What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-03-22 compared with 2020-03-16 · 189 added, 116 removed, 321 unchanged (49% of the section changed)

Management's Discussion and Analysis of Financial Condition and Results of Operations

General  

The Bancorp's earnings are dependent upon the earnings of the Bank.

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Fees and service charges, wealth management operations income, gains and losses from the sale of assets, provisions for loan losses, income taxes and operating expenses also affect the Bancorp's profitability.

A summary of the Bancorp’s significant accounting policies are detailed in Note 1 to the Bancorp’s consolidated financial statements included in this report.

Preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided.

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Net income for 2020 was $16.6 million, or $4.80 basic and diluted earnings per common share.

The return on average assets was 0.94%, while the return on average stockholders’ equity was 9.54%.

The return on average assets was 1.16%, while the return on average stockholders’

equity was 11.51%.

Recent Developments

Acquisition of AJSB.

On January 24, 2019, the Bancorp completed its acquisition of AJSB, pursuant to an Agreement and Plan of Merger dated July 30, 2018 (the “AJSB Merger Agreement”) between the Bancorp and AJSB.

Pursuant to the terms of the AJSB Merger Agreement, AJSB merged with and into the Bancorp, with the Bancorp as the surviving corporation (the “AJSB Merger”).

On January 24, 2019, the Bancorp completed its acquisition of AJSB, pursuant to an Agreement and Plan of Merger dated July 30, 2018 (the “AJSB Merger Agreement”) between the Bancorp and AJSB.

Pursuant to the terms of the AJSB Merger Agreement, AJSB merged with and into the Bancorp, with the Bancorp as the surviving corporation (the “AJSB Merger”).

Simultaneous with the AJSB Merger, A.J.

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The Bancorp issued 416,478 shares of Bancorp common stock to the former AJSB stockholders, and paid cash consideration of approximately $15.7 million.

Based upon the closing price of NWIN’s common stock on January 23, 2019, the transaction had an implied valuation of approximately $33.2 million, which includes unallocated shares held by the AJSB Employee Stock Ownership Plan (“ESOP”), some of which were cancelled in connection with the closing to satisfy the ESOP’s outstanding loan balance.

As of December 31, 2020, acquisition costs related to the AJSB Merger equaled approximately $2.1 million.

The acquisition further expanded the Bank’s banking center network in Cook County, Illinois, expanding the Bank’s full-service retail banking network to 22 banking centers.

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Acquisition of First Personal.

On July 26, 2018, the Bancorp completed its previously announced acquisition of First Personal, pursuant to an Agreement and Plan of Merger dated February 20, 2018 (the “First Personal Merger Agreement”) between the Bancorp and First Personal.

Pursuant to the terms of the First Personal Merger Agreement, First Personal merged with and into the Bancorp, with the Bancorp as the surviving corporation (the “First Personal Merger”).

Simultaneous with the First Personal Merger, First Personal Bank, an Illinois state chartered commercial bank and wholly-owned subsidiary of First Personal, merged with and into Peoples Bank SB, with Peoples Bank as the surviving institution.

The acquisition represented the Bank’s first expansion into the South Suburban Chicagoland market, and expanded the Bank’s full-service retail banking network to 19 banking centers.

In connection with the First Personal Merger, each First Personal stockholder holding 100 or more shares of First Personal common stock received fixed consideration of (i) 0.1246 shares of Bancorp common stock, and (ii) $6.67 per share in cash for each outstanding share of First Personal common stock.

Stockholders holding less than 100 shares of First Personal common stock received $12.12 in cash and no stock consideration for each outstanding share of First Personal common stock.

Any fractional shares of Bancorp common stock that a First Personal stockholder would have otherwise received in the First Personal Merger were cashed out in the amount of such fraction multiplied by $42.95.

The Bancorp issued a total of 161,875 shares of Bancorp common stock to the former First Personal stockholders, and paid cash consideration of approximately $8.7 million.

Based upon the closing price of Bancorp’s common stock on July 25, 2018, the transaction had an implied valuation of approximately $15.6 million.

Impacts of COVID-19

The COVID-19 pandemic began to affect the Bancorp’s operations during March 2020, and as of the date of this release, continues to influence operating decisions.

In response to the pandemic, the Bancorp’s management implemented the following policy actions:

Participating in the U.S.

Small Business Administration’s Paycheck Protection Program (“PPP”), a program initiated to help small businesses maintain their workforces during the pandemic.

As of December 31, 2020, the Bancorp approved 782 applications totaling $91.5 million, with an average loan size of approximately $117,000.

These loans will help local business owners retain 10,758 employees based on the borrowers’

applications.

The Bancorp’s SBA lender fee is averaging approximately 3.80% for this program, and fees will be earned over the life of the associated loans.

As of December 31, 2020, the Bancorp had remaining loan balances under the Paycheck Protection Program totaling $67.2 million.

On December 21, 2020, Congress passed the Consolidated Appropriations Act, 2021, which included provisions for a second round of Paycheck Protection Funding in 2021.

