Finward Bancorp 10-K

Item 7. 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. The Bank's earnings are primarily dependent upon net interest margin. The net interest margin is the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowings stated as a percentage of average interest earning assets. The net interest margin is perhaps the clearest indicator of a financial institution's ability to generate core earnings. 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. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses, fair values of foreclosed real estate, loan servicing rights, investment securities, deferred tax assets, goodwill, and the status of contingencies are particularly susceptible to material change in the near term.   At December 31, 2020, the Bancorp had total assets of $1.5 billion and total deposits of $1.3 billion. The Bancorp's deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (DIF) that is administered by the Federal Deposit Insurance Corporation (FDIC), an agency of the federal government. At December 31, 2020, stockholders' equity totaled $152.9 million, with book value per share at $44.16. Net income for 2020 was $16.6 million, or $4.80 basic and diluted earnings per common share. 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”). Simultaneous with the AJSB Merger, A.J. Smith Federal Savings Bank, a federally chartered savings bank and wholly-owned subsidiary of AJSB, merged with and into the Bank, with the Bank as the surviving institution.   In connection with the AJSB Merger, each AJSB stockholder holding 100 or more shares of AJSB common stock received fixed consideration of (i) 0.2030 shares of the Bancorp common stock, and (ii) $7.20 per share in cash for each outstanding share of AJSB common stock. Stockholders holding less than 100 shares of AJSB common stock received $16.00 in cash and no stock consideration for each outstanding share of AJSB common stock. Any fractional shares of Bancorp common stock that an AJSB stockholder would have otherwise received in the AJSB Merger were cashed out in the amount of such fraction multiplied by $43.01.   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.   Page 51 of 117     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     26     $ 3,141       8     $ 10,053       2     $ 82   Full payment deferral     4       250       6       1,398       -       -   Total $     30     $ 3,391       14     $ 11,451       2     $ 82       ● 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.   Page 52 of 117     U.S. 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 During the year ended December 31, 2020, total assets increased by $168.8 million (12.7%), to $1.5 billion, with interest-earning assets increasing by $177.7 million (14.5%). At December 31, 2020, interest-earning assets totaled $1.4 billion and represented 93.5% of total assets. 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.   Page 53 of 117         December 31,     December 31,   (Dollars in thousands)   2020     2019       Balance     % Loans     Balance     % Loans                                     Residential real estate   $ 285,651       29.6 %     299,333       33.0 % Home equity     39,286       4.1 %     49,181       5.4 % Commercial real estate     298,257       30.9 %     283,108       31.2 % Construction and land development     93,562       9.7 %     87,710       9.7 % Multifamily     50,571       5.2 %     51,286       5.7 % Farmland     215       0.0 %     227       0.0 % Consumer     1,025       0.1 %     627       0.1 % Manufactured Homes     30,904       3.2 %     16,505       1.8 % Commercial business     156,965       16.2 %     103,088       11.4 % Government     10,142       1.0 %     15,804       1.7 % Loans receivable   $ 966,578       100.0 %   $ 906,869       100.0 %                                   Adjustable rate loans / loans receivable   $ 491,860       50.9 %   $ 504,941       55.7 %       December 31,     December 31,       2020     2019                     Loans receivable to total assets     64.5 %     68.3 % Loans receivable to earning assets     69.0 %     74.2 % Loans receivable to total deposits     74.2 %     78.6 %   The Bancorp is primarily a portfolio lender. Mortgage banking activities historically have been limited to the sale of fixed rate mortgage loans with contractual maturities greater than 15 years. These loans are identified as held for sale when originated and sold, on a loan-by-loan basis, in the secondary market. The Bancorp will also retain fixed rate mortgage loans with a contractual maturity greater than 15 years on a limited basis. During the twelve months ended December 31, 2020, the Bancorp originated $224.9 million in new fixed rate mortgage loans for sale, compared to $78.2 million during the twelve months ended December 31, 2019. Net gains realized from the mortgage loan sales totaled $7.6 million for the twelve months ended December 31, 2020, compared to $2.1 million for the twelve months ended December 31, 2019. 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.   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, 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:   (Dollars in thousands)                 Loan Segment   December 31, 2020     December 31, 2019   Residential real estate   $ 6,470     $ 4,826   Home equity     505       492   Commercial real estate     5,827       719   Construction and land development     20       -   Multifamily     504       420   Farmland     -       -   Commercial business     1,039       870   Consumer     -       -   Manufactured homes     -       46   Government     -       -   Total   $ 14,365     $ 7,373   Nonperforming loans to total loans     1.49 %     0.81 % Nonperforming loans to total assets     0.96 %     0.67 %   Page 54 of 117     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. No loans were internally classified as doubtful or loss at December 31, 2020 or December 31, 2019.   