UMPQ Umpqua Holdings Corp - 10-K

ITEM 1A.   RISK FACTORS.

In addition to the other information set forth in this report, you should carefully consider the risk factors discussed below. These factors could adversely affect our business, financial condition, liquidity, results of operations and capital position, and the value of, and return on, an investment in the Company. These factors could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report. An investment in the Company involves risk, including the possibility that the value of the investment could fall substantially and that dividends on the investment could be reduced or eliminated.

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Risks Related to the Proposed Mergers and the Bank Merger

Combining Umpqua and Columbia may be more difficult, costly or time consuming than expected and the anticipated benefits and cost savings of the merger may not be realized.

Umpqua and Columbia have operated and, until the completion of the Mergers and the Bank Merger, will continue to operate independently. The success of the proposed transaction, will depend, in part, on the ability to realize the anticipated cost savings from combining the businesses of Umpqua and Columbia. To realize the anticipated benefits and cost savings, Columbia and Umpqua must successfully integrate and combine their businesses in a manner that permits growth opportunities and does not materially disrupt the existing customer relations nor result in decreased revenues due to loss of customers. It is possible that the integration process could result in the loss of key employees, the disruption of either company's ongoing businesses or inconsistencies in standards, controls, procedures, and policies that adversely affect the combined company's ability to maintain relationships with clients, customers, depositors, and employees or to achieve the anticipated benefits and cost savings. If Umpqua experiences difficulties with the integration process, the anticipated benefits may not be realized fully or at all or may take longer to realize than expected. Integration efforts between the two companies will also divert management attention and resources. These integration matters could have an adverse effect on Umpqua during this transition period and for an undetermined period after completion of the Mergers and the Bank Merger on the combined company. In addition, the actual cost savings could be less than anticipated.

Termination of the Merger Agreement could negatively impact Umpqua.

If the Merger Agreement is terminated, there may be adverse consequences. For example, Umpqua's businesses may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Mergers, without realizing any of the anticipated benefits of completing the Mergers. Also, Umpqua has devoted significant internal resources to the pursuit of the Mergers and the expected benefit of those resource allocations would be lost if the Mergers are not completed. Additionally, if the Merger Agreement is terminated, the market price of Umpqua's common stock could decline to the extent that the current market prices reflect a market assumption that the merger will be completed. If the Merger Agreement is terminated under certain circumstances, Umpqua may be required to pay to Columbia a termination fee of $145.0 million.

Umpqua will be subject to business uncertainties and contractual restrictions while the Merger is pending that could adversely affect our business and operations.

Uncertainty about the effect of the Mergers on employees, customers, and other persons Umpqua has a business relationship with may have an adverse effect on Umpqua's business, operations, and stock price. These uncertainties may impair Umpqua's ability to attract, retain and motivate key personnel until the Mergers are completed, and could cause customers and others that deal with Umpqua to seek to change existing business relationships. Retention of certain employees by Umpqua may be challenging while the Mergers are pending, as certain employees may experience uncertainty about their future roles. These retention challenges could require Umpqua to incur additional expenses to retain key employees. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with Umpqua, Umpqua's business could be harmed. In addition, subject to certain exceptions, Umpqua has agreed to operate its business in the ordinary course prior to closing the Mergers and to refrain from taking certain actions. These restrictions may prevent Umpqua from pursuing attractive business opportunities that may arise prior to the completion of the Mergers. Umpqua may delay or abandon projects and other business decisions could be deferred during the pendency of the Mergers.

Umpqua will incur substantial costs related to the Mergers.

Umpqua has incurred and expects to incur a number of significant non-recurring costs associated with the Mergers. These costs include legal, financial advisory, accounting, consulting, and other advisory fees, severance/employee benefit-related costs, public company filing fees and other regulatory fees, financial and other printing costs, and other related costs. Some of these costs are payable regardless of whether the Mergers are completed. We may incur additional costs to maintain employee morale and retain key employees during the pendency of the Mergers. There can be no assurances that the expected benefits and efficiencies related to the integration of the businesses will be realized to offset these transaction costs over time.

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The Merger Agreement limits Umpqua's ability to pursue acquisition proposals.

The merger agreement prohibits Umpqua from soliciting, initiating, knowingly encouraging, or knowingly facilitating certain third‑party acquisition proposals. These provisions, which could result in a $145.0 million termination fee payable under certain circumstances, might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of Umpqua from considering or proposing such an acquisition.

COVID-19 RISK

The COVID-19 pandemic has impacted our business, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted.

The COVID-19 pandemic has negatively impacted the economy, changed customer behaviors, disrupted supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. The pandemic could impact the demand for our products and services, which could adversely affect our revenue and result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses close, unemployment levels rise, or regional economic conditions worsen. Our business operations may also be disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic.

Future governmental actions may require additional types of customer-related responses that could negatively impact our financial results. We could be required to take capital actions in response to the COVID-19 pandemic, including reducing dividends and eliminating stock repurchases. The extent to which the COVID-19 pandemic continues to impact our business, results of operations, and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic; actions taken by governmental authorities and other third parties in response to the pandemic; the effect on our customers, counterparties, employees and third party service providers; and the effect on economies and markets. To the extent that the COVID-19 pandemic continues, it may also have the effect of heightening many of the other risks.

CREDIT RISK

The majority of our assets are loans, which if not repaid would result in losses to the Bank.

The Bank and its operating subsidiary are subject to credit risk, which is the risk of losing principal or interest due to borrowers' failure to repay loans or leases in accordance with their terms. Underwriting and documentation controls cannot mitigate all credit risk. A downturn in the economy or the real estate market in our market areas or a rapid increase in interest rates could have a negative effect on collateral values and borrowers' ability to repay. To the extent loans are not paid timely by borrowers, the loans are placed on non-accrual status, thereby reducing interest income. Further, under these circumstances, an additional provision for loan and lease losses or unfunded commitments may be required. Risk of borrower default may arise from events or circumstances that are difficult to detect or foresee.

We maintain an allowance for credit losses on loans and leases, which is a reserve established through a provision for credit losses charged to expense, that represents management's best estimate of current expected credit losses over the life of the loan or lease within the existing portfolio of loans and leases. The allowance for credit losses on loans and leases, in the judgment of management, is necessary to reserve for current expected credit losses and risks in the loan and lease portfolio. The level of the allowance for credit losses on loans and leases is an estimate that reflects management's consideration of relevant available information, including historical credit loss experience, current conditions, and reasonable and supportable forecasts. The determination of the appropriate level of the allowance for credit losses on loans and leases inherently involves a high degree of subjectivity and requires us to make significant estimates of current expected credit risks using existing qualitative and quantitative information, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans and leases, identification of additional problem loans and leases, and other factors, both within and outside of our control, may require an increase in the allowance for credit losses on loans and leases.

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In addition, bank regulatory agencies periodically review our allowance for credit losses on loans and leases and may require an increase in the provision for credit losses or the recognition of additional loan charge offs, based on judgments different than those of management. An increase in the allowance for credit losses on loans and leases would result in a decrease in net income, and possibly risk-based capital, and could have a material adverse effect on our financial condition and results of operations.

We are subject to lending concentration risks.

As of December 31, 2022, approximately 72% of our loan portfolio consisted of commercial and industrial, real estate construction, commercial real estate loans, and lease financing. Commercial loans are generally viewed as having more inherent risk of default than residential mortgage loans or other consumer loans. Also, the commercial loan balance per borrower is typically larger than that for residential mortgage loans and other consumer loans, implying higher potential losses on an individual loan basis. Because our loan portfolio contains a number of commercial loans with balances over $20 million, the deterioration of one or a few of these loans could cause a significant increase in nonaccrual loans, which could have a material adverse effect on our financial condition and results of operations.

Deterioration in the real estate market or other segments of our loan portfolio would lead to additional losses, which could have a material adverse effect on our business, financial condition and results of operations.

As of December 31, 2022, approximately 78% of our total loan portfolio is secured by real estate, the majority of which is commercial real estate located in the five Western states in our footprint. Our success depends in part on economic conditions in the western United States and adverse changes in markets where our real estate collateral is located could adversely affect our business. Increases in delinquency rates or declines in real estate market values would require increased net charge-offs and increases in the allowance for credit losses on loans and leases, which could have a material adverse effect on our business, financial condition and results of operations and prospects.

The CECL accounting for the ACL may create volatility in our provision for credit losses and could have a material impact on our financial condition or results of operations.

Under the CECL model, we are required to present loans and leases, as well as certain other financial assets, carried at amortized cost at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement takes place at the time the financial asset is first added to the balance sheet and periodically thereafter. The CECL model creates more volatility in the level of our allowance for credit losses on loans and leases. We expect to incur ongoing costs in maintaining the additional CECL models and methodology along with acquiring forecasts used within the models, and that the methodology will result in increased costs. The CECL process involves significant management judgment in determining the overall adequacy of the ACL. Management considers various qualitative factors including changes within the portfolio, changes to Bank policies and processes, as well as external factors, which may result in qualitative overlays to the model results.

MARKET AND INTEREST RATE RISK

Difficult or volatile market conditions or weak economic conditions may adversely affect our business.

Our business and financial performance are vulnerable to weak economic conditions, primarily in the United States and especially in the western United States. Additionally, financial markets may be adversely affected by United States fiscal policy and events such as a government shutdown; the current or anticipated impact of military conflict, including escalating military tension between Russia and Ukraine; pandemics, terrorism or other geopolitical events. A deterioration in economic conditions in our primary market areas could result in the following consequences, any of which could materially and adversely affect our business: increased loan delinquencies; problem assets and foreclosures; significant write-downs of asset values; volatile financial markets; lower demand for our products and services; reduced low cost or noninterest bearing deposits; intangible asset impairment; and collateral for loans made by us, especially real estate, may decline in value, in turn reducing customers' borrowing power, and reducing the value of assets and collateral associated with our existing loans. Additional issues surrounding weakening economic conditions and volatile markets that could adversely impact us include:

• Increased regulation of our industry, and resulting increased costs associated with regulatory compliance and potential limits on our ability to pursue business opportunities.

• Our ability to assess the creditworthiness of our customers may be impaired if the models and approaches we use to select, manage, and underwrite our customers become less predictive of future performance.

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• The process we use to estimate current expected credit losses in our loan portfolio requires difficult, subjective, and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans, which may no longer be capable of accurate estimation and may, in turn, impact its reliability.

• Downward pressure on our stock price.

A rapid change in interest rates, or maintenance of rates at historically high or low levels for an extended period, could make it difficult to improve or maintain our current interest income spread and could result in reduced earnings.

Our earnings are largely derived from net interest income, which is interest income and fees earned on loans and investments, less interest paid on deposits and other borrowings. Interest rates are highly sensitive to many factors that are beyond the control of our management, including general economic conditions and the policies of various governmental and regulatory authorities. The actions of the Federal Reserve influence the rates of interest that we charge on loans and pay on borrowings and interest-bearing deposits. We cannot predict the nature or timing of future changes in monetary, tax and other policies or the effects that they may have on our activities and financial results.