The Bancorp is currently participating in the program.

Prudently helping borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19.

Consistent with regulatory guidance, the Bancorp will consider deferring or modifying a loan customer’s repayment obligation if the customer’s cash flow has been negatively impacted by the pandemic.

The Bancorp’s management anticipates that additional borrower deferral and modification requests will continue in 2021.

Loans modified to interest only payment or full payment deferral as part of the effects of COVID-19 as of December 31, 2020, are as follows:

(Dollars in thousands)

As of December 31, 2020

Mortgage loans

Commercial Loans

Manufactured Homes

Number of Loans

Recorded Investment

Number of Loans

Recorded Investment

Number of Loans

Recorded Investment

Interest only

Full payment deferral

As the Bancorp continues to monitor the borrowers that are in and outside of deferral status, some loan relationships may be deemed non-performing.

As of December 31, 2020, a single large commercial real estate loan relationship, which operates a hotel, with a carrying balance of $5.3 million, remains in deferral and was deemed non-performing after COVID-19 pandemic stresses negatively impacted weak operating performance prior to the pandemic.

Through management’s review of the loan relationship, a specific reserve within the allowance for loan losses was allocated as of December 31, 2020.

As of December 31, 2020, the customer has opened a payment reserve account with the Bancorp to be used for future contractual payments and is currently in compliance with all modified loan terms.

No other material COVID-19 impacted loans that are in deferral status have been deemed non-performing at this time.

As of December 31, 2020, a total of 154 loans have come out of COVID-19 related deferral status with carrying balances of $72.8 million.

All of these loans continue to be performing, except 1 residential real estate loan with a carrying balances of $433 thousand which was deemed non-performing.

Commercial real estate loans are one of the Bancorp’s primary loan concentrations.

Key loan data, sourced from origination or last credit review, for commercial real estate loans secured by restaurants, hotels, and retail non-owner occupied properties indicate a strong weighted average loan-to-value and debt service coverage.

As of December 31, 2020, commercial real estate loans secured by restaurants totaled $20.5 million and represented 7% of the commercial real estate portfolio, and had a weighted average debt coverage ratio of 1.71 and loan to value of 49%.

The restaurant portfolio is comprised of 49% quick service and fast casual loan balances.

As of December 31, 2020, commercial real estate loans secured by hotels totaled $23.7 million and represented 8% of the commercial real estate portfolio, and had a weighted average debt coverage ratio of 1.31 and loan to value of 60%.

The hotel portfolio is comprised of 89% flagged hotel loan balances.

As of December 31, 2020, commercial real estate loans secured by retail non-owner occupied properties totaled $64.5 million and represented 22% of the commercial real estate portfolio and had a weighted average debt coverage of 1.63 and loan to value of 56%.

Maintaining a strong liquidity position to support funding demand.

The Bancorp has sufficient on balance sheet liquidity and contingent liquidity sources to meet funding demand.

Implementing remote working policies for the Bancorp’s workforce.

142 employees or 50% of the workforce have been provided remote work capabilities to support social distancing measures.

Keeping the Bancorp’s 22 banking centers open during the pandemic.

To ensure banking processes run efficiently, drive-ups are open and fully functional, and a wide range of digital banking options are available.

All banking centers lobbies are also available to serve customers, however we are requesting that they make appointments via the Bank’s website to help us adhere to social distancing guidelines.

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Small Business Administration Paycheck Protection Program

The Bank has participated in the U.S.

Small Business Administration’s (“SBA”) PPP, which was initiated on April 3, 2020 in order to help small businesses maintain their workforce during the COVID-19 pandemic.

The Bank began accepting applications from qualified business customers immediately upon the initiation of the PPP.

Under the PPP, borrowers who use the funds for payroll and certain other expenses are eligible to have the loan balances forgiven by the SBA.

Applications for forgiveness can be submitted to the Bank beginning eight weeks after loan disbursement.

The PPP loans carry a fixed interest rate of 1.0% and a term of two years (for loans made before June 5, 2020) or five years (for loans made on or after June 5, 2020), if not forgiven, in whole or in part, and are 100% guaranteed by the SBA.

Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the Bank or the date that is nine months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period.

As of December 31, 2020, the Bank approved 782 applications totaling $91.5 million in loan requests, with an average loan size of approximately $117,000.

The Bank began closing and funding PPP loans during the week of April 6, 2020.

These loans are expected to help local business owners retain 10,758 employees.

As of December 31, 2020, the Bancorp had remaining loan balances under the Paycheck Protection Program totaling $67.2 million.

We expect the majority of the PPP loans we have originated to qualify for and apply for forgiveness.

This expectation is subject to change due to borrower behavior, changing SBA requirements and processes related to loan forgiveness, and other relevant factors.

The Bank is a certified SBA lender and was one of the first local banks to fund loans under the PPP.

The first round of PPP expired on August 8, 2020.