The Bancorp's substandard loans are summarized below:           (Dollars in thousands)                 Loan Segment   December 31, 2020     December 31, 2019   Residential real estate   $ 6,387     $ 4,491   Home equity     495       507   Commercial real estate     8,180       1,565   Construction and land development     -       -   Multifamily     504       802   Farmland     -       -   Commercial business     1,061       727   Consumer     -       -   Manufactured homes     -       -   Government     -       -   Total   $ 16,627     $ 8,092     In addition to identifying and monitoring non-performing and other classified loans, management maintains a list of special mention loans. Special mention loans represent loans management is closely monitoring due to one or more factors that may cause the loan to become classified as substandard.   The Bancorp's special mention loans are summarized below:           (Dollars in thousands)                 Loan Segment   December 31, 2020     December 31, 2019   Residential real estate   $ 3,539     $ 4,203   Home equity     761       813   Commercial real estate     11,983       5,380   Construction and land development     3,652       -   Multifamily     1,408       -   Farmland     -       -   Commercial business     1,341       2,228   Consumer     -       -   Manufactured homes     -       -   Government     -       -   Total   $ 22,684     $ 12,624     A loan is considered impaired when, based on current information and events, it is probable that a borrower will be unable to pay all amounts due according to the contractual terms of the loan agreement. Typically, management does not individually classify smaller-balance homogeneous loans, such as residential mortgages or consumer loans, as impaired, unless they are troubled debt restructurings.   Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date. 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. In determining the acquisition date fair value of purchased credit impaired loans, and in subsequent accounting, the Bancorp aggregates these purchased loans into pools of loans by common risk characteristics, such as credit risk rating and loan type. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses.   Page 55 of 117     The Bancorp's impaired loans, including purchased credit impaired loans, are summarized below: (Dollars in thousands)                 Loan Segment   December 31, 2020     December 31, 2019   Residential real estate   $ 2,165     $ 2,223   Home equity     353       437   Commercial real estate     6,341       1,565   Construction and land development     -       -   Multifamily     716       802   Farmland     -       -   Commercial business     2,246       2,191   Consumer     -       -   Manufactured homes     -       -   Government     -       -   Total   $ 11,821     $ 7,218     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.   The Bancorp's troubled debt restructured loans are summarized below: (Dollars in thousands)                                     December 31, 2020     December 31, 2019   Loan Segment   Number of Loans     Recorded Investment     Number of Loans     Recorded Investment   Residential real estate     8     $ 614       6     $ 480   Home equity     7       187       6       176   Commercial real estate     4       872       3       822   Construction and land development     -       -       -       -   Multifamily     -       -       -       -   Farmland     -       -       -       -   Commercial business     6       448       7       622   Consumer     -       -       -       -   Manufactured homes     -       -       -       -   Government     -       -       -       -   Total   $ 25     $ 2,121     $ 22     $ 2,100     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.   Page 56 of 117     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.   The Bancorp's provision for loan losses for the twelve months ended are summarized below:           (Dollars in thousands)                                   Loan Segment   December 31, 2020     December 31, 2019   Residential real estate   $ 374     $ 228   Home equity     53       21   Commercial real estate     1,713       667   Construction and land development     324       342   Multifamily     97       57   Farmland     -       -   Commercial business     1,145       1,295   Consumer     (2 )     (5 ) Manufactured homes     -       -   Government     (17 )     (21 ) Total   $ 3,687     $ 2,584     The Bancorp's charge-off and recovery information is summarized below:           (Dollars in thousands)   (unaudited)       As of December 31, 2020   Loan Segment   Charge-off     Recoveries     Net Charge-offs   Residential real estate   $ (2 )   $ 27     $ 25   Home equity     -       -       -   Commercial real estate     (80 )     -       (80 ) Construction and land development     (17 )     -       (17 ) Multifamily     -       -       -   Farmland     -       -       -   Commercial business     (158 )     17       (141 ) Consumer     (29 )     14       (15 ) Manufactured homes     -       -           Government     -       -       -   Total   $ (286 )   $ 58     $ (228 )   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.   