As interest rates change, net interest income is affected. With fixed rate assets (such as fixed rate loans and most investment securities) and liabilities (such as certificates of deposit), the effect on net interest income depends on the cash flows associated with the maturity of the asset or liability. Asset/liability management policies may not be successfully implemented and from time to time our risk position is not balanced. An unanticipated rapid decrease or increase in interest rates could have an adverse effect on the spreads between the interest rates earned on assets and the rates of interest paid on liabilities, and therefore on the level of net interest income. For instance, any rapid decrease in interest rates in the future could result in interest income decreasing faster than interest expense because of variable rate loans repricing and fixed rate loans and longer-term investments accelerating prepayment. Low rates for an extended period of time result in reduced returns from the investment and loan portfolios. Higher interest rates generally reduce loan demand and may result in slower loan growth than previously experienced.

The Federal Reserve raised benchmark interest rates throughout 2022 and may continue to raise interest rates in response to economic conditions, particularly inflationary pressures. Increases in interest rates, to combat inflation or otherwise, may result in a change in the mix of noninterest and interest-bearing accounts, and may have otherwise have unpredictable effects. For example, increases in interest rates may result in increases in the number of delinquencies, bankruptcies or defaults by clients and more nonperforming assets and net charge-offs, decreases in deposit levels, decreases to the demand for interest rate-based products and services, including loans, and changes to the level of off-balance sheet market-based investments preferred by our clients, each of which may reduce our interest rate spread. Lower rates would continue to constrain our interest rate spread.

Interest rate volatility and credit risk adjusted rate spreads may impact our financial assets and liabilities measured at fair value.

Our investment portfolio consists of mortgage backed securities and collateralized mortgage obligations, the nature of these securities is such that changes in market interest rates impact the value of the assets. In addition, the MSR are measured at fair value and changes in the interest rates may also impact their value. The widening of the credit risk adjusted rate spreads on potential new issuances of junior subordinated debentures above our contractual spreads and reductions in three-month LIBOR rates have contributed to the cumulative positive fair value adjustment in our junior subordinated debentures carried at fair value. Tightening of these credit risk adjusted rate spreads and interest rate volatility may result in recognizing negative fair value adjustments in the future.

It is possible the Company may accelerate redemption of the existing junior subordinated debentures to support regulatory total capital levels. This could result in adjustments to the fair value of these instruments including the acceleration of accumulated losses on junior subordinated debentures carried at fair value.

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We rely on the soundness of other financial institutions and government sponsored enterprises.

Financial services institutions and government sponsored enterprises are interrelated as a result of trading, clearing, processing, lending, counterparty, guarantor and other relationships. We have exposure to many different industries and counterparties in financial services, including brokers and dealers, commercial banks, bankers banks, correspondent banks, investment banks, mutual and hedge funds, institutions involved in the mortgage business and others. Transactions with these entities expose us to risk in the event of default of our counterparty, including due to their failure or financial difficulty. Our ability to engage in funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions, including if there is a default by, or rumors about, one or more financial services institutions. Our credit risk could also be impacted when the collateral we hold cannot be realized or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us.

We may be impacted by the retirement of LIBOR as a reference rate.

In November 2020, the ICE Benchmark Administration, the LIBOR administrator, announced its intention to continue publishing most tenors of U.S. dollar LIBOR until June 30, 2023. In March 2022, the LIBOR Act was enacted, providing a uniform approach for replacing LIBOR as a reference interest rate in contracts and in so-called "tough legacy" contracts. Tough legacy contracts are contracts that do not include effective fallback provisions, for example, because they have no provisions for a replacement benchmark. Under the LIBOR Act, references to the most common tenors of LIBOR in these contracts will be replaced automatically to reference a SOFR-based benchmark interest rate identified in Federal Reserve regulations. In December 2022, the Federal Reserve issued final regulations identifying benchmark replacements, based on SOFR, for various types of contracts subject to the LIBOR Act. We may be adversely impacted by the changes involving LIBOR and other benchmark rates as a result of our business activities and our underlying operations, and interest rates on our loans, derivatives and other financial instruments tied to LIBOR rates, as well as the revenue and expenses associated with those financial instruments, may be adversely affected.

The Company holds financial instruments that will be impacted by the discontinuance of LIBOR, primarily certain loans, derivatives, and junior subordinated debentures that use LIBOR as the benchmark rate. These financial instruments will transition to new reference rates. This transition is progressing and will continue to occur over time as many of these arrangements do not have an alternative rate referenced in their contracts. Our existing LIBOR exposures are limited primarily to three instruments—adjustable and variable-rate loans, loan-related derivatives, and junior subordinated debentures. We have prepared for the cessation of USD LIBOR by taking steps to avoid new exposures and reduce our remaining exposures. We have actively originated new variable and adjustable-rate loans using SOFR, forward-looking term SOFR and other non-LIBOR indexes. We have substantially completed amendments to all loans maturing after June 30, 2023, to include robust LIBOR index replacement provisions.

We have organized an internal transition program to identify system, operational, and contractual impacts, assess our risks, manage the transition, facilitate communication with our customers, and monitor the program progress. The LIBOR retirement is a significant shift in the industry. A transition away from LIBOR could impact our pricing and interest rate risk models, our loan product structures, our hedging strategies, and communication with our customers.

The market transition away from LIBOR could:

• adversely affect the interest rates paid or received on our floating rate obligations, loans, derivatives and other financial instruments tied to LIBOR

• adversely affect the value of our financial instruments tied to LIBOR

• result in additional regulatory scrutiny of our preparedness for the transition away from LIBOR and increased compliance and operational costs related to the transition;

• result in disputes, litigation or other actions with counterparties regarding the interpretation and enforceability of fallback or replacement index language in LIBOR-based instruments and securities;

• cause customer confusion and negatively impact our relationships with borrowers; and

• require the transition to or development of appropriate systems and analytics to effectively transition our risk management processes from LIBOR-based products to those based on an alternative benchmark.

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LIQUIDITY RISK

Deposits are a critical source of funds for our continued growth and profitability.

Our business strategy calls for continued growth. Our ability to continue to grow depends primarily on our ability to successfully attract deposits to fund loan growth. Core deposits are a low cost and generally stable source of funding and a significant source of funds for our lending activities. Our inability to retain or attract such funds could adversely affect our liquidity. If we are forced to seek other sources of funds, such as additional brokered deposits or borrowings from the FHLB, the interest expense associated with these other funding sources may be higher than the rates we are currently paying on our deposits, which would adversely impact our net income, and such sources of funding may be more volatile and unavailable to us.

Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets due to market conditions could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. An adverse regulatory action against us could detrimentally impact our access to liquidity sources. Our ability to borrow could also be impaired by factors that are nonspecific to us, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole as evidenced by turmoil in the domestic and worldwide credit markets.

Our wholesale funding sources may prove insufficient to support our future growth or an unexpected reduction in deposits.

We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. If we grow more rapidly than any increase in our deposit balances, we are likely to become more dependent on these sources, which include brokered deposits, FHLB advances, proceeds from the sale of loans and liquidity resources at the holding company. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs, and our profitability would be adversely affected.

MORTGAGE BANKING RISK

Changes in interest rates could reduce the value of mortgage servicing rights.

We acquire MSR when we keep servicing rights after we sell originated residential mortgage loans. We sell the majority of our originated residential mortgage loans with servicing retained. We measure MSR at fair value. Fair value is the present value of estimated future net servicing income, calculated based on a number of variables, including assumptions about the likelihood of prepayment by borrowers. Changes in interest rates can affect prepayment assumptions and consequently MSR fair value. When interest rates fall, borrowers are usually more likely to prepay their mortgage loans by refinancing them at a lower rate. As the likelihood of prepayment increases, MSR fair value can decrease, which reduces earnings in the period in which the decrease occurs.

A low interest rate environment increases our exposure to prepayment risk in our mortgage portfolio and the mortgage-backed securities in our investment portfolio. Increased prepayments, refinancing or other factors that impact loan balances could reduce expected revenue associated with mortgage assets and could also lead to a reduction in the value of our mortgage servicing rights, which could have a negative impact on our financial results. We may choose to hedge the interest rate sensitivity of the MSR fair value. Hedges may not perform in line with our modeled projections.

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Our mortgage banking revenue can fluctuate significantly.

We earn revenue from fees received for originating, selling and servicing mortgage loans. Generally, if interest rates rise, the demand for mortgage loans tends to fall, reducing the revenue we receive from originations and sales of mortgage loans. At the same time, mortgage banking revenue can increase through increases in fair value of MSR. When interest rates decline, originations tend to increase and the value of MSR tends to decline, also with some offsetting revenue effect. The negative effect on revenue from a decrease in the fair value of residential MSR is immediate, but any offsetting revenue benefit from more originations and the MSR relating to new loans accrues over time. It is also possible that even if interest rates were to fall, mortgage originations may also fall or any increase in mortgage originations may not be enough to offset the decrease in the MSR value caused by the lower rates.

We depend upon programs administered by Fannie Mae, Freddie Mac and Ginnie Mae.

Our ability to generate revenues in our home lending group depends on programs administered by government-sponsored entities that play an important role in the residential mortgage industry. During 2022, 49% of mortgage loans were originated for sale to, or through programs sponsored by Fannie Mae, Freddie Mac or Ginnie Mae. We service loans on behalf of Fannie Mae and Freddie Mac, as well as loans that have been securitized pursuant to securitization programs sponsored by Fannie Mae, Freddie Mac and Ginnie Mae.  A majority of our mortgage servicing rights and loans serviced through subservicing agreements relate to these servicing activities. These entities establish the base service fee to compensate us for servicing loans as well as the assessment of fines and penalties that may be imposed upon us for failing to meet servicing standards. Our status as a Fannie Mae, Freddie Mac and Ginnie Mae approved seller and servicer is subject to compliance with guidelines and failure to meet such guidelines could result in the unilateral termination of our status as an approved seller or servicer.  Changes in the existing government-sponsored mortgage programs or servicing eligibility standards through legislation or otherwise, or our failure to maintain a relationship with each of Fannie Mae, Freddie Mac and Ginnie Mae, could materially and adversely affect our business, financial position, results of operations and cash flows through negative impact on the pricing of mortgage related assets in the secondary market, higher mortgage rates to borrowers, or lower mortgage origination volumes and margins.

LEGAL, REGULATORY AND COMPLIANCE RISK

We are subject to extensive government regulation and supervision.