On December 21, 2020, Congress passed the Consolidated Appropriations Act, 2021, which included provisions for a second round of Paycheck Protection Funding in 2021.

The Bancorp is currently participating in the program.

SBA Loan Subsidy Program

Pursuant to the CARES Act, Section 1112, Congress has determined that all existing borrowers under the SBA Section 7(a) program are adversely affected by COVID-19, and are therefore entitled to a subsidy in the form of relief payments.

Specifically, the CARES Act provides that the SBA will pay the principal and interest on any existing and current SBA 7(a) loan for a period of nine months.

These principal and interest payments will be made by the SBA directly to the SBA 7(a) lender and will begin with the next payment due.

The Bancorp is a qualified SBA Section 7(a) lender, and is participating in the Section 1112 program.

As of December 31, 2020, the Bancorp had 9 loans eligible for the program, with an aggregate principal amount of $3.7 million.

Payments under the program will not constitute new loans for the Bancorp, but simply payments of principal and interest on loans that already exist in the Bancorp’s SBA 7(a) loan portfolio and are current on borrower payments.

The Bancorp received its first tranche of payments under the program on April 30, 2020, and expects to receive subsequent payments from the SBA by the 25th of each month thereafter until the expiration of the six-month program period.

Financial Condition

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Loans totaled $966.6 million and represented 69.0% of interest-earning assets, 64.5% of total assets and 74.2% of total deposits.

The loan portfolio, which is the Bancorp’s largest asset, is a significant source of both interest and fee income.

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(Dollars in thousands)

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At December 31, 2020, the Bancorp had $11.3 million in loans that were classified as held for sale, compared to $6.1 million at December 31, 2019.

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Non-performing loans include those loans that are 90 days or more past due and accruing and those loans that have been placed on non-accrual status.

At December 31, 2019, all non-performing loans are also accounted for on a non-accrual basis, except for six residential loan totaling $451 thousand, three commercial business loans totaling $288 thousand, one commercial real estate loan totaling $61 thousand, one manufactured home loan totaling $46 thousand, and one home equity loan totaling $20 thousand that remained accruing and more than 90 days past due.

At December 31, 2020, all non-performing loans are also accounted for on a non-accrual basis, except for one commercial real estate loan totaling $437 thousand, one residential real estate loan totaling $80 thousand, one home equity loan totaling $29 thousand, and one construction and land development loan totaling $20 thousand that remained accruing and more than 90 days past due.

The Bancorp's nonperforming loans are summarized below:

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Nonperforming loans to total assets

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Substandard loans include non-performing loans and potential problem loans, where information about possible credit issues or other conditions causes management to question the ability of such borrowers to comply with loan covenants or repayment terms.

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Manufactured homes

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In addition to identifying and monitoring non-performing and other classified loans, management maintains a list of special mention loans.

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Purchased loans with evidence of credit quality deterioration since origination are considered purchased credit impaired loans.

Expected future cash flows at the purchase date in excess of the fair value of loans are recorded as interest income over the life of the loans if the timing and amount of the future cash flows is reasonably estimable (“accretable yield”).

The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference and represents probable losses in the portfolio.

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Subsequent decreases to the expected cash flows will generally result in a provision for loan losses.

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The Bancorp's impaired loans, including purchased credit impaired loans, are summarized below:

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Manufactured homes

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At times, the Bancorp will modify the terms of a loan to forego a portion of interest or principal or reduce the interest rate on the loan to a rate materially less than market rates, or materially extend the maturity date of a loan as part of a troubled debt restructuring.

The valuation basis for the Bancorp’s troubled debt restructurings is based on the present value of expected future cash flows;

unless consistent cash flows are not present, then the fair value of the collateral securing the loan is the basis for valuation.

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Manufactured homes

The increase in the nonperforming, special mention and impaired loans reflected in the tables above for the twelve months ending December 31, 2019, are the result of the completion of the AJSB acquisition as well as four commercial real estate loans to two borrowers and eleven commercial business loans to eight borrowers which were not related to the acquisition.

The decrease in the substandard loans reflected in the tables above for the twelve months ending December 31, 2019, are the result of the removal of numerous residential loans, which was offset by the AJSB acquisition as well as one commercial real estate loan and eight commercial business loans to five borrowers.

One commercial real estate customer with loans totaling $5.3 million and residential real estate loans totaling $3.0 million contributed to the December 31, 2020, increase in nonperforming loans.

One commercial real estate customer with loans totaling $5.3 million, residential real estate loans totaling $2.8 million and one commercial real estate customer with loans totaling $1.3 million contributed to the December 31, 2020, increase in substandard loans.

One commercial real estate relationship with loans totaling $8.6 million, one commercial real estate relationship with loans totaling $4.1 million, and one commercial real estate customer with loans totaling $1.1 million contributed to the December 31, 2020, increase in special mention loans, which was offset by the movement of one commercial real estate customer with loans totaling $1.3 million to substandard and a $2.1 million decline in residential real estate loans.