In addition, management considers reserves that are not part of the ALL that have been established from acquisition activity. The Bancorp acquired loans for which there was evidence of credit quality deterioration since origination and it was determined that it was probable that the Bancorp would be unable to collect all contractually required principal and interest payments. At December 31, 2020, total purchased credit impaired loans nonaccretable and accretable discount totaled $2.1 million compared to $2.2 million at December 31, 2019. 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 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.   Page 57 of 117     A deferred cost reserve is maintained for the portfolio of manufactured home loans that have been purchased. This reserve is available for use for manufactured home loan nonperformance and costs associated with nonperformance. 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.   The Bancorp's allowance to total loans and non-performing loans are summarized below:   (Dollars in thousands)                     December 31, 2020     December 31, 2019                     Allowance for loan losses   $ 12,458     $ 8,999   Total loans   $ 966,578     $ 906,869   Non-performing loans   $ 14,365     $ 7,373   ALL-to-total loans     1.29 %     0.99 % ALL-to-non-performing loans (coverage ratio)     86.7 %     122.1 %   The December 31, 2020, balance in the ALL account is considered adequate by management after evaluation of the loan portfolio, past experience and current economic and market conditions. While management may periodically allocate portions of the allowance for specific problem loans, the whole allowance is available for any loan charge offs that occur. The allocation of the ALL reflects performance and growth trends within the various loan categories, as well as consideration of the facts and circumstances that affect the repayment of individual loans, and loans which have been pooled as of the evaluation date, with particular attention given to non-performing loans and loans which have been classified as substandard, doubtful or loss. Management has allocated reserves to both performing and non-performing loans based on current information available.   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 2020, 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. Funds are generally invested in federal funds, interest bearing balances in other financial institutions, U.S. government securities, federal agency obligations, obligations of state and local municipalities and corporate securities. The securities portfolio, all of which is designated as available-for-sale, totaled $410.7 million at December 31, 2020, compared to $277.2 million at December 31, 2019, an increase of $133.5 million (48.1%). The increase in the securities portfolio during the year is a result of market value adjustments and investment of excess liquidity. 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, 2020, the Bancorp’s two investments in trust preferred securities are in “payment in kind” status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed these securities on non-accrual status. At December 31, 2020, the cost basis of the two trust preferred securities on non-accrual status totaled $2.2 million.   Page 58 of 117     The Bancorp’s end-of-period investment portfolio and other short-term investments and stock balances were as follows:       December 31.             December 31,           (Dollars in thousands)   2020             2019               Balance     % Securities     Balance     % Securities                                     Money market fund   $ 52,941       12.9 %   $ 9,670       3.5 % U.S. government sponsored entities     7,860       1.9 %     13,058       4.7 % Collateralized mortgage obligations and residential mortgage-backed securities     154,736       37.7 %     150,988       54.5 % Municipal securities     194,203       47.3 %     102,427       36.9 % Collateralized debt obligations     929       0.2 %     1,076       0.4 % Total securities available-for-sale   $ 410,669       100.0 %   $ 277,219       100.0 %         December 31.     December 31,     YTD           (Dollars in thousands)   2020     2019     Change               Balance     Balance       $       %                                     Interest bearing deposits in other financial institutions   $ 5,908     $ 10,750     $ (4,842 )     -45.0 % Fed funds sold     -       15,544       (15,544 )     -100.0 % Certificates of deposit in other financial institutions     1,897       2,170       (273 )     -12.6 % Federal Home Loan Bank stock     3,918       3,912       6       0.2 %   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:       December 31,     December 31,     YTD   (Dollars in thousands)   2020     2019     Change       Balance     Balance       $        %                                     Checking   $ 516,487     $ 392,324     $ 124,163       31.6 % Savings     254,108       209,945       44,163       21.0 % Money market     246,916       224,398       22,518       10.0 % Certificates of deposit     284,828       327,703       (42,875 )     -13.1 % Total deposits   $ 1,302,339     $ 1,154,370     $ 147,969       12.8 %   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:       December 31,     December 31,     YTD   (Dollars in thousands)   2020     2019     Change       Balance     Balance       $        %                                     Repurchase agreements   $ 13,711     $ 11,499     $ 2,212       19.2 % Borrowed funds     6,149       14,000       (7,851 )     -56.1 % Total borrowed funds   $ 19,860     $ 25,499     $ (5,639 )     -22.1 %   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.   Page 59 of 117     Liquidity and Capital Resources 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.   Changes in the liquidity position result from operating, investing and financing activities. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. The primary investing activities include loan originations, loan repayments, investments in interest bearing balances in financial institutions, and the purchase, sale, and maturity of investment securities. Financing activities focus almost entirely on the generation of customer deposits. In addition, the Bancorp utilizes borrowings (i.e., repurchase agreements, FHLB advances and federal funds purchased) as a source of funds.   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, 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 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 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 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 $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.   The Bancorp is subject to risk-based capital guidelines adopted by the FRB, and the Bank is subject to risk-based capital guidelines adopted by the FDIC. 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, 2020, the Bancorp’s capital exceeded all regulatory capital requirements. The dollar amounts are in millions.   (Dollars in millions)                                   Minimum Required To Be                       Minimum Required For     Well Capitalized Under Prompt       Actual     Capital Adequacy Purposes     Corrective Action Regulations   At December 31, 2020   Amount     Ratio     Amount     Ratio     Amount     Ratio   Common equity tier 1 capital to risk-weighted assets   $ 125.3       12.8 %   $ 43.9       4.5 %     N/A       N/A   Tier 1 capital to risk-weighted assets   $ 125.3       12.8 %   $ 58.6       6.0 %     N/A       N/A   Total capital to risk-weighted assets   $ 137.5       14.0 %   $ 78.1       8.0 %     N/A       N/A   Tier 1 capital to adjusted average assets   $ 125.3       8.5 %   $ 59.2       4.0 %     N/A       N/A     Page 60 of 117     The following table shows that, at December 31, 2020, the Bank’s capital exceeded all regulatory capital requirements. The dollar amounts are in millions.   (Dollars in millions)                                   Minimum Required To Be                       Minimum Required For     Well Capitalized Under Prompt       Actual     Capital Adequacy Purposes     Corrective Action Regulations   At December 31, 2020   Amount     Ratio     Amount     Ratio     Amount     Ratio   Common equity tier 1 capital to risk-weighted assets   $ 123.3       12.7 %   $ 43.8       4.5 %   $ 63.2       6.5 % Tier 1 capital to risk-weighted assets   $ 123.3       12.7 %   $ 58.4       6.0 %   $ 77.8       8.0 % Total capital to risk-weighted assets   $ 135.4       13.9 %   $ 77.8       8.0 %   $ 97.3       10.0 % Tier 1 capital to adjusted average assets   $ 123.3       8.3 %   $ 59.1       4.0 %   $ 73.9       5.0 %   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. 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. 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; the proposed dividend would not result in a Tier 1 leverage ratio below 7.5%; 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 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 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 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. The return on average equity was 11.51% for 2020, compared to 9.54% for 2019.   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 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. The weighted-average cost of funds was 0.45% for 2020, compared to 0.80% for 2019. 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 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 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.   Page 61 of 117     Information relating to the average consolidated balance sheet and the yield on average earning assets and cost of average liabilities for the periods indicated are in the following table. Dividing the related interest, on an annualized basis, by the average balance of assets or liabilities drives the disclosed rates. Average balances are derived from daily balances.   Year-to-Date                                                 (Dollars in thousands)   Average Balances, Interest, and Rates   (unaudited)   December 31, 2020     December 31, 2019       Average Balance     Interest     Rate (%)     Average Balance     Interest     Rate (%)   ASSETS                                                 Interest bearing deposits in other financial institutions   $ 37,582     $ 182       0.48     $ 33,502     $ 703       2.10   Federal funds sold     2,307       15       0.65       5,170       79       1.53   Certificates of deposit in other financial institutions     1,869       45       2.41       2,154       65       3.02   Securities available-for-sale     314,298       6,392       2.03       257,003       6,773       2.64   Loans receivable     961,187       44,867       4.67       876,611       44,455       5.07   Federal Home Loan Bank stock     3,916       120       3.06       3,899       175       4.49   Total interest earning assets     1,321,159     $ 51,621       3.91       1,178,339     $ 52,250       4.43   Cash and non-interest bearing deposits in other financial institutions     16,879                       23,237                   Allowance for loan losses     (9,881 )                     (8,660 )                 Other noninterest bearing assets     99,019                       93,048                   Total assets   $ 1,427,176                     $ 1,285,964                                                                     LIABILITIES AND STOCKHOLDERS' EQUITY                                                 Total deposits   $ 1,239,314     $ 5,321       0.43     $ 1,108,687     $ 8,359       0.75   Repurchase agreements     14,956       87       0.58       12,928       233       1.80   Borrowed funds     12,298       332       2.70       18,702       500       2.67   Total interest bearing liabilities     1,266,568     $ 5,740       0.45       1,140,317     $ 9,092       0.80   Other noninterest bearing liabilities     16,333                       18,802                   Total liabilities     1,282,901                       1,159,119                   Total stockholders' equity     144,275                       126,845                   Total liabilities and stockholders' equity   $ 1,427,176                     $ 1,285,964                     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.   