Umpqua and its subsidiaries, primarily Umpqua Bank, are subject to extensive federal and state regulation and supervision including by the FDIC, DCBS, Federal Reserve, CFPB, and the SEC, the primary focus of which is to protect customers, depositors, the deposit insurance fund and the safety and soundness of the banking system as a whole, and not shareholders. The quantity and scope of applicable federal and state regulations may place banks at a competitive disadvantage compared to less regulated competitors such as Fintech companies, finance companies, credit unions, mortgage banking companies and leasing companies. These laws and regulations apply to almost every aspect of our business, and affect our lending practices and procedures, capital structure, investment activities, deposit gathering activities, our services and products, risk management practices, dividend policy and growth, including through acquisitions.

Legislation and regulation with respect to our industry has increased in recent years, and we expect that supervision and regulation will continue to expand in scope and complexity. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways, and could subject us to additional costs, restrict our growth, limit the services and products we may offer or limit the pricing of banking services and products. In addition, establishing systems and processes to achieve compliance with laws and regulation increases our costs and could limit our ability to pursue business opportunities.

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If we receive less than satisfactory results on regulatory examinations, we could be subject to damage to our reputation, significant fines and penalties, requirements to increase compliance and risk management activities and related costs and restriction on acquisitions, new locations, new lines of business, or continued growth. Future changes in federal and state banking and brokerage regulations could adversely affect our operating results and ability to continue to compete effectively. For example, the Dodd-Frank Act and related regulations subject us to additional restrictions, oversight and reporting obligations, which have significantly increased costs. And over the last several years, state and federal regulators have focused on enhanced risk management practices, compliance with the Bank Secrecy Act and anti-money laundering laws, data integrity and security, use of service providers, and fair lending and other consumer protection issues, which has increased our need to build additional processes and infrastructure. Government agencies charged with adopting and interpreting laws, rules and regulations, may do so in an unforeseen manner, including in ways that potentially expand the reach of the laws, rules or regulations more than initially contemplated or currently anticipated. We cannot predict the substance or impact of pending or future legislation or regulation, or the application thereof. Compliance with such current and potential regulation and scrutiny could significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital and limit our ability to pursue business opportunities in an efficient manner. Our success depends on our ability to maintain compliance with both existing and new laws and regulations.

We are required to comply with stringent capital requirements.

We are required to maintain a common equity Tier 1 capital ratio of 4.5%, a Tier 1 capital ratio of 6%, a total capital ratio of 8%, and a leverage ratio of 4%.  In addition, we must maintain an additional capital conservation buffer of 2.5% of total risk weighted assets or be subject to limitations on dividends and other capital distributions, as well as limiting discretionary bonus payments to executive officers. The capital rules may require us to raise more common capital or other capital that qualifies as Tier 1 capital. Maintaining higher levels of capital may reduce our profitability and otherwise adversely affect our business, financial condition, or results of operations. The application of more stringent capital requirements could, among other things, result in lower returns on invested capital and result in regulatory actions if we were to be unable to comply with such requirements.

We may be required to raise additional capital in the future, but that capital may not be available when it is needed, or it may only be available on unacceptable terms, which could adversely affect our financial condition and results of operations.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may not be able to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations and pursue our growth strategy could be materially impaired. We and the Bank are currently well capitalized under applicable regulatory guidelines. However, our business could be negatively affected if we or the Bank failed to remain well capitalized. For example, because Umpqua Bank is well capitalized, and we otherwise qualify as a financial holding company, we are permitted to engage in a broader range of activities than are permitted to a bank holding company. Loss of financial holding company status could require that we cease these broader activities. The banking regulators are authorized (and sometimes required) to impose a wide range of requirements, conditions, and restrictions on banks, thrifts, and bank holding companies that fail to maintain adequate capital levels.

We have risk related to legal proceedings.

We are involved in judicial, regulatory, and arbitration proceedings concerning matters arising from our business activities and fiduciary responsibilities. We establish reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. We may incur costs for a legal matter even if we have not established a reserve, and the actual costs of resolving a legal matter may substantially exceed any established reserves for the matter. Our insurance may not cover all claims that may be asserted against us. Any claim asserted against us, regardless of merit or eventual outcome, could harm our reputation. The ultimate resolution of a pending or future legal proceeding, depending on the remedy sought and granted, could materially adversely affect our results of operations and financial condition.

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As a bank holding company that conducts substantially all of our operations through the Bank, our ability to pay dividends, repurchase our shares or to repay our indebtedness depends upon liquid assets held by the holding company and the results of operations of our subsidiaries.

The Company is a separate and distinct legal entity from our subsidiaries and it receives substantially all of its revenue from dividends paid from the Bank. There are legal limitations on the extent to which the Bank may extend credit, pay dividends or otherwise supply funds to, or engage in transactions with, us. Our inability to receive dividends from the Bank could adversely affect our business, financial condition, results of operations and prospects.

Our net income depends primarily upon the Bank's net interest income, which is the income that remains after deducting from total income generated by earning assets the expense attributable to the acquisition of the funds required to support earning assets (primarily interest paid on deposits). The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of changes in interest rates and the levels of nonperforming loans. All of those factors affect the Bank's ability to pay dividends to the Company.

Various statutory provisions restrict the amount of dividends the Bank can pay to us without regulatory approval. The Bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet the "adequately capitalized" level in accordance with regulatory capital requirements. It is also possible that, depending upon the financial condition of the Bank and other factors, regulatory authorities could conclude that payment of dividends or other payments, including payments to us, is an unsafe or unsound practice and impose restrictions or prohibit such payments.

Under Oregon law, the Bank may not pay dividends in excess of unreserved retained earnings, deducting there from, to the extent not already charged against earnings or reflected in a reserve, the following: (1) all bad debts, which are debts on which interest is past due and unpaid for at least six months, unless the debt is fully secured and in the process of collection; (2) all other assets charged-off as required by Oregon bank regulators or a state or federal examiner; and (3) all accrued expenses, interest and taxes of the institution. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company's capital needs, asset quality and overall financial condition.

We are currently required to seek prior regulatory approval for dividends from the Bank to Umpqua and from Umpqua to shareholders. Our regulators have broad discretion whether to approve (or to not object to) dividends and when they will respond to our requests.

TECHNOLOGY RISK

We face significant cyber, data and information security risk.

Cyber attacks and other data security risks and breaches include computer viruses, malicious or destructive code, denial of service or information attacks, hacking, ransomware, social engineering attacks targeting our associates and customers, improper access by associates or vendors, malware intrusion and data corruption attempts, and identity theft that could result in the disclosure or destruction of confidential or proprietary information.

Cyberattack techniques can be very sophisticated and difficult to prevent and promptly detect, change regularly, and can originate from a wide variety of sources including third parties who are or may be involved in organized crime or linked to terrorist organizations or hostile foreign governments. Cyber security risk management programs are expensive to maintain and as cyber threats continue to grow and evolve we may be required to expend significant additional resources to continue to modify or enhance protective measures or to investigate and remediate information security vulnerabilities or incidents. Although we have programs in place related to business continuity, disaster recovery and information and cyber security to maintain the confidentiality, integrity, and availability of our systems, business applications and customer information, we may not timely detect disruptions and disruptions may still give rise to interruptions in service to customers and loss or liability to us, including loss of customer data.

Cyber risks increase as we continue to develop and grow our mobile and other internet-based product offerings and expand our internal usage of web-based products and applications.

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Hacking of personal information and identity theft risks, in particular, could cause serious reputational harm. A successful penetration or circumvention of system security could cause serious negative consequences that could adversely impact its results of operations, liquidity and financial condition, including:

• loss of customers and business opportunities;

• costs associated with maintaining business relationships after an attack or breach;

• significant business disruption to our operations;

• misappropriation, exposure, or destruction of our confidential information, intellectual property, funds, or those of our customers;

• damage to computers or systems;

• violation of applicable privacy and other laws;

• litigation;

• regulatory fines, penalties or intervention;

• loss of confidence in our security measures;

• reimbursement or other compensatory costs; and

• additional compliance costs.

Our cybersecurity insurance may not provide sufficient coverage in the event of a breach or may not be available in the future on acceptable terms.

Cybersecurity and data privacy are areas of heightened legislative and regulatory focus.

As cybersecurity and data privacy risks for banking organizations and the broader financial system have significantly increased in recent years, cybersecurity and data privacy issues have become the subject of increasing legislative and regulatory focus. The federal bank regulatory agencies have proposed enhanced cyber risk management standards, focusing on cyber risk governance and management, management of internal and external dependencies, and incident response, cyber resilience and situational awareness. Several states have proposed or adopted cybersecurity legislation and regulations, which require, among other things, notification to affected individuals when there has been a security breach of their personal data. We receive, maintain and store non-public personal information of our customers and counterparties, including, but not limited to, personally identifiable information and personal financial information. The sharing, use, disclosure and protection of this information are governed by federal and state law. Both personally identifiable information and personal financial information is increasingly subject to legislation and regulation, the intent of which is to protect the privacy of personal information that is collected and handled. For example, we are subject to the recently enacted California Consumer Privacy Act and California Privacy Rights Act. We may become subject to new legislation or regulation concerning cybersecurity or the privacy of personally identifiable information and personal financial information or of any other information we may store or maintain. We could be adversely affected if new legislation or regulations are adopted or if existing legislation or regulations are modified such that we are required to alter our systems or require changes to our business practices or privacy policies. If cybersecurity, data privacy, data protection, data transfer or data retention laws are implemented, interpreted or applied in a manner inconsistent with our current practices, we may be subject to fines, litigation or regulatory enforcement actions or ordered to change its business practices, policies or systems in a manner that adversely impacts our operating results.

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The failure to understand and adapt to continual technological changes could negatively impact our business.

The financial services industry is undergoing rapid technological change with frequent introductions of new technology-driven products and services by depository institutions and fintech companies. Technological changes are often designed to eliminate banks as intermediaries which could result in the loss of income and customer deposits. New technology-driven products and services are often introduced and adopted, including innovative ways that customers can make payments, access products and manage accounts. We could be required to make substantial capital expenditures to modify or adapt existing products and services or develop new products and services. We may not be successful in introducing new products and services or those new products may not achieve market acceptance. We could lose business, be forced to price products and services on less advantageous terms to retain or attract clients, or be subject to cost increases if we do not effectively develop and implement new technology. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in operations. In addition, advances in technology such as digital, mobile, telephone, text, and online banking; e-commerce; and self-service automatic teller machines and other equipment, as well as changing customer preferences to access our products and services through digital channels, could decrease the value of our store network and other assets. We may close or sell certain stores and restructure or reduce our remaining stores and work force. These actions could lead to losses on assets, expense to reconfigure stores and loss of customers in certain markets. As a result, our business, financial condition or results of operations may be adversely affected.

We may not be able to successfully implement current or future information technology system enhancements and operational initiatives.

We are investing significant resources in information technology system enhancements and operational initiative to provide functionality, new and enhanced products and services, more efficient internal operations, meet regulatory requirements and streamline our customer experience. We may not be able to successfully implement and integrate such system enhancements and related operational initiatives or do so within budgets and on time. We may incur significant training, licensing, maintenance, consulting and amortization expenses during and after implementation, and may not realize the anticipated long-term benefits.