One commercial real estate customer with loans totaling $5.3 million, one commercial business relationship with loans totaling $360 thousand, and two commercial business customers with loans totaling $303 thousand contributed to the December 31, 2020, increase in impaired loans. 

At December 31, 2020, management is of the opinion that there are no loans, except certain of those discussed above, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which will imminently result in such loans being classified as past due, non-accrual or a troubled debt restructure.

Management does not presently anticipate that any of the non-performing loans or classified loans would materially affect future operations, liquidity or capital resources.

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The allowance for loan losses (ALL) is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses, and decreased by charge-offs net of recoveries.

A loan is charged off against the allowance by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur.

The determination of the amounts of the ALL and provisions for loan losses is based on management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability as of the reporting date.

The appropriateness of the current period provision and the overall adequacy of the ALL are determined through a disciplined and consistently applied quarterly process that reviews the Bancorp’s current credit risk within the loan portfolio and identifies the required allowance for loan losses given the current risk estimates.

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The Bancorp's provision for loan losses for the twelve months ended are summarized below:

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Manufactured homes

The ALL provisions take into consideration management’s current judgments about the credit quality of the loan portfolio, loan portfolio balances, changes in the portfolio mix and local economic conditions.

In determining the provision for loan losses for the current period, management has considered risks associated with the local economy, changes in loan balances and mix, and asset quality.

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Additionally, the Bancorp has acquired loans where there was no evidence of credit quality deterioration since origination and has marked these loans to their fair values.

As part of the fair value of loans receivable, a net fair value discount was established for loans acquired of $3.8 million at December 31, 2019, compared to $1.8 million at December 31, 2018.

The increase in the fair value discount and purchase credit impaired discounts, as of December 31, 2019, is the result of the AJSB acquisition.

As part of the fair value of loans receivable, a net fair value discount was established for loans acquired and has a balance of $2.0 million at December 31, 2020, compared to $3.8 million at December 31, 2019.

Details on these fair value marks and the additional reserves created can be found in Note 4, Loans Receivable.

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A deferred cost reserve is maintained for the portfolio of manufactured home loans that have been purchased.

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If the segment performs in line with expectation, the deferred cost reserve is paid as an origination cost to the third party originator of the loan.

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The Bancorp's allowance to total loans and non-performing loans are summarized below:

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Management has allocated reserves to both performing and non-performing loans based on current information available.

At December 31, 2019, foreclosed real estate totaled $1.1 million, which was comprised of seventeen properties, compared to $1.6 million and twenty-four properties at December 31, 2018.

During 2019, loans totaling $639 thousand were transferred into foreclosed real estate, approximately $86 thousand of foreclosed real estate resulted from the AJSB acquisition, while net sales of foreclosed real estate totaled $1.3 million.

At December 31, 2020, foreclosed real estate totaled $538 thousand, which was comprised of ten properties, compared to $1.1 million and seventeen properties at December 31, 2019.

During 2020, loans totaling $233 thousand were transferred into foreclosed real estate, while net sales of foreclosed real estate totaled $855 thousand.

Net gains from the 2020 sales totaled $78 thousand.

Market value adjustments in 2020 of $46 thousand were also made.

At the end of December 2019, all of the Bancorp’s foreclosed real estate is located within its primary market area.

The primary objective of the Bancorp’s investment portfolio is to provide for the liquidity needs of the Bancorp and to contribute to profitability by providing a stable flow of dependable earnings.

At the end of December 2020, all of the Bancorp’s foreclosed real estate is located within its primary market area.

Funds are generally invested in federal funds, interest bearing balances in other financial institutions, U.S.

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At December 31, 2020, the securities portfolio represented 29.3% of interest-earning assets and 27.4% of total assets compared to 22.7% of interest-earning assets and 20.9% of total assets at December 31, 2019.

As of December 31, 2019, the Bancorp’s two investments in trust preferred securities are in “payment in kind” status.

As of December 31, 2020, the Bancorp’s two investments in trust preferred securities are in “payment in kind”

Payment in kind status results in a temporary delay in the payment of interest.

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The Bancorp’s end-of-period investment portfolio and other short-term investments and stock balances were as follows:

(Dollars in thousands)

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Federal Home Loan Bank stock

The net increase in interest bearing deposits in other financial institutions and fed funds sold is primarily the result of the AJSB acquisition and timing of liquidity needs.

The increase in Federal Home Loan Bank stock corresponds to stock ownership requirements based the AJSB acquisition.

The net decrease in interest bearing deposits in other financial institutions and fed funds sold is primarily the result of the Bancorp funding investments in securities and loan growth.

Deposits are a fundamental and cost-effective source of funds for lending and other investment purposes.

The Bancorp offers a variety of products designed to attract and retain customers, with the primary focus on building and expanding relationships.

The Bancorp’s end-of-period deposit portfolio balances were as follows:

(Dollars in thousands)

Certificates of deposit

Total deposits

The overall increase in total deposits is primarily a result of the acquisition of AJSB, along with internally generated growth.