Page 62 of 117     The following table shows the change in noninterest income for the year ending December 31, 2020, and December 31, 2019.   (Dollars in thousands, except per share data)   Year Ended December 31,     12/31/2020 vs. 12/31/2019       2020     2019     $ Change     % Change   Noninterest income:                                 Gain on sale of loans held-for-sale, net   $ 7,588     $ 2,071     $ 5,517       266.4 % Fees and service charges     5,161       4,737       424       9.0 % Gain on sale of securities, net     2,348       621       1,727       278.1 % Wealth management operations     2,138       1,915       223       11.6 % Increase in cash value of bank owned life insurance     708       688       20       2.9 % Gain on sale of foreclosed real estate     78       78       0       0.0 % Benefit from bank owned life insurance     -       205       (205 )     -100.0 % Other     127       355       (228 )     -64.2 %                                   Total noninterest income   $ 18,148     $ 10,670     $ 7,478       70.1 %   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, except per share data)   Year Ended December 31,     12/31/2020 vs. 12/31/2019       2020     2019     $ Change     % Change   Noninterest expense:                                 Compensation and benefits   $ 22,065     $ 19,617     $ 2,448       12.5 % Occupancy and equipment     4,933       4,548       385       8.5 % Data processing     2,267       2,967       (700 )     -23.6 % Federal deposit insurance premiums     788       300       488       162.7 % Marketing     732       926       (194 )     -21.0 % Professional services     640       803       (163 )     -20.3 % Other     9,421       8,227       1,194       14.5 %                                   Total noninterest expense   $ 40,846     $ 37,388     $ 3,458       9.2 %   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.   Page 63 of 117     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 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. 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. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates.   We consider the following factors when determining an other-than-temporary impairment for a security: The length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; and an assessment of whether the Bancorp has (1) the intent to sell the debt securities or (2) more likely than not will be required to sell the debt securities before its anticipated market recovery. 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. 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. Factors that are taken into consideration in the analysis include an assessment of national and local economic trends, a review of current year loan portfolio growth and changes in portfolio mix, and an assessment of trends for loan delinquencies and loan charge-off activity. Particular attention is given to non-accruing loans and accruing loans past due 90 days or more, and loans that have been classified as substandard, doubtful, or loss. Changes in the provision are directionally consistent with changes in observable data.   Page 64 of 117     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. Management has allocated general reserves to both performing and non-performing loans based on historical data and current information available.   Risk factors for non-performing and internally classified loans are based on an analysis of either the projected discounted cash flows or the estimated collateral liquidation value for individual loans defined as substandard or doubtful. Estimated collateral liquidation values are based on established loan underwriting standards and adjusted for current mitigating factors on a loan-by-loan basis. Aggregate substandard loan collateral deficiencies are determined for residential, commercial real estate, commercial business, and consumer loan portfolios. These deficiencies are then stated as a percentage of the total substandard balances to determine the appropriate risk factors.   Risk factors for performing and non-classified loans are based on a weighted average of net charge-offs for the most recent three years, which are then stated as a percentage of average loans for the same period. Historical risk factors are calculated for residential, commercial real estate, commercial business, and consumer loans. The three year weighted average historical factors are then adjusted for current subjective risks attributable to: regional and national economic factors; loan growth and changes in loan composition; organizational structure; composition of loan staff; loan concentrations; policy changes and out of market lending activity. 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.   Impact of Inflation and Changing Prices The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. 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.   Item 7A. Quantitative and Qualitative Disclosures about Market Risk Not applicable.   Page 65 of 117