Losses (ACL) for the three and nine months ended September 30, 2023, and 2022, reflecting the impact of CECL adoption, charge-offs, recoveries, and the credit quality of the loan portfolio ACL Activity (in thousands): | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :-------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Balance, beginning of period | $25,919 | $23,362 | $21,039 | $31,709 | | Impact of CECL adoption | N/A | N/A | $4,125 | N/A | | Provision for (recapture of) credit losses | $200 | $(2,388) | $1,033 | $(7,564) | | Total loans charged-off | $(13) | $(54) | $(134) | $(3,411) | | Total recoveries of loans charged-off | $5 | $33 | $48 | $219 | | Balance, end of period | $26,111 | $20,953 | $26,111 | $20,953 | Aging of Past Due Loans (in thousands) - September 30, 2023: | Loan Segment | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due | Total Past Due | Current Loans | Total Loans | | :-------------------------------- | :------------------ | :------------------ | :----------------------- | :------------- | :------------ | :---------- | | Commercial real estate | $0 | $0 | $6 | $6 | $1,260,647 | $1,260,653 | | Owner-occupied commercial real estate | $0 | $0 | $667 | $667 | $122,829 | $123,496 | | Acquisition, construction & development | $0 | $0 | $0 | $0 | $96,535 | $96,535 | | Commercial & industrial | $0 | $0 | $0 | $0 | $61,571 | $61,571 | | Single family residential (1-4 units) | $0 | $39 | $59 | $98 | $525,460 | $525,558 | | Consumer non-real estate and other | $3 | $3 | $0 | $6 | $2,797 | $2,803 | | Total | $3 | $42 | $732 | $777 | $2,069,839 | $2,070,616 | - The Company did not extend any loan modifications to borrowers experiencing financial difficulty that resulted in a more-than-insignificant direct change in contractual cash flows for the three and nine months ended September 30, 2023[518][519] Note 5— Deposits This note provides details on the Company's deposit composition and scheduled maturities of time deposits, highlighting an increase in brokered time deposits Scheduled Maturities of Time Deposits (in thousands) - September 30, 2023: | Maturity Period | Amount | | :-------------------------------- | :----- | | Remaining three months ending Dec 31, 2023 | $59,683 | | 2024 | $269,103 | | 2025 | $135,389 | | 2026 | $83,185 | | 2027 | $49,432 | | 2028 | $78,046 | | Total | $674,838 | - Brokered time deposits significantly increased to $389.0 million at September 30, 2023, from $100.3 million at December 31, 2022. Time deposits through the Certificate of Deposit Account Registry Service program also increased to $21.8 million from $11.7 million over the same period[495] - The aggregate amount of time deposits with a minimum denomination of $250,000 was approximately $65.5 million at September 30, 2023, up from $32.6 million at December 31, 2022[495] Note 6— Advances and Other Borrowings This note details the Company's borrowing activities, including outstanding balances, interest rates, and available lines of credit Borrowings (in thousands): | Metric | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :----------- | :----------- | | Total Borrowings | $299,000 | $343,100 | | Interest Rate Range (at period end) | 4.38% - 5.57% | 4.13% - 4.57% | | Average Balance Outstanding (9 months) | $302,100 | $269,500 | - The Company has unused borrowing capacity of $883.5 million through FHLB of Atlanta lines of credit and unsecured federal fund lines from correspondent banking relationships. All borrowings as of September 30, 2023, are set to mature within one calendar year[521] Note 7— Leased Property This note describes the Company's lessor and lessee arrangements for property, including operating and finance leases, and provides supplemental information on lease terms and discount rates Right-of-Use Assets and Lease Liabilities (in thousands): | Lease Type | Balance Sheet Classification | Sep 30, 2023 | Dec 31, 2022 | | :-------------------- | :--------------------------- | :----------- | :----------- | | Operating Leases (Assets) | Other assets | $4,846 | $7,255 | | Finance Leases (Assets) | Other assets | $3,661 | $2,620 | | Total Right-of-Use Assets | | $8,507 | $9,875 | | Operating Leases (Liabilities) | Other liabilities | $5,075 | $7,592 | | Finance Leases (Liabilities) | Other liabilities | $3,829 | $2,745 | | Total Lease Liabilities | | $8,904 | $10,337 | Supplemental Lease Information: | Metric | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :----------- | :----------- | | Finance lease weighted average remaining lease term (years) | 12.87 | 12.76 | | Finance lease weighted average discount rate | 2.93% | 2.22% | | Operating lease weighted average remaining lease term (years) | 3.12 | 3.26 | | Operating lease weighted average discount rate | 3.02% | 3.19% | Note 8— Regulatory Capital Matters This note details the Company's and the Bank's compliance with regulatory capital requirements, including Basel III rules and 'prompt corrective action' regulations, confirming their 'well capitalized' status - As of September 30, 2023, and December 31, 2022, the Bank was categorized as 'well capitalized' under the regulatory framework for 'prompt corrective action' by the FDIC[8][103] Regulatory Capital Ratios (Consolidated) - September 30, 2023: | Capital Ratio | Actual Amount (in thousands) | Actual Ratio | Adequacy Purposes Applicable Ratio | To Be Well Capitalized Under Prompt Corrective Action Ratio | | :-------------------------------- | :--------------------------- | :----------- | :--------------------------------- | :---------------------------------------- | | Total Capital to risk weighted assets | $443,293 | 17.48% | ≥ 10.5% | ≥ 10.0% | | Tier 1 (Core) Capital to risk weighted assets | $416,977 | 16.44% | ≥ 8.5% | ≥ 8.0% | | Common Tier 1 (CET 1) to risk-weighted assets | $416,977 | 16.44% | ≥ 7.0% | ≥ 6.5% | | Tier 1 (Core) Capital to average assets | $416,977 | 11.32% | ≥ 4.0% | ≥ 5.0% | Regulatory Capital Ratios (Consolidated) - December 31, 2022: | Capital Ratio | Actual Amount (in thousands) | Actual Ratio | Adequacy Purposes Applicable Ratio | To Be Well Capitalized Under Prompt Corrective Action Ratio | | :-------------------------------- | :--------------------------- | :----------- | :--------------------------------- | :---------------------------------------- | | Total Capital to risk weighted assets | $433,958 | 18.88% | ≥ 10.5% | ≥ 10.0% | | Tier 1 (Core) Capital to risk weighted assets | $412,946 | 17.97% | ≥ 8.5% | ≥ 8.0% | | Common Tier 1 (CET 1) to risk-weighted assets | $412,946 | 17.97% | ≥ 7.0% | ≥ 6.5% | | Tier 1 (Core) Capital to average assets | $412,946 | 11.34% | ≥ 4.0% | ≥ 5.0% | - As of September 30, 2023, approximately $175.0 million of retained earnings was available for dividend declaration without prior regulatory approval[558] Note 9— Derivatives This note details the Company's use of interest rate derivatives for risk management and customer financing, including cash flow hedges and derivatives not designated as hedges, and their impact on financial statements - The Company uses interest rate swaps and floors as cash flow hedges to manage interest rate risk, aiming to stabilize interest income. For derivatives designated as cash flow hedges, gains or losses are recorded in AOCI and reclassified to interest income as hedged transactions affect earnings[11][530] - The Company enters into back-to-back interest rate swaps with loan customers and third parties, which are reported at fair value as economic hedges not qualifying for hedge accounting. Changes in fair value for these are recorded in other non-interest expense and sum to zero[532] Fair Value of Derivative Financial Instruments (in thousands): | Derivative Type | Balance Sheet Location | Notional Amount (Sep 30, 2023) | Fair Value (Sep 30, 2023) | Notional Amount (Dec 31, 2022) | Fair Value (Dec 31, 2022) | | :-------------------------------- | :--------------------------- | :----------------------------- | :------------------------ | :----------------------------- | :------------------------ | | Interest rate swaps (cash flow hedges) | Other liabilities | $50,000 | $1,446 | $50,000 | $2,254 | | Interest rate swaps (customer loans) | Other assets | $72,836 | $2,732 | $34,674 | $1,311 | | Interest rate swaps (customer loans) | Other liabilities | $72,836 | $2,732 | $34,674 | $1,311 | - The Company estimates an additional $1.1 million will be reclassified as a reduction to interest income from AOCI related to derivatives over the next 12 months[11] 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, and discusses litigation matters Contractual Amounts of Financial Instruments Outstanding (in thousands): | Instrument | Sep 30, 2023 | Dec 31, 2022 | | :-------------------- | :----------- | :----------- | | Commitments to extend credit | $269,097 | $291,265 | | Commercial letters of credit | $10,443 | $8,539 | - The Company records a provision for credit losses on unfunded commitments, which totaled $35.0 thousand for the three months ended September 30, 2023, and a recapture of $69.8 thousand for the nine months ended September 30, 2023. The ACL on off-balance-sheet credit was $205.0 thousand at September 30, 2023[600] - Interest rate lock commitments are treated as free-standing derivative instruments, with changes in fair value reported as non-interest income[540][568] - Management believes that liabilities from pending or threatened litigation will not have a material adverse effect on the Company's financial position[571] Note 11— Fair Value Measurements This note describes the Company's methodologies for fair value measurements, categorizing assets and liabilities into Level 1, 2, or 3 based on input observability, and provides a summary of financial instruments measured at fair value - Fair value measurements are categorized into three levels: Level 1 (quoted prices in active markets for identical assets/liabilities), Level 2 (significant other observable inputs), and Level 3 (significant unobservable inputs)[544][572][602] - Derivatives are valued using observable market data (Level 2) via third-party vendors. Interest rate lock commitments are also valued at fair value based on underlying loan prices from investors (Level 2)[22] Assets Measured at Fair Value on a Recurring Basis (in thousands) - September 30, 2023: | Financial Assets | Level 1 | Level 2 | Level 3 | Total | | :-------------------------------- | :------ | :-------- | :------ | :-------- | | Investment Securities: | | | | | | U.S. Treasuries and government agencies | $172,982 | $0 | $0 | $172,982 | | Obligations of states and municipalities | $0 | $429,479 | $0 | $429,479 | | Residential mortgage backed - agency | $0 | $41,836 | $0 | $41,836 | | Residential mortgage backed - non-agency | $0 | $282,108 | $0 | $282,108 | | Commercial mortgage backed - agency | $0 | $35,539 | $0 | $35,539 | | Commercial mortgage backed - non-agency | $0 | $173,344 | $0 | $173,344 | | Asset-backed | $0 | $8