This increase also reflects the cyclical nature and timing of municipality deposits.

The Bancorp’s borrowed funds are primarily used to fund asset growth not supported by deposit generation.

The Bancorp’s end-of-period borrowing balances were as follows:

The overall increase in total deposits is primarily a result of the Bancorp’s efforts to maintain and grow core deposits and customer preferences for the security and liquidity of the Bancorp’s deposit product offerings

The Bancorp’s borrowed funds are primarily used to fund asset growth not supported by deposit generation.

The Bancorp’s end-of-period borrowing balances were as follows:

(Dollars in thousands)

Repurchase agreements

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Total borrowed funds

Repurchase agreements decreased as part of normal account fluctuations within that product line.

Repurchase agreements increased as part of normal account fluctuations within that product line.

Borrowed funds decreased as FHLB advances were paid down and matured during the year.

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For the Bancorp, liquidity management refers to the ability to generate sufficient cash to fund current loan demand, meet deposit withdrawals, and pay dividends and operating expenses.

Because profit and liquidity are often conflicting objectives, management attempts to maximize the Bank’s net interest margin by making adequate, but not excessive, liquidity provisions.

Furthermore, funds are managed so that future profits will not be significantly impacted as funding costs increase.

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In addition, the Bancorp utilizes borrowings (i.e., repurchase agreements, FHLB advances and federal funds purchased) as a source of funds.

During 2019, cash and cash equivalents increased $30.1 million compared to an increase of $6.1 million for 2018.

During 2019, the primary sources of cash and cash equivalents were from the change in deposits, acquisition of AJSB, maturities and sales of securities, and loan sales and repayments.

During 2020, cash and cash equivalents decreased $27.3 million compared to an increase of $30.1 million for 2019.

During 2020, the primary sources of cash and cash equivalents were from the change in deposits, maturities and sales of securities, and loan sales and repayments.

The primary uses of cash and cash equivalents were for loan originations, purchases of securities, FHLB advance repayments, and the payment of common stock dividends.

During 2020, net cash from operating activities totaled $21.1 million, compared to $11.0 million for 2019.

The increase in cash in-flow from operating activities was primarily due to higher net income year over year.

The increase in cash in-flow from operating activities was primarily due to higher net income year over year, sale of loans originated for sale, and net change in accrued expenses and other liabilities.

Net cash outflows from investing activities totaled $186.6 million during 2020, compared to outflows of $28.2 million during 2019.

The changes for the current year were primarily related to the increased cash and cash equivalents from acquisition activity, offset against increased purchases of securities.

The changes for the current year were primarily related to the increased purchases of securities.

Net cash inflows from financing activities totaled $138.1 million in 2020, compared to net cash inflows of $47.3 million in 2019.

The increase during 2019 was primarily due to the increase in deposits.

The increase during 2020 was primarily due to the increase in deposits, and less repayments of FHLB advances.

On a cash basis, the Bancorp paid dividends on common stock of $4.3 million and $4.1 million during 2020 and 2019, respectively.

During 2019, the Bancorp’s Board of Directors increased dividends as earnings and capital continued to be sufficient to warrant dividend increases.

During 2020, the Bancorp’s Board of Directors maintained dividends as earnings and capital continued to be sufficient to warrant the current dividend.

Management strongly believes that safety and soundness is enhanced by maintaining a high level of capital.

Stockholders' equity totaled $152.9 million at December 31, 2020, compared to $134.1 million at December 31, 2019, an increase of $18.8 million (14.0%).

The increase was primarily the result of net income of $12.1 million, issuance of $17.5 million shares related to the acquisition of AJSB, and net unrealized gains of available for sale securities of $7.1 million less $4.2 million in dividends.

The increase was primarily the result of net income of $16.6 million, and net unrealized gains of available for sale securities of $6.2 million less $4.3 million in dividends.

At December 31, 2020, book value per share was $44.16 compared to $38.85 for 2019.

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As applied to the Bancorp and the Bank, the FRB and FDIC capital requirements are substantially the same.

These regulations divide capital into various tiers, as described in “Recent Developments – Regulatory Capital Rules” above.

The following table shows that, at December 31, 2019, the Bancorp’s capital exceeded all regulatory capital requirements.

These regulations divide capital into various tiers, as described in “Recent Developments –

Regulatory Capital Rules”

The following table shows that, at December 31, 2020, the Bancorp’s capital exceeded all regulatory capital requirements.

The dollar amounts are in millions.

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The following table shows that, at December 31, 2019, the Bank’s capital exceeded all regulatory capital requirements.

The following table shows that, at December 31, 2020, the Bank’s capital exceeded all regulatory capital requirements.

The dollar amounts are in millions.

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Tier 1 capital to adjusted average assets

The Bancorp’s ability to pay dividends to its shareholders is entirely dependent upon the Bank’s ability to pay dividends to the Bancorp.

Under Indiana law, the Bank may pay dividends from its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by the Bank’s Board of Directors.