Our business is highly reliant on technology and our ability to manage the operational risks associated with technology.

Our business involves storing, transmitting, retrieving and processing sensitive consumer and business customer data. We depend on internal systems and outsourced technology to support these data storage and processing operations in a secure manner. Despite our efforts to ensure the security and integrity of our systems, we may not be able to anticipate, detect or recognize threats to our systems or to implement effective preventive measures against all cyber security breaches. A cyber security breach or cyberattack could persist for a long time before being detected and could result in theft of sensitive data or disruption of our transaction processing systems. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations. Our customers and other third parties may use personal mobile devices or computing devices that are outside of its network environment and are subject to their own cybersecurity risks to access our network, products and services.

We depend on our ability to manage the operational risks associated with technology to avoid losses and reputational damage.

Our business involves storing and processing sensitive consumer and business customer data. We depend on internal systems and outsourced technology to support these data storage and processing operations. Despite our efforts to ensure the security and integrity of our systems, we may not be able to anticipate, detect or recognize threats to our systems or to implement effective preventive measures against all cyber security breaches. A cyber security breach or cyberattack could persist for a long time before being detected and could result in theft of sensitive data or disruption of our transaction processing systems. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations.

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OPERATIONAL RISK

Our business is highly reliant on third party vendors (and their vendors) and our ability to manage the operational risks associated with outsourcing those services.

We rely on third parties to provide services that are integral to our operations, including the storage and processing of sensitive consumer and business customer data, as well as our sales efforts. We cannot be sure that we will be able to maintain these relationships on favorable terms. In addition, some of our data processing services are provided by companies associated with our competitors. The loss of these vendor relationships could disrupt the services we provide to our customers and cause us to incur significant expense in connection with replacing these services.

Our non-interest income includes revenues related to overdraft and non-sufficient funds fees and may be subject to increased scrutiny.

Recently, there has been a heightened interest in bank overdraft protection programs and other fees earned by banks. In response to increased interest and scrutiny, and in anticipation of enhanced supervision and enforcement of overdraft protection practices in the future, certain banking organizations have begun to modify their overdraft protection programs, including discontinuation of charging their customers overdraft transaction fees. Competitive pressures from our peers, as well as any new rules or supervisory guidance or more aggressive examination and enforcement policies in respect of banks' overdraft protection practices, could cause Umpqua to change our practices in ways that may have a negative impact on our revenue and earnings, which could have an adverse effect on our financial condition and results of operations.

Damage to our brand and reputation could significantly harm our business and prospects.

Our brand and reputation are important assets. Our relationship with many of our customers is predicated upon our reputation as a high-quality provider of financial services that adheres to the highest standards of ethics, service quality and regulatory compliance. We believe that our brand has been, and continues to be, well received in our industry, with current and potential customers, investors and employees. Our ability to attract and retain customers, investors and employees depends upon external perceptions of us. Damage to our reputation among existing and potential customers, investors and employees could cause significant harm to our business and prospects and may arise from numerous sources, including litigation or regulatory actions, failing to deliver minimum standards of service and quality, lending practices, inadequate protection of customer information, sales and marketing efforts, compliance failures, unethical behavior and the misconduct of employees. Adverse developments with respect to our industry may also, by association, negatively impact our reputation or result in greater regulatory or legislative scrutiny or litigation against us.

We and our customers are susceptible to fraud.

Financial institutions are inherently exposed to fraud risk. A fraud can be perpetrated by a customer, associate, vendor or member of the general public. We are most subject to fraud risk with the origination of loans, ACH and wire transactions, ATM transactions and checking transactions. Fraud risk within digital channels is challenging to detect and prevent and we are expanding our business more deeply into these channels. We rely on financial and other data from customers when we accept them as new customers and when they conduct transactions, which information could be fraudulent and expose us to losses that negatively impact our net income especially when delivered through digital channels. Our operational controls to prevent and detect such fraud may be ineffective in preventing new methods of fraud. If our customers experience fraud, theft or a cyber attack on their systems that results in loss of funds held at the Bank, they will often look to the Bank to make them whole regardless of fault, which can increase our costs to defend threatened litigation and result in loss of customer relationships.

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STRATEGIC AND OTHER BUSINESS RISKS

The financial services industry is highly competitive.

We face pricing competition for loans and deposits. We also face competition with respect to customer convenience, product lines, accessibility of service and service capabilities. Our most direct competition comes from other banks, brokerages, mortgage companies and savings institutions, but more recently has also come from fintech companies that rely on technology to provide financial services. We also face competition from credit unions, government-sponsored enterprises, mutual fund companies, insurance companies and other non-bank businesses. The significant competition in attracting and retaining deposits and making loans, as well as providing other financial services throughout our market area may impact future earnings and growth. Our success depends, in part, on the ability to adapt products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices, which can reduce net interest income and non-interest income from fee-based products and services.

Climate change and related legislative and regulatory initiatives may materially adversely affect the Company's business and results of operations.

The effects of climate change continue to create concern for the state of the global environment. The impacts of climate change, such as extreme weather conditions, natural disasters and rising sea levels, could impact our operations as well as those of our customers and our third party vendors. Increased regulation related to climate change could have an adverse effect on our business and our customers. Our efforts to take these risks into account in making lending and other decisions, including by increasing our business with climate-friendly companies, may not be effective in protecting us from the negative impact of new laws and regulations or changes in consumer or business behavior. Overall, climate change, its effects and the resulting, unknown impact could have a material adverse effect on our financial condition and results of operations.

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

FORWARD LOOKING STATEMENTS AND RISK FACTORS

See the discussion of forward-looking statements and risk factors in Part I Item 1 and Item 1A of this report.

The following discussion and analysis of our financial condition and results of operations constitutes management's review of the factors that affected our financial and operating performance for the years ended December 31, 2022 and 2021. This discussion should be read in conjunction with the consolidated financial statements and notes thereto contained elsewhere in this report. For a discussion of the year ended December 31, 2020, including a comparison to the year ended December 31, 2021, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, on Registrant's Annual Report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission on February 25, 2022.

EXECUTIVE OVERVIEW

Financial Performance

• Earnings per diluted common share were $1.55 for the year ended December 31, 2022, compared to $1.91 for the year ended December 31, 2021. The decrease for the year ended December 31, 2022, as compared to the prior period, was driven by an increase in the provision for credit losses. Higher net interest income and lower non-interest expense offset a decrease in non-interest income due to a decline in residential mortgage banking revenue and a fair value loss, captured in other income, related to certain loans held for investment.

• Net interest income was $1.1 billion for the year ended December 31, 2022, compared to $919.6 million for the year ended December 31, 2021. The increase compared to the prior year was primarily due to an increase in interest income due to the rising interest rate environment and higher average loan balances, with the impact partially offset by an increase in interest expense due to the increased cost of interest on deposits and other interest-bearing liabilities.

• Net interest margin, on a tax equivalent basis, was 3.62% for the year ended December 31, 2022, compared to 3.18% for the year ended December 31, 2021. The increase is primarily a result of the rising rate environment and a higher level of average loans as a percentage of earning assets.

• Non-interest income was $199.5 million for the year ended December 31, 2022, compared to $356.3 million for the year ended December 31, 2021. The decline was due primarily to the $80.0 million decrease in residential mortgage banking revenue, as discussed below, and an increase in fair value loss on certain loans held for investment of $61.5 million as compared to the prior period.

• Residential mortgage banking revenue was $106.9 million for the year ended December 31, 2022, compared to $186.8 million for year ended December 31, 2021. The decrease was primarily attributable to lower revenue from the origination and sale of residential mortgages given lower volumes and gain on sale margins. The decrease was partially offset by a net write-up of the MSR asset, though the favorable income impact was partially reduced by the loss on the MSR hedge that was put in place in mid-August 2022. For-sale mortgage closed loan volume decreased by 61% in 2022, as compared to 2021. In addition, the gain on sale margin decreased to 2.54%, for the year ended December 31, 2022, as compared to 3.32% for the year ended December 31, 2021. Mortgages remain an important product for the Bank and for our customers and we remain committed to serving our communities; however, due to the current and projected market conditions, the Company is downsizing the scale of mortgage operations and expects a smaller impact on the financial statements in the future.

• Non-interest expense was $735.0 million for the year ended December 31, 2022, compared to $760.5 million for the year ended December 31, 2021. The decrease was driven by a reduction in salaries and employee benefits of $39.6 million, due to a decrease in mortgage banking production related incentive pay.

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• Total gross loans and leases were $26.2 billion as of December 31, 2022, an increase of $3.6 billion, or 16%, compared to December 31, 2021.  The increase is primarily due to an increase in commercial real estate balances of $1.8 billion, mostly within multifamily lending, and an increase in residential real estate balances of $1.6 billion.

• Total deposits were $27.1 billion as of December 31, 2022, an increase of $470.9 million, or 2%, from December 31, 2021. This increase was due primarily to the growth in time and interest bearing demand deposits of $901.6 million and $305.5 million, respectively, as a result of the rising interest rate environment.

• Total consolidated assets were $31.8 billion as of December 31, 2022, compared to $30.6 billion at December 31, 2021. The increase was due predominantly to an increase in loans and leases during the period, offset by decreases in cash and cash equivalents and available for sale securities.

Credit Quality

• Non-performing assets increased to $58.8 million, or 0.18% of total assets, as of December 31, 2022, compared to $53.1 million, or 0.17% of total assets, as of December 31, 2021.  Non-performing loans were $58.6 million, or 0.22% of total loans and leases, as of December 31, 2022, compared to $51.2 million, or 0.23% of total loans and leases, as of December 31, 2021.

• The allowance for credit losses was $315.4 million, as of December 31, 2022, an increase of $54.2 million, as compared to December 31, 2021. The increase is due to the growth of the loan portfolio, as well as deterioration in the economic forecasts used in the credit models.

• The Company had a provision for credit losses of $84.0 million for the year ended December 31, 2022, compared to a recapture of the provision for credit losses of $42.7 million in the prior period. The provision for credit losses in the current period was due to allowance requirements for new loan generation, loan mix changes, and changes to the economic forecasts used in credit models. As a percentage of average outstanding loans and leases, the provision for credit losses for the year ended December 31, 2022 was 0.35%, as compared to (0.19)% for the prior year.

Liquidity

• Total cash and cash equivalents was $1.3 billion as of December 31, 2022, a decrease of $1.5 billion from December 31, 2021. The decrease in cash and cash equivalents is due to an increase in loan production, which outpaced deposit generation for the period.