The Bancorp’s ability to pay dividends to its shareholders is entirely dependent upon the Bank’s ability to pay dividends to the Bancorp.

However, the Bank must obtain the approval of the Indiana Department of Financial Institutions (DFI) if the total of all dividends declared by the Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years.

For this purpose, “retained net income,” means net income as calculated for call report purposes, less all dividends declared for the applicable period.

For this purpose, “retained net income,”

means net income as calculated for call report purposes, less all dividends declared for the applicable period.

An exemption from DFI approval would require that the Bank have been assigned a composite uniform financial institutions rating of 1 or 2 as a result of the most recent federal or state examination;

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and that the Bank not be subject to any corrective action, supervisory order, supervisory agreement, or board approved operating agreement.

The aggregate amount of dividends that may be declared by the Bank in 2020, without the need for qualifying for an exemption or prior DFI approval, is its 2020 net profits.

The aggregate amount of dividends that may be declared by the Bank in 2021, without the need for qualifying for an exemption or prior DFI approval, is its 2021 net profits plus $4.7 million.

Moreover, the FDIC and the Federal Reserve Board may prohibit the payment of dividends if it determines that the payment of dividends would constitute an unsafe or unsound practice in light of the financial condition of the Bank.

On November 20, 2020 the Board of Directors of the Bancorp declared a fourth quarter dividend of $0.31 per share.

The Bancorp’s fourth quarter dividend was paid to shareholders on January 7, 2020.

Results of Operations –

The Bancorp’s fourth quarter dividend was paid to shareholders on January 8, 2021.

Results of Operations –

Comparison of 20 20 to 201 9

Net income for 2020 was $16.6 million, compared to $12.1 million for 2019, an increase of $4.5 million (37.3%).

The twelve-month earnings increase is related to strong loan originations as well as the effects of the mergers with AJSB and First Personal increasing net interest income.

The twelve-month earnings increase is primarily related to lower interest expense and higher noninterest income.

The earnings represent a return on average assets of 1.16% for 2020, compared to 0.94% for 2019.

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Net interest income for 2020, was $45.9 million, an increase of $2.7 million (6.3%) from $43.2 million for 2019.

During the year, the Bancorp’s yield on interest earning assets was positively impacted by higher yields and loan growth, while interest expense was driven higher primarily by deposit account growth and an increased cost of funds.

During the year, the Bancorp’s interest earning assets were negatively impacted by lower yields, while interest expense was driven lower primarily by decreased cost of funds.

The weighted-average yield on interest-earning assets was 3.91% for 2020, compared to 4.43% for 2019.

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The impact of the 3.91% return on interest earning assets and the 0.45% cost of funds resulted in a net interest spread of 3.46% for 2020, compared to a net interest spread of 3.63% for 2019.

During 2019, total interest income increased by $12.8 million (32.4%) while total interest expense increased by $4.0 million (78.6%).

During 2020, total interest income decreased by $629 thousand (1.2%) while total interest expense decreased by $3.4 million (36.9%).

The net interest margin was 3.47% for 2020, compared to 3.66% for 2019.

The Bancorp’s tax equivalent net interest margin for 2019 was 3.73% compared to 3.81% for 2018.

The Bancorp’s tax equivalent net interest margin for 2020, was 3.63% compared to 3.73% for 2019.

Comparing the net interest margin on a tax equivalent basis more accurately compares the returns on tax-exempt loans and securities to those on taxable interest-earning assets.

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Total liabilities and stockholders' equity

The increase in interest income for interest bearing deposits in other financial institutions was the result of higher average balance for the year ended December 31, 2019, compared to the year ended December 31, 2018.

The increase in federal funds sold was result of higher average balances for the year ended December 31, 2019, compared to the year ended December 31, 2018.

The increase in certificates of deposits in other financial institutions was the result of higher average rates for the year ended December 31, 2019, compared to the year ended December 31, 2018.The increase in interest income for securities available-for-sale was the result of higher average balances for the year ended December 31, 2019, compared to the year ended December 31, 2018.

The increase for loans receivable was the result of higher average balances, higher weighted average rates, and the recognition of one-time gains from excess reserves associated with purchase credit impaired loans from the former acquisitions of First Federal Savings & Loan of Hammond and Liberty Savings Bank during the year ended December 31, 2019, compared to the year ended December 31, 2018.

The increase in Federal Home Loan Bank stock is the result of higher average balances for the year ended December 31, 2019, compared to the year ended December 31, 2018.

The increase in the cost of total deposits was the result of higher average balances and higher weighted average rates for the year ended December 31, 2019, compared to the year ended December 31, 2018.

The increase in the cost of repurchase agreements was the result of higher weighted average rates and balances for the year ended December 31, 2019, compared to the year ended December 31, 2018.

The decrease in the cost of borrowed was the result of lower average balances for the year ended December 31, 2019, compared to the year ended December 31, 2018.

The decrease in interest income for interest bearing deposits in other financial institutions was the result of lower average rate for the year ended December 31, 2020, compared to the year ended December 31, 2019.

The decrease in interest income for federal funds sold was result of lower average balances and rates for the year ended December 31, 2020, compared to the year ended December 31, 2019.

The decrease in interest income for certificates of deposits in other financial institutions was the result of lower average balances and rates for the year ended December 31, 2020, compared to the year ended December 31, 2019.The decrease in interest income for securities available-for-sale was the result of lower average rates for the year ended December 31, 2020, compared to the year ended December 31, 2019.

The increase in interest income for loans receivable was the result of higher average balances for the year ended December 31, 2020, compared to the year ended December 31, 2019.

The decrease in interest income in Federal Home Loan Bank stock is the result of lower average rates for the year ended December 31, 2020, compared to the year ended December 31, 2019.

The decrease in the interest expense of total deposits was the result of lower weighted average rates for the year ended December 31, 2020, compared to the year ended December 31, 2019.

The decrease in interest expense of repurchase agreements was the result of lower weighted average rates for the year ended December 31, 2020, compared to the year ended December 31, 2019.

The decrease in the interest expense of borrowed was the result of lower average balances for the year ended December 31, 2020, compared to the year ended December 31, 2019.

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The following table shows the change in noninterest income for the year ending December 31, 2020, and December 31, 2019.

(Dollars in thousands)

(Dollars in thousands, except per share data)

Year Ended December 31,

12/31/2020 vs.

Noninterest income:

Gain on sale of loans held-for-sale, net

Fees and service charges

Gain on sale of securities, net

Wealth management operations

Gain on sale of loans held-for-sale, net

Increase in cash value of bank owned life insurance

Gain on sale of securities, net

Benefit from bank owned life insurance

Gain on sale of foreclosed real estate

Benefit from bank owned life insurance

Total noninterest income

The increase in fees and service charges is the result of the Bancorp’s continued focus on maintaining competitive fees within its market place, as well the acquisition of AJSB and full-year benefit of the First Personal acquisition.

The increase in wealth management income is related to book value changes in assets under management and the timing of one time fees.

The increase in gain on sale of loans held for sale is the result of continued efforts on loan growth and normal course of business sales.

The increase in cash value of bank owned life insurance is related to the increased bank owned life insurance balances from the AJSB and First Personal acquisitions.

The decrease in gains on sale of securities is a result of current market conditions, maintaining current securities cash flows, and the loss associated with the sale of a trust preferred security.

Due to a death benefit recorded during the year, the Bancorp will receive a benefit from bank owned life insurance.

The increase in other noninterest income is primarily driven by gains made on the sale of fixed assets and gains related to interest rate lock derivatives.

The increase in gain on sale of loans held-for-sale, net, is the result of the current economic and rate environment, and our ability to close loans in a timely fashion during record demand.

We anticipate the demand for mortgage loans will return to more normal levels as the current low rate environment persists or rates return to higher levels.

The increase in fees and service charges is primarily the result of increased lending fees earned as part of opportunities resulting from the current economic and rate environment.

The increase in gains on the sale of securities is a result of current market conditions and actively managing the portfolio.

The increase in wealth management income is the result of the Bancorp’s continued focus on expanding its wealth management line of business.

In the prior year, a death benefit from bank owned life insurance was recorded;

no events of this nature have occurred in the twelve months of 2020.

The decrease in other noninterest income is the result of a one-time fixed asset sale for a gain in the prior year.

The following table shows the change in noninterest expense for the year ending December 31, 2020, and December 31, 2019.

(Dollars in thousands)

(Dollars in thousands, except per share data)

Year Ended December 31,

12/31/2020 vs.

Noninterest expense:

2 unchanged sentences

Data processing

Professional services

Federal deposit insurance premiums

Professional services

Total noninterest expense

The increase in compensation and benefits is primarily the result of increased headcount due to the acquisitions of AJSB and full-year impact of the First Personal acquisition.

Additionally, increases to compensation and benefits can be attributed to management’s continued focus on talent management and retention.

The increase in occupancy and equipment is primarily related to the AJSB acquisition and full-year impact of the First Personal acquisition, and related assets brought over.

The increase in data processing expense is primarily the result of increased utilization of systems.

The increase in professional services is the result of the AJSB acquisition and full-year impact of the First Personal acquisition.

The increase in marketing expenses is primarily related to the acquisition of AJSB as well as regular advertising initiatives.

The decrease in federal deposit insurance premiums is primarily the result of a credit applied by the Federal Deposit Insurance Corporation.

The increase in other operating expenses is related to the acquisition costs for AJSB and higher third party costs.

The Bancorp’s efficiency ratio was 69.5% for the year ended December 31, 2019, compared to 72.2% for the year ended December 31, 2018.

The decreased ratio is related primarily to the increase in interest income.

The acquisition of AJSB and First Personal acquisitions are discussed in Note 2 of the financial statements.