Capital and Growth Initiatives

• In October 2021, Umpqua and Columbia announced their Merger Agreement under which the two companies will combine in an all-stock transaction. On September 17, 2022, a Letter of Agreement was entered into with the Department of Justice, which stipulates that in order to obtain regulatory approvals necessary to complete the transaction, ten Columbia State Bank branches need to be divested. In January 2023, Columbia completed the divestiture of three of the ten branches to satisfy regulatory requirements. On October 25, 2022, Columbia received regulatory approval from the Board of Governors of the Federal Reserve System to complete the proposed merger with Umpqua. The last remaining regulatory approval was received from the FDIC on January 9, 2023, conditioned upon completing the branch divestitures, which we expect to occur on February 24, 2023. The transaction is expected to close after the close of business on February 28, 2023, subject to satisfaction of closing conditions.

• The Company's total risk based capital was 13.7% and its Tier 1 common to risk weighted assets ratio was 11.0% as of December 31, 2022. As of December 31, 2021, the Company's total risk based ratio was 14.3% and its Tier 1 common to risk weighted assets ratio was 11.6%.

• The Company declared cash dividends of $0.84 per common share during the year ended December 31, 2022.

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CRITICAL ACCOUNTING ESTIMATES

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. The estimate that is particularly susceptible to significant change is the determination of the ACL.

The consolidated financial statements are prepared in conformity with GAAP and follow general practices within the financial services industry, in which the Company operates. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain estimates inherently have a greater reliance on the use of assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following estimate is both important to the portrayal of the Company's financial condition and results of operations and requires difficult, subjective or complex judgments and, therefore, management considers the following to be a critical accounting estimate.

Allowance for Credit Losses

The Bank has established an Allowance for Credit Losses Committee, which is responsible for, among other things, regularly reviewing the ACL methodology, including allowance levels, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The Company's Audit and Compliance Committee provides board oversight of the ACL process and reviews the ACL methodology on a quarterly basis.

CECL is not prescriptive in the methodology used to determine the expected credit loss estimate. Therefore, management has flexibility in selecting the methodology. However, the expected credit losses must be estimated over a financial asset's contractual term, adjusted for prepayments, utilizing quantitative and qualitative factors.

The Company utilizes complex models to obtain reasonable and supportable forecasts of future economic conditions dependent upon specific macroeconomic variables related to each of the Company's loan and lease portfolios. Loans and leases deemed to be collateral dependent, or loans deemed to be reasonably expected to become troubled debt restructured or are troubled debt restructured, are individually evaluated for loss based on the value of the underlying collateral or a discounted cash flow analysis.

The adequacy of the ACL is monitored on a regular basis and is based on management's evaluation of numerous factors, including: the CECL model outputs; quality of the current loan portfolio; the trend in the loan portfolio's risk ratings; current economic conditions; loan concentrations; loan growth rates; past-due and non-performing trends; evaluation of specific loss estimates for all significant problem loans; historical charge-off and recovery experience; and other pertinent information. As of December 31, 2022, the Bank used Moody's Analytics November consensus scenario to estimate the ACL. To assess the sensitivity in the ACL results and, when necessary, to inform qualitative adjustments, the Bank used a second scenario, Moody's Analytics November S2 scenario, that differs in terms of severity within the variables, both favorable and unfavorable. For additional information related to the Company's ACL, see Note 5 in the Notes to Consolidated Financial Statements in Item 8 of this report.

Because current economic conditions and forecasts can change and future events are inherently difficult to predict, the anticipated amount of estimated credit losses on loans, and therefore the appropriateness of the ACL, could change significantly. It is difficult to estimate how potential changes in any one economic factor or input might affect the overall allowance because a wide variety of factors and inputs are considered in estimating the allowance and changes in those factors and inputs considered may not occur at the same rate and may not be consistent across all product types. Additionally, changes in factors and inputs may be directionally inconsistent, such that improvement in one factor may offset deterioration in others. Management believes that the ACL was adequate as of December 31, 2022.

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RECENT ACCOUNTING PRONOUNCEMENTS

Information regarding Recent Accounting Pronouncements is included in Note 1 of the Notes to Consolidated Financial Statements in Item 8 below .

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RESULTS OF OPERATIONS

The Company reports two segments: Core Banking and Mortgage Banking, which aligns with how we manage the profitability of the Company and provides greater transparency into the financial contribution of mortgage banking activities.

The Core Banking segment includes all lines of business, except Mortgage Banking, including commercial, retail, private banking, as well as the operations, technology, and administrative functions of the Bank and Holding Company. The Mortgage Banking segment includes the revenue earned from the production and sale of residential real estate loans, the servicing income from our serviced loan portfolio, the quarterly changes in the MSR asset, the quarterly changes in the MSR hedge, and the specific expenses that are related to mortgage banking activities including variable commission expenses. Revenue and associated expenses related to residential real estate loans held for investment are included in the Core Banking segment as portfolio loans are primarily originated through the Bank's retail consumer (store) and private banking channels. Management periodically updates the allocation methods and assumptions within the current segment structure. Refer to the segment information footnote for additional detail of the segments' financial statements.

The Core Banking segment had net income of $317.5 million for the year ended December 31, 2022, compared to a net income of $372.0 million for the year ended December 31, 2021. This decrease is due to an increase in provision for credit losses and a decrease in non-interest income, partially offset by an increase in net interest income and a decrease in non-interest expense. The change in the provision is due to allowance requirements for new loan generation, loan mix changes, and changes to the economic forecasts used in credit models. The decrease in non-interest income was mainly due to a net fair value loss of $49.3 million for the year ended December 31, 2022, compared to a net fair value gain of $9.9 million for the same period in the prior year. The change in fair value, which is recorded in other income, was driven by an increase in long-term interest rates and their effect on fair value adjustments related to equity securities, swap derivatives, and loans carried at fair value. The increase in net interest income, which reflects higher interest income that was partially offset by higher interest expense, is a result of higher interest rates and average balances during the period, as well as a higher mix of average loans as a percentage of earning assets.

The Mortgage Banking segment had net income of $19.2 million for the year ended December 31, 2022, compared to net income of $48.3 million for the year ended December 31, 2021. The decrease was primarily due to lower revenue from the origination and sale of residential mortgages given lower volumes and gain on sale margins, and it was partially offset by a corresponding decrease in non-interest expense due to decreased incentives as originations have slowed due to rising interest rates. The variance was also impacted by a net increase in the fair value of the MSR asset for the year ended December 31, 2022, compared to a net decrease for the year ended December 31, 2021, though the favorable income impact was partially reduced by the loss on the MSR hedge that was put in place during the third quarter of 2022 to reduce net income volatility related to changes in fair value of MSR assets due to valuation inputs or assumptions. Origination revenue decreased from $157.8 million for the year ended December 31, 2021, to $46.7 million in the current period. The gain on sale margin decreased from 3.32% as of December 31, 2021, to 2.54% in the current period. Mortgages remain an important product for the bank and for our customers and we remain committed to serving our communities; however, due to the current and projected market conditions, the Company is downsizing the scale of mortgage operations and expects a smaller impact on the financial statements in the future.

The following table presents the returns on average assets, average common shareholders' equity, and average tangible common shareholders' equity for the years ended December 31, 2022, 2021, and 2020. For each of the periods presented, the table includes the calculated ratios based on reported net income (loss). Our return on average common shareholders' equity in 2020 were negatively impacted as the result of capital required to support goodwill. To the extent this performance metric is used to compare our historical performance with other financial institutions that did not have merger and acquisition-related intangible assets, we believe it is beneficial to also consider the return on average tangible common shareholders' equity. The return on average tangible common shareholders' equity is calculated by dividing net income (loss) by average shareholders' common equity less average goodwill and intangible assets, net (excluding MSRs). The return on average tangible common shareholders' equity is considered a non-GAAP financial measure and should be viewed in conjunction with the return on average common shareholders' equity.

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Return on Average Assets, Common Shareholders' Equity and Tangible Common Shareholders' Equity

For the Years Ended December 31, 2022, 2021, and 2020

(dollars in thousands)

Return on average assets

Return on average common shareholders' equity

Return on average tangible common shareholders' equity

Calculation of average common tangible shareholders' equity:

Average common shareholders' equity

Less: average goodwill and other intangible assets, net

Average tangible common shareholders' equity

Additionally, management believes tangible common equity and the tangible common equity ratio are meaningful measures of capital adequacy. Umpqua believes the exclusion of certain intangible assets in the computation of tangible common equity and the tangible common equity ratio provides a meaningful base for period-to-period and company-to-company comparisons, which management believes will assist investors in analyzing the operating results and capital of the Company. Tangible common equity is calculated as total shareholders' equity less goodwill and other intangible assets, net (excluding MSRs). In addition, tangible assets are total assets less goodwill and other intangible assets, net (excluding MSRs). The tangible common equity ratio is calculated as tangible common shareholders' equity divided by tangible assets. Tangible common equity and the tangible common equity ratio are considered non-GAAP financial measures and should be viewed in conjunction with total shareholders' equity and the total shareholders' equity ratio.

The following table provides a reconciliation of ending shareholders' equity (GAAP) to ending tangible common equity (non-GAAP), and ending assets (GAAP) to ending tangible assets (non-GAAP) as of December 31, 2022, and 2021:

(dollars in thousands)

December 31, 2022

December 31, 2021

Total shareholders' equity

Subtract:

Other intangible assets, net

Tangible common shareholders' equity

Total assets

Subtract:

Other intangible assets, net

Tangible assets

Total shareholders' equity to total assets ratio

Tangible common equity ratio

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although we believe these non-GAAP financial measures are frequently used by stakeholders in the evaluation of 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.

NET INTEREST INCOME

Net interest income for 2022 increased by $150.4 million or 16% compared to the same period in 2021, due primarily to higher loan interest income from increasing rates and higher average loan and lease balances. This increase was partially offset by an increase in the cost of interest-bearing liabilities, which includes an increase of $21.0 million in deposit interest expense for 2022 as compared to 2021, due to rising interest rates, the addition of brokered deposits, and customer account movements.

The net interest margin (net interest income as a percentage of average interest-earning assets) on a fully tax equivalent basis was 3.62% for 2022, an increase of 44 basis points compared to 2021. This increase resulted from an increase in the average yields on interest-earning assets, due to higher interest rates and a higher mix of loans as a percentage of earning assets.

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The yield on loans and leases for 2022 increased by 30 basis points as compared to 2021, primarily attributable to the rise in interest rates, which favorably impacted the repricing of floating and adjustable rate loans and the coupon rate on new loan generation. The cost of interest-bearing liabilities increased 21 basis points for 2022, as compared to 2021, due primarily to rising interest rates driving up interest expense by $35.6 million. Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, as well as changes in the yields earned on interest-earning assets and rates paid on deposits and borrowed funds. The Company continues to be "asset-sensitive."

The following table presents condensed average balance sheet information, together with interest income and yields on average interest-earning assets, and interest expense and rates paid on average interest-bearing liabilities for the years ended December 31, 2022, 2021, and 2020:

(dollars in thousands)

Average Balance

Interest Income or Expense

Average Yields or Rates

Average Balance

Interest Income or Expense

Average Yields or Rates

Average Balance

Interest Income or Expense

Average Yields or Rates

INTEREST-EARNING ASSETS:

Loans held for sale

Loans and leases (1)

Taxable securities

Non-taxable securities (2)

Temporary investments and interest-bearing cash

Total interest earning assets (1), (2)

Other assets

Total assets

INTEREST-BEARING LIABILITIES:

Interest-bearing demand deposits

Money market deposits

Savings deposits

Time deposits

Total interest-bearing deposits

Repurchase agreements and federal funds purchased

Borrowings

Junior subordinated debentures

Total interest-bearing liabilities

Non-interest-bearing deposits

Other liabilities

Total liabilities

Common equity

Total liabilities and shareholders' equity

NET INTEREST INCOME (2)

NET INTEREST SPREAD

NET INTEREST INCOME TO EARNING ASSETS OR NET INTEREST MARGIN (1), (2)

(1) Non-accrual loans and leases are included in the average balance.

(2) Tax-exempt income has been adjusted to a tax equivalent basis at a 21% tax rate. The amount of such adjustment was an addition to recorded income of approximately $1.3 million, $1.5 million, and $1.4 million for the years ended December 31, 2022, 2021, and 2020, respectively.

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The following table sets forth a summary of the changes in tax equivalent net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for 2022 compared to 2021, as well as between 2021 and 2020. Changes in tax equivalent interest income and expense, which are not attributable specifically to either volume or rate, are allocated proportionately between both variances.

2022 compared to 2021

2021 compared to 2020

Increase (decrease) in interest income and expense due to changes in

Increase (decrease) in interest income and expense due to changes in

(in thousands)

Volume

Rate

Total

Volume

Rate

Total

Interest-earning assets:

Loans held for sale

Loans and leases

Taxable securities

Non-taxable securities (1)

Temporary investments and interest bearing deposits

Total interest-earning assets (1)

Interest-bearing liabilities:

Interest bearing demand

Money market

Savings

Time deposits

Repurchase agreements and federal funds

Borrowings

Junior subordinated debentures

Total interest-bearing liabilities

Net increase in net interest income (1)

(1) Tax exempt income has been adjusted to a tax equivalent basis at a 21% tax rate.

PROVISION FOR CREDIT LOSSES

The Company had a $84.0 million provision for credit losses for 2022, as compared to a $42.7 million recapture of provision for credit losses for 2021. The change in the provision reflects allowance requirements for new loan generation, loan mix changes, and changes between economic forecasts used in credit models. As a percentage of average outstanding loans and leases, the provision (recapture) for credit losses recorded for 2022 was 0.35%, as compared to (0.19)% for the prior period.

Net-charge offs were $30.9 million for 2022, or 0.13% of average loans and leases, compared to net charge-offs of $44.9 million, or 0.20% of average loans and leases, for 2021. The majority of net charge-offs relate to leases and equipment finance loans, included within the commercial loan portfolio.

Typically, loans in a non-accrual status will not have an allowance for credit loss as they will be written down to their net realizable value or charged off. However, the net realizable value for homogeneous leases and equipment finance agreements are determined by the loss given default calculated by the CECL model, and therefore homogeneous leases and equipment finance agreements on non-accrual will have an allowance for credit loss amount until they become 181 days past due, at which time they are charged off. The non-accrual leases and equipment finance agreements of $20.4 million as of December 31, 2022 have a related allowance for credit losses of $17.5 million, with the remaining loans written down to their estimated fair value of the collateral, less estimated costs to sell, and are expected to be resolved with no additional material loss, absent further decline in market prices.

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NON-INTEREST INCOME

The following table presents the key components of non-interest income for years ended December 31, 2022 and 2021:

2022 compared to 2021

(dollars in thousands)

Change Amount

Change Percent

Service charges on deposits

Card-based fees

Brokerage revenue

Residential mortgage banking revenue, net

Gain on sale of debt securities, net

Loss on equity securities, net

Gain on loan and lease sales, net

BOLI income

Other (losses) income

Total non-interest income

Brokerage revenue decreased for the year ended December 31, 2022 as compared to prior periods, due to the sale of Umpqua Investments, Inc. in April 2021.

The gain on loan and lease sales in 2022 decreased compared to 2021 due to a decrease in SBA loan sales during the period.

Other (losses) income in 2022 compared to 2021 decreased primarily due to a fair value loss on certain loans held for investment of $58.5 million in 2022, as compared to a fair value gain of $3.0 million in 2021.

Residential mortgage banking revenue, which is the primary source of income for the Mortgage Banking segment, decreased for the year ended December 31, 2022. The variance was driven by rising long-term interest rates and attributed to lower revenue from the origination and sale of residential mortgages, favorable changes in the fair value of the MSR asset, and a loss on the MSR hedge that was put in place during the third quarter of 2022. Revenue related to the origination and sale of residential mortgages decreased by $111.1 million, as compared to the prior period. This was partially offset by a net fair value gain of $22.8 million related to the MSR asset, partially offset by a MSR hedge loss of $14.5 million, for the year ended December 31, 2022, compared to a net loss on fair value of $7.8 million for the same period in 2021. The MSR hedge was put in place in August 2022.

For-sale mortgage closed loan volume decreased 61% as compared to the prior period, and the gain on sale margin decreased to 2.54% in 2022, compared to 3.32% in 2021. Mortgage banking trends in 2022 as compared to the prior period were impacted by higher mortgage rates and their effect on refinance demand, home purchase activity, and the locked pipeline. Direct expense related to the origination of for-sale mortgage loans as a percentage of loan production was 2.46% for the year ended December 31, 2022, compared to 2.00% for the year ended December 31, 2021.

Origination volume for mortgage loans is generally linked to the level of mortgage interest rates. When rates fall, origination volumes are expected to be elevated relative to historical levels. If rates rise, origination volumes would be expected to decline. The MSR asset value is also sensitive to interest rates, and generally falls with lower rates and rises with higher rates, resulting in fair value losses and gains, respectively, due to changes in valuation inputs or assumptions, where applicable. In August 2022, a MSR hedge was put in place as we work to minimize the interest rate risk of mortgage servicing rights and reduce net income volatility related to changes in fair value of MSR assets due to valuation inputs or assumptions.

In 2022, the Company made a number of structural changes within the mortgage banking segment, intended to reduce expenses, limit the impact of MSR changes to the income statement and moderate portfolio mortgage growth. Management notes that although mortgages remain an important product for the bank and for our customers, the Company is downsizing the scale of mortgage operations and expects a smaller impact on the financial statements in the future.

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The following table presents our residential mortgage banking revenues for the years ended December 31, 2022 and 2021:

(dollars in thousands)

Origination and sale

Servicing

Change in fair value of MSR asset:

Changes due to collection/realization of expected cash flows over time

Changes in valuation inputs or assumptions (1)

MSR hedge loss

Residential mortgage banking revenue, net

Loans Held for Sale Production Statistics:

Closed loan volume for-sale

Gain on sale margin

(1) The changes in valuation inputs and assumptions principally reflect changes in discount rates and prepayment speeds, which are primarily affected by changes in interest rates.

NON-INTEREST EXPENSE

The following table presents the key elements of non-interest expense for the years ended December 31, 2022 and 2021:

2022 compared to 2021

(dollars in thousands)

Change Amount

Change Percent

Salaries and employee benefits

Occupancy and equipment, net

Communications

Marketing

Services

FDIC assessments

Intangible amortization

Merger related expenses

Other expenses

Total non-interest expense

Salaries and employee benefits decreased for 2022, compared to 2021, primarily due to a decrease in mortgage banking production related incentive pay during the period, due to increasing rates suppressing demand for mortgage products.

Merger related expenses are directly related to the pending merger with Columbia, which is set to close February 28, 2023.

Other non-interest expense increased for 2022, compared to 2021, primarily due to an increase in state and local taxes of $5.9 million due to a one-time adjustment as well as other miscellaneous fluctuations in other expense, partially offset by a $6.0 million decrease in exit and disposal costs in 2022, compared to 2021. The prior elevated levels of exit and disposal costs were due to store consolidations and back-office lease exits as part of Umpqua's Next Gen 2.0 strategy.

INCOME TAXES

Our consolidated effective tax rate as a percentage of pre-tax income for 2022 was 25.3%, compared to 24.7% for 2021. The 2022 effective tax rate differed from the federal statutory rate of 21% principally because of state taxes, income on tax-exempt investment securities, and tax credits and benefits arising from low-income housing investments.

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FINANCIAL CONDITION

CASH AND CASH EQUIVALENTS

Cash and cash equivalents were $1.3 billion at December 31, 2022, compared to $2.8 billion at December 31, 2021. The decrease of interest bearing cash and temporary investments reflects strong loan portfolio growth of $3.6 billion, which was partially funded by increases in borrowings of $900.0 million and deposits of $470.9 million, respectively, in the period.

INVESTMENT SECURITIES

The composition of our investment securities portfolio reflects management's investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of interest income. The investment securities portfolio provides a vehicle for the investment of available funds, a source of liquidity (by pledging as collateral or through repurchase agreements) and collateral for certain public funds deposits.

Equity and other securities consist primarily of investments in fixed income mutual funds to support our CRA initiatives and securities invested in rabbi trusts for the benefit of certain current or former executives and employees as required by the underlying agreements. Equity and other securities were $73.0 million at December 31, 2022, compared to $81.2 million at December 31, 2021. This decrease is primarily due to losses on equity securities of $7.1 million during the year due to changes in fair value.

Investment debt securities available for sale were $3.2 billion as of December 31, 2022, compared to $3.9 billion at December 31, 2021. The decrease is due to a drop in the fair value of investment securities available for sale of $548.2 million and investment securities sales and paydowns of $396.1 million, partially offset by purchases of investment securities of $276.8 million.

The following table presents information regarding the amortized cost, fair value, average yield and maturity structure of the investment portfolio at December 31, 2022:

(dollars in thousands)

Amortized Cost

Fair Value

Average Yield (1)

U.S. treasury and agencies

One year or less

One to five years

Five to ten years

Over ten years

Total U.S. treasury and agencies

Obligations of states and political subdivisions

One year or less

One to five years

Five to ten years

Over ten years

Total obligations of states and political subdivisions

Other Securities

Mortgage-backed securities and collateralized mortgage obligations

Total debt securities

(1) Weighted average yields are stated on a federal tax-equivalent basis of 21%. Weighted average yields for available for sale investments have been calculated on an amortized cost basis.

The mortgage-related securities in the table above include both pooled mortgage-backed issues and high-quality collateralized mortgage obligation structures, with an average duration of 6.0 years. These mortgage-related securities provide yield spread to U.S. Treasury or agency securities; however, the cash flows arising from them can be volatile due to refinancing of the underlying mortgage loans.

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We review investment securities on an ongoing basis for the presence of impairment, taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether we intend to sell a security or if it is more likely than not that we will be required to sell the security before recovery of our amortized cost basis of the investment, which may be maturity, and other factors.

Gross unrealized losses in the available for sale investment portfolio was $542.3 million at December 31, 2022. This consisted primarily of unrealized losses on mortgage-backed securities and collateralized mortgage obligations of $415.0 million. The unrealized losses were primarily attributable to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities and are not attributable to changes in credit quality. In the opinion of management, no ACL was considered necessary on these debt securities as of December 31, 2022.

RESTRICTED EQUITY SECURITIES

Restricted equity securities were $47.1 million and $10.9 million at December 31, 2022 and 2021, respectively, the majority of which represents the Bank's investment in the Federal Home Loan Bank. The increase is attributable to the purchase of FHLB stock during the period due to increased FHLB borrowing activity during the period. FHLB stock is carried at par and does not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member institutions, and can only be purchased and redeemed at par. At December 31, 2022, the Bank's minimum required investment in FHLB stock was $46.9 million.

LOANS AND LEASES

Total loans and leases outstanding at December 31, 2022 increased $3.6 billion compared to December 31, 2021. This increase was principally attributable to net new loan and lease originations of $3.7 billion, with the majority of the increase in multifamily and residential mortgage loans. The increase was partially offset by the sale of loans totaling $142.3 million and charge-offs of $45.0 million. The loan to deposit ratio as of December 31, 2022 is 97%, as compared to 85% for the year ended December 31, 2021, which reflects the strong loan growth that occurred during 2022.

The following table presents the concentration distribution of our loan and lease portfolio by major type as of December 31, 2022 and 2021:

December 31, 2022

December 31, 2021

(dollars in thousands)

Amount

Percentage

Amount

Percentage

Commercial real estate

Non-owner occupied term, net

Owner occupied term, net

Multifamily, net

Construction & development, net

Residential development, net

Commercial

Term, net

Lines of credit & other, net

Leases & equipment finance, net

Residential

Mortgage, net

Home equity loans & lines, net

Consumer & other, net

Total, net of deferred fees and costs

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The following table presents the maturity distribution of our loan portfolios and the rate sensitivity of these loans to changes in interest rates as of December 31, 2022:

By Maturity

Loans Over One Year by Rate Sensitivity

(in thousands)

One Year or Less

One Through Five Years

Five Through 15 Years

Over 15 Years

Total

Fixed Rate

Floating/Adjustable Rate

Commercial real estate, net

Commercial, net

Residential, net

Consumer & other, net

ASSET QUALITY AND NON-PERFORMING ASSETS

The following table summarizes our non-performing assets and restructured loans, as of December 31, 2022 and 2021:

(dollars in thousands)

December 31, 2022

December 31, 2021

Loans and leases on non-accrual status

Commercial real estate, net

Commercial, net

Residential, net

Consumer & other, net

Total loans and leases on non-accrual status

Loans and leases past due 90 days or more and accruing

Commercial real estate, net

Commercial, net

Residential, net (1)

Consumer & other, net

Total loans and leases past due 90 days or more and accruing (1)

Total non-performing loans and leases

Other real estate owned

Total non-performing assets

Restructured loans (2)

Allowance for credit losses on loans and leases

Reserve for unfunded commitments

Allowance for credit losses

Asset quality ratios:

Non-performing assets to total assets

Non-performing loans and leases to total loans and leases

Allowance for credit losses on loan and lease losses to total loans and leases

Allowance for credit losses to total loans and leases

Allowance for credit losses to total non-performing loans and leases

(1) Excludes government guaranteed GNMA mortgage loans that Umpqua has the right but not the obligation to repurchase that are past due 90 days or more totaling $6.6 million at December 31, 2022.

(2) Represents accruing TDR loans performing according to their restructured terms.

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At December 31, 2022 and 2021, loans of $6.8 million and $6.7 million, respectively, were classified as accruing restructured loans. The restructurings were granted in response to borrower financial difficulty, and generally provide for a modification of loan repayment terms.

A decline in the economic conditions and other factors could adversely impact individual borrowers or the loan portfolio in general. Accordingly, there can be no assurance that loans will not become 90 days or more past due, placed on non-accrual status, restructured or transferred to other real estate owned in the future.

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ALLOWANCE FOR CREDIT LOSSES

The ACL totaled $315.4 million at December 31, 2022, an increase of $54.2 million from the $261.2 million at December 31, 2021. The following table shows the activity in the ACL for the years ended December 31, 2022 and 2021:

(dollars in thousands)

Allowance for credit losses on loans and leases

Balance, beginning of period

Provision (recapture) for credit losses on loans and leases

Loans charged-off:

Commercial real estate, net

Commercial, net

Residential, net

Consumer & other, net

Total loans charged-off

Recoveries:

Commercial real estate, net

Commercial, net

Residential, net

Consumer & other, net

Total recoveries

Net (charge-offs) recoveries:

Commercial real estate, net

Commercial, net

Residential, net

Consumer & other, net

Total net charge-offs

Balance, end of period

Reserve for unfunded commitments

Balance, beginning of period

Provision (recapture) for credit losses on unfunded commitments

Balance, end of period

Total allowance for credit losses

As a percentage of average loans and leases (annualized):

Net charge-offs

Commercial real estate, net

Commercial, net

Residential, net

Consumer & other, net

Provision (recapture) for credit losses

Recoveries as a percentage of charge-offs

The provision (recapture) for credit losses includes the provision (recapture) for credit losses on loans and leases and the provision (recapture) for unfunded commitments. The increase in the provision is due to organic loan growth as well as updates to the economic forecasts used in credit models.

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The following table sets forth the allocation of the allowance for credit losses on loans and leases and percent of loans and leases in each category to total loans and leases, net of deferred fees, as of December 31 for each of the last two years:

December 31, 2022

December 31, 2021

(dollars in thousands)

Amount

Amount

Commercial real estate, net

Commercial, net

Residential, net

Consumer & other, net

Allowance for credit losses on loans and leases

The following table shows the change in the allowance for credit losses from December 31, 2021 to December 31, 2022:

(dollars in thousands)

December 31, 2021

2022 net (charge-offs) recoveries

Reserve (release) build

December 31, 2022

% of loans and leases, net outstanding

Commercial real estate

Commercial

Residential

Consumer

Total allowance for credit losses

% of loans and leases, net outstanding

To calculate the ACL, the CECL models use a forecast of future economic conditions and are dependent upon specific macroeconomic variables that are relevant to each of the Bank's loan and lease portfolios. The forward-looking assumptions revert to historical data when they reach the point where future assumptions are no longer estimated. As of December 31, 2022, the Bank used Moody's Analytics November consensus economic forecast to estimate the ACL. Key macroeconomic variables within this forecast include U.S. real GDP, U.S. unemployment rate, and Federal Reserve Fed Funds rate. The key components include U.S. real GDP average annualized growth of 0.4% in 2023, increasing to 1.4% in 2024, 2.0% in 2025, and 2.0% in 2026, and an average U.S. unemployment rate of 4.3% in 2023, 4.5% in 2024, 4.2% in 2025, and 3.9% in 2026. The forecasted average federal funds rate is expected to be 4.9% in 2023, 4.0% in 2024, 2.9% in 2025, and 2.5% in 2026. The models for calculating the ACL are sensitive to changes in these and other economic variables, which could result in volatility as these assumptions change over time.

We believe that the allowance for credit losses as of December 31, 2022 is sufficient to absorb losses inherent in the loan and lease portfolio and in credit commitments outstanding as of that date based on the information available. If the economic conditions decline, the Bank may need additional provisions for credit losses in future periods.

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RESIDENTIAL MORTGAGE SERVICING RIGHTS

The following table presents the key elements of our residential mortgage servicing rights asset as of December 31, 2022, 2021, and 2020:

(dollars in thousands)

Balance, beginning of period

Additions for new MSR capitalized

Changes in fair value:

Changes due to collection/realization of expected cash flows over time

Changes due to valuation inputs or assumptions (1)

Balance, end of period

(1) The changes in valuation inputs and assumptions principally reflect changes in discount rates and prepayment speeds, which are primarily affected by changes in interest rates.

Information related to our serviced loan portfolio as of December 31, 2022 and 2021 were as follows:

(dollars in thousands)

December 31, 2022

December 31, 2021

Balance of loans serviced for others

MSR as a percentage of serviced loans

Residential MSR are adjusted to fair value quarterly with the change recorded in residential mortgage banking revenue. The value of servicing rights can fluctuate based on changes in interest rates and other factors. Generally, as interest rates decline and borrowers are able to take advantage of a refinance incentive, prepayments increase, and the total value of existing servicing rights declines as expectations of future servicing fee collections decline. Historically, the fair value of our residential MSR will increase as market rates for mortgage loans rise and decrease if market rates fall. Mortgage rates increased during the period and are expected to continue to rise, which has caused prepayment speeds to slow.

Due to changes to inputs in the valuation model including changes in discount rates, prepayment speeds, and other inputs, the fair value of the MSR asset increased by $57.5 million for the year ended December 31, 2022, as compared to an increase of $11.1 million for the year ended December 31, 2021. The fair value of the MSR asset decreased by $20.3 million due to the passage of time, including the impact of regularly scheduled repayments, paydowns, and payoffs, as compared to a decrease of $18.9 million in 2021.

DEPOSITS

Total deposits were $27.1 billion at December 31, 2022, an increase of $470.9 million, or 2%, compared to year-end 2021. The increase is mainly attributable to growth in time and other interest bearing deposits accounts, which reflects an increase in brokered deposits and customer account movements.

The following table presents the deposit balances by major category as of December 31, 2022 and 2021:

December 31, 2022

December 31, 2021

(dollars in thousands)

Amount

Amount

Non-interest bearing demand

Interest bearing demand

Money market

Savings

Time, greater than $250,000

Time, $250,000 or less

Total deposits

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The following table presents the scheduled maturities of uninsured time deposits greater than $250,000 as of December 31, 2022:

(in thousands)

Amount

Three months or less

Over three months through six months

Over six months through twelve months

Over twelve months

Uninsured deposits, greater than $250,000

Uninsured deposits at December 31, 2022, totaled $10.6 billion, which is an estimated amount based on the methodologies and assumptions used for the Bank's regulatory requirements. The Company's total core deposits, which are deposits less time deposits greater than $250,000 and all brokered deposits, were $25.6 billion at December 31, 2022, compared to $26.0 billion at December 31, 2021. The Company's total brokered deposits were $866.9 million or 3% of total deposits at December 31, 2022, compared to $149.9 million or 1% of total deposits at December 31, 2021.

BORROWINGS

At December 31, 2022, the Bank had outstanding securities sold under agreements to repurchase of $308.8 million, a decrease of $183.5 million from December 31, 2021. At December 31, 2022, the Bank had no outstanding federal funds purchased balances. The Bank had outstanding borrowings of $906.2 million at December 31, 2022, consisting of advances from the FHLB, which increased $899.8 million since December 31, 2021. The increase was due to $900.0 million in short-term advances, which have fixed rates ranging from 4.54% to 4.87% and are set to mature in the first quarter of 2023. The remaining advance has a fixed interest rate of 7.10% and matures in 2030. Advances from the FHLB are secured by investment securities and loans secured by real estate.

JUNIOR SUBORDINATED DEBENTURES

We had junior subordinated debentures with carrying values of $411.5 million and $381.1 million at December 31, 2022 and 2021, respectively. The increase is mainly due to the $28.8 million change in the fair value for the junior subordinated debentures elected to be carried at fair value, which is due mostly to the implied forward curve shifting higher and a decrease in the credit spread, partially offset by the spot curve shifting higher. As of December 31, 2022, substantially all of the junior subordinated debentures had interest rates that are adjustable on a quarterly basis based on a spread over three-month LIBOR. These instruments mature after June 2023, and we anticipate they will be covered under pending federal legislation that will allow us to replace the LIBOR index with SOFR under a safe-harbor provision.

LIQUIDITY AND SOURCES OF FUNDS

The principal objective of our liquidity management program is to maintain the Bank's ability to meet the day-to-day cash flow requirements of our customers who either wish to withdraw funds or to draw upon credit facilities to meet their cash needs. The Bank's liquidity strategy includes maintaining a sufficient on-balance sheet liquidity position to provide flexibility, to grow deposit balances and fund growth in lending and investment portfolios, as well as to deleverage non-deposit liabilities as economic conditions permit. As a result, the Company believes that it has sufficient cash and access to borrowings to effectively manage through the current economic conditions, as well as meet its working capital and other needs. The Company will continue to prudently evaluate and maintain liquidity sources, including the ability to fund future loan growth and manage our borrowing sources.

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We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. One source of funds includes public deposits. Individual state laws require banks to collateralize public deposits, typically as a percentage of their public deposit balance in excess of FDIC insurance.  Public deposits represent 7% and 5% of total deposits at December 31, 2022 and 2021, respectively. The amount of collateral required varies by state and may also vary by institution within each state, depending on the individual state's risk assessment of depository institutions. Changes in the pledging requirements for uninsured public deposits may require pledging additional collateral to secure these deposits, drawing on other sources of funds to finance the purchase of assets that would be available to be pledged to satisfy a pledging requirement, or could lead to the withdrawal of certain public deposits from the Bank. At December 31, 2022, the Bank has $2.3 billion in time deposits scheduled to mature within the next 12 months, which we anticipate the majority of personal time deposits will renew or transfer to other deposit products of the Bank at prevailing rates, although no assurance can be given in this regard. In addition to liquidity from core deposits and the repayments and maturities of loans and investment securities, the Bank can utilize established uncommitted federal funds lines of credit, sell securities under agreements to repurchase, borrow on a secured basis from the FHLB or issue brokered certificates of deposit.

The Bank had available lines of credit with the FHLB totaling $7.1 billion at December 31, 2022, subject to certain collateral requirements, namely the amount of pledged loans and investment securities. The Bank had available lines of credit with the Federal Reserve totaling $1.2 billion, subject to certain collateral requirements, namely the amount of certain pledged loans. The Bank had uncommitted federal funds line of credit agreements with additional financial institutions totaling $460.0 million at December 31, 2022. Availability of these lines is subject to federal funds balances available for loan and continued borrower eligibility. These lines are intended to support short-term liquidity needs, and the agreements may restrict consecutive day usage.

The Company is a separate entity from the Bank and must provide for its own liquidity. Substantially all of the Company's revenues are obtained from dividends declared and paid by the Bank. There were $192.0 million of dividends paid by the Bank to the Company in 2022. There are statutory and regulatory provisions that limit the ability of the Bank to pay dividends to the Company. FDIC and Oregon Division of Financial Regulation approval is required for quarterly dividends from Umpqua Bank to the Company. Due to the Company's announcement of its pending merger with Columbia, Umpqua is restricted from paying quarterly cash dividends in excess of the current level and from repurchasing shares of Company common stock.

Although we expect the Bank's and the Company's liquidity positions to remain satisfactory during 2023, it is possible that our deposit balances may not be maintained at previous levels due to pricing pressure or customers' behavior in the current economic environment. In addition, in order to generate deposit growth, our pricing may need to be adjusted in a manner that results in increased interest expense on deposits. We may utilize borrowings or other funding sources, which are generally more costly than deposit funding, to support our liquidity levels.

CONCENTRATIONS OF CREDIT RISK

Information regarding Concentrations of Credit Risk is included in Notes 2, 4, and 17 of the Notes to Consolidated Financial Statements in Item 8 below .

CAPITAL RESOURCES

Shareholders' equity at December 31, 2022 and 2021 was $2.5 billion and $2.7 billion, respectively. The fluctuation in shareholders' equity during the year ended December 31, 2022 was principally due to the other comprehensive loss, net of tax of $428.6 million and cash dividends paid of $183.2 million, offset by net income of $336.8 million for the year ended December 31, 2022.

The Federal Reserve Board has in place guidelines for risk-based capital requirements applicable to U.S. banks and bank/financial holding companies. These risk-based capital guidelines take into consideration risk factors, as defined by regulation, associated with various categories of assets, both on and off-balance sheet. Refer to the discussion of the capital adequacy requirements in Supervision and Regulatio n in Item 1 of this 10-K.

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Under the Basel III guidelines, capital strength is measured in three tiers, which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios. The guidelines require an 8% total risk-based capital ratio, of which 6% must be Tier 1 capital and 4.5% must be CET1. Our CET1 capital primarily includes shareholders' equity less certain deductions for goodwill and other intangibles, net of taxes, net unrealized gains (losses) on AFS securities, net of tax, net unrealized gains (losses) related to fair value of liabilities, net of tax, and certain deferred tax assets that arise from tax loss and credit carry-forwards, and totaled $2.9 billion at December 31, 2022. Tier 1 capital is primarily comprised of common equity Tier 1 capital, less certain additional deductions applied during the phase-in period, totaled $2.9 billion at December 31, 2022. Tier 2 capital components include all, or a portion of, the allowance for credit losses in excess of Tier 1 statutory limits and combined trust preferred security debt issuances. The total of Tier 1 capital plus Tier 2 capital components is referred to as Total Risk-Based Capital, and was $3.7 billion at December 31, 2022. The percentage ratios, as calculated under the guidelines, were 11.02%, 11.02% and 13.71% for CET1, Tier 1 and Total Risk-Based Capital, respectively, at December 31, 2022. The CET1, Tier 1 and Total Risk-Based Capital ratios at December 31, 2021 were 11.58%, 11.58% and 14.26%, respectively.

A minimum leverage ratio is required in addition to the risk-based capital standards and is defined as period-end shareholders' equity, less accumulated other comprehensive income, goodwill and deposit-based intangibles, divided by average assets as adjusted for goodwill and other intangible assets. Although a minimum leverage ratio of 4% is required for the highest-rated financial holding companies that are not undertaking significant expansion programs, the Federal Reserve Board may require a financial holding company to maintain a leverage ratio greater than 4% if it is experiencing or anticipating significant growth or is operating with less than well-diversified risks in the opinion of the Federal Reserve Board. The Federal Reserve Board uses the leverage and risk-based capital ratios to assess capital adequacy of banks and financial holding companies. Our consolidated leverage ratios at December 31, 2022 and 2021 were 9.14% and 9.01%, respectively.

Basel III also requires all banking organizations to maintain a 2.50% capital conservation buffer above the minimum risk-based capital requirements to avoid certain limitations on capital distributions, stock repurchases and discretionary bonus payments to executive officers. The capital conservation buffer is exclusively comprised of common equity Tier 1 capital, and it applies to each of the three risk-based capital ratios but not to the leverage ratio. The common equity Tier 1, Tier 1, and total capital ratio minimums inclusive of the capital conservation buffer were 7.00%, 8.50%, and 10.50%. At December 31, 2022, the Company and Bank were in compliance with the capital conservation buffer requirements.

As of December 31, 2022, the most recent notification from the FDIC categorized the Bank as "well-capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's regulatory capital category.

Along with enactment of the CARES Act, the federal bank regulatory authorities issued an interim final rule to provide banking organizations that are required to implement CECL before the end of 2020 the option to delay the estimated impact on regulatory capital by up to two years, with a three-year transition period to phase out the cumulative benefit to regulatory capital provided during the two-year delay. The Company elected this capital relief and delayed the estimated regulatory capital impact of adopting CECL, relative to the incurred loss methodology's effect on regulatory capital.

During the year ended December 31, 2022, the Company made no capital contributions to the Bank. At December 31, 2022, all four of the capital ratios of the Bank exceeded the minimum ratios required by federal regulation. Management monitors these ratios on a regular basis to ensure that the Bank remains within regulatory guidelines.

The Company's dividend policy considers, among other things, earnings, regulatory capital levels, the overall payout ratio and expected asset growth to determine the amount of dividends declared, if any, on a quarterly basis. There is no assurance that future cash dividends on common shares will be declared or increased. We cannot predict the extent of the economic decline that could result in inadequate earnings, regulatory restrictions and limitations, changes to our capital requirements, or a decision to increase capital by retention of earnings, which may result in the inability to pay dividends at previous levels, or at all.

During 2022, Umpqua's Board approved dividends of $0.21 per common share for all quarters. These dividends were made pursuant to our existing dividend policy and in consideration of, among other things, earnings, regulatory capital levels, the overall payout ratio, and expected asset growth. Umpqua agreed to refrain from paying quarterly cash dividends in excess of the then-current level ($0.21 per share) at the time we entered into the Merger Agreement.

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The payment of future cash dividends is at the discretion of our Board and subject to a number of factors, including results of operations, general business conditions, growth, financial condition, and other factors deemed relevant by the Board. Further, our ability to pay future cash dividends is subject to certain regulatory requirements and restrictions discussed in the Supervision and Regulation section in Item 1 above.

The following table presents cash dividends declared and dividend payout ratios (dividends declared per common share divided by basic earnings per common share) for the years ended December 31, 2022, 2021, and 2020:

Dividend declared per common share

Dividend payout ratio

In July 2021, the Company announced that its Board approved a new share repurchase program, which authorizes the Company to repurchase up to $400 million of common stock over the next twelve months from time to time in open market transactions, accelerated share repurchases, or in privately negotiated transactions as permitted under applicable rules and regulations. The program expired July 31, 2022. As of December 31, 2022, the Company repurchased a total of $78.2 million in shares under the program. The Company did not repurchase any shares during 2022.

The Company halted repurchases, based on the announced merger with Columbia and in accordance with the Merger Agreement. The timing and amount of future repurchases will depend upon the market price for our common stock, securities laws restricting repurchases, asset growth, earnings, our capital plan, and bank or bank holding company regulatory approvals. In addition, our stock plans provide that award holders may pay for the exercise price and tax withholdings in part or entirely by tendering previously held shares.

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