The increase in compensation and benefits is primarily the result of management’s continued focus on talent management and retention.

The increase in occupancy and equipment is primarily related to facilities improvement efforts aimed at enhancing technology and to accommodate recent growth.

The decrease in data processing expense is primarily the result of prior year data conversion expenses incurred in the first quarter of 2019 related to the acquisition of AJS Bancorp Inc.

The increase in federal deposit insurance premiums is a result of one-time credits received in prior year.

The decrease in marketing is a result of the timing of the Bancorp’s marketing initiatives.

The increase in other operating expenses is primarily the result of investments in strategic initiatives.

The Bancorp’s efficiency ratio was 63.8% for the year ended December 31, 2020, compared to 69.5% for the year ended December 31, 2019.

The improved ratio is related primarily to the increase in noninterest income and lower interest expense.

The acquisition of AJSB is discussed in Note 2 of the financial statements.

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Income tax expenses for the year ended December 31, 2019 totaled $1.8 million, compared to income tax expense of $1.4 for the year ended December 31, 2018, an increase of $329 thousand (23.0%).

Income tax expenses for the year ended December 31, 2020, totaled $2.9 million, compared to income tax expense of $1.8 for the year ended December 31, 2019, an increase of $1.1 million (64.4%).

The combined effective federal and state tax rates for the Bancorp was 14.8% for the year ended December 31, 2020, compared to 12.7% for the year ended December 31, 2019.

The Bancorp’s lower current period effective tax rate is a result of a larger increase to tax preferred income relative to earnings, and the tax benefits resulting from a new market tax credit entered into during 2019.

The Bancorp’s higher current period effective tax rate is a result of a smaller increase to tax preferred income relative to earnings.

Critical Accounting Policies

Critical accounting policies are those accounting policies that management believes are most important to the portrayal of the Bancorp’s financial condition and that require management’s most difficult, subjective or complex judgments.

The Bancorp’s most critical accounting policies are summarized below.

Other accounting policies, including those related to the fair values of financial instruments and the status of contingencies, are summarized in Note 1 to the Bancorp’s consolidated financial statements.

Valuation of Investment Securities – The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

The Bancorp’s most critical accounting policies are summarized below.

Valuation of Investment Securities –

The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’

relationship to other benchmark quoted securities.

Different judgments and assumptions used in pricing could result in different estimates of value.

In certain cases where market data is not readily available because of lack of market activity or little public disclosure, values may be based on unobservable inputs and classified in Level 3 of the fair value hierarchy.

At the end of each reporting period securities held in the investment portfolio are evaluated on an individual security level for other-than-temporary impairment in accordance with the Investments – Debt and Equity Securities Topic of the Accounting Standards Codification.

Debt and Equity Securities Topic of the Accounting Standards Codification.

Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates.

5 unchanged sentences

If either of these conditions is met, management will recognize other-than-temporary impairment.

If, in management’s judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings.

Management will utilize an independent valuation specialist to value securities semi-annually for other-than-temporary impairment.

Allowance for Loan Losses – The Bancorp maintains an Allowance for Loan Losses (ALL) to absorb probable incurred credit losses that arise from the loan portfolio.

Allowance for Loan Losses –

The Bancorp maintains an Allowance for Loan Losses (“ALL”) to absorb probable incurred credit losses that arise from the loan portfolio.

The ALL is increased by the provision for loan losses, and decreased by charge-offs net of recoveries.

The determination of the amounts of the ALL and provisions for loan losses is based upon management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability.

The methodology used to determine the current year provision and the overall adequacy of the ALL includes a disciplined and consistently applied quarterly process that combines a review of the current position with a risk assessment worksheet.

4 unchanged sentences

Commercial and industrial, and commercial real estate loans that exhibit credit weaknesses and loans that have been classified as impaired are subject to an individual review.

Where appropriate, ALL allocations are made to these loans based on management’s assessment of financial position, current cash flows, collateral values, financial strength of guarantors, industry trends, and economic conditions.

ALL allocations for homogeneous loans, such as residential mortgage loans and consumer loans, are based on historical charge-off activity and current delinquency trends.

14 unchanged sentences

The risk factors are applied to these types of loans to determine the appropriate level for the ALL.

Adjustments may be made to these allocations that reflect management’s judgment on current conditions, delinquency trends, and charge-off activity.

Based on the above discussion, management believes that the ALL is currently adequate, but not excessive, given the risk inherent in the loan portfolio.

2 unchanged sentences

The primary assets and liabilities of the Bancorp are monetary in nature.

As a result, interest rates have a more significant impact on the Bancorp’s performance than the effects of general levels of inflation.

Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.

Forward-Looking Statements

Statements contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

The words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are also intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act.

The Bancorp cautions readers that forward-looking statements, including without limitation, those relating to the Bancorp’s future business prospects, interest income and expense, net income, liquidity, and capital needs are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements, due to, among other things, factors identified in this report.

Quantitative and Qualitative Disclosures about Market Risk

2 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis