Finward Bancorp 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   Summary Finward Bancorp (the “Bancorp”) is a financial holding company registered with the Board of Governors of the Federal Reserve System. Peoples Bank (the “Bank”), an Indiana commercial bank, and NWIN Risk Management, Inc., a captive insurance company, are wholly-owned subsidiaries of the Bancorp. The Bancorp has no other business activity other than being a holding company for the Bank and NWIN Risk Management, Inc. The following management’s discussion and analysis presents information concerning our financial condition as of March 31, 2022, as compared to December 31, 2021, and the results of operations for the three months ending March 31, 2022, and March 31, 2021. This discussion should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein and with the financial statements and other financial data, as well as the Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.   At March 31, 2022, the Bancorp had total assets of $2.1 billion, total loans receivable, net of deferred fees and costs of $1.4 billion and total deposits of $1.9 billion. Stockholders' equity totaled $157.6 million or 7.51% of total assets, with a book value per share of $36.71. Net income for the three months ended March 31, 2022, was $2.1 million, or $0.53 earnings per common share for both basic and diluted calculations. For the three months ended March 31, 2022, the return on average assets (ROA) was 0.44%, while the return on average stockholders’ equity (ROE) was 5.01%.   Recent Developments   Acquisition of Royal Financial, Inc. On January 31, 2022, the Bancorp completed its acquisition of Royal Financial, Inc. (“RYFL”) pursuant to an Agreement and Plan of Merger dated July 28, 2021 (the “Merger Agreement”) between the Bancorp and RYFL. Pursuant to the terms of the Merger Agreement, RYFL merged with and into the Bancorp, with the Bancorp as the surviving corporation (the “RYFL Merger”). Simultaneous with the RYFL Merger, Royal Savings Bank, an Illinois state-chartered savings bank and wholly-owned subsidiary of RYFL, merged with and into the Bank, with the Bank as the surviving institution.   Under the terms of the Merger Agreement, RYFL stockholders who owned 101 or more shares of RYFL common stock were permitted to elect to receive either 0.4609 shares of Finward common stock or $20.14 in cash, or a combination of both, for each share of RYFL common stock owned, subject to proration and allocation provisions such that 65% of the shares of RYFL common stock outstanding immediately prior to the closing of the merger were converted into the right to receive shares of Finward common stock and the remaining 35% of the outstanding RYFL shares were converted into the right to receive cash. Stockholders holding less than 101 shares of RYFL common stock received fixed consideration of $20.14 in cash and no stock consideration for each share of RYFL common stock.   As a result of RYFL stockholder stock and cash elections and the related allocation and proration provisions of the Merger Agreement, Finward issued 795,423 shares of its common stock and paid cash consideration of approximately $18.7 million in the RYFL Merger. Based on the January 28, 2022 closing price of $47.75 per share of Finward common stock, the transaction had an implied valuation of approximately $56.7 million. The acquisition further expanded the Bank’s banking center network in Cook County and DuPage County, Illinois, expanding the Bank’s full-service retail banking network.   Financial Condition During the three months ended March 31, 2022, total assets increased by $477.1 million (29.4%), with interest-earning assets increasing by $419.5 million (27.5%). Interest-earning assets totaled $1.9 billion at March 31, 2022, and $1.5 billion at December 31, 2021. Earning assets represented 92.6% of total assets at March 31, 2022, and 94.0% of total assets at December 31, 2021. The increase in total assets and interest earning assets for the three months was primarily the result of the acquisition of Royal.   Net loans receivable totaled $1.4 billion at March 31, 2022, compared to $966.7 million at December 31, 2021. The loan portfolio, which is the Bancorp’s largest asset, is the primary source of both interest and fee income. The Bancorp’s lending strategy emphasizes quality loan growth, product diversification, and competitive and profitable pricing.   28     The Bancorp’s end-of-period loan balances were as follows:       (unaudited)                       March 31,     December 31,   (Dollars in thousands)   2022     2021       Balance     % Loans     Balance     % Loans                                     Residential real estate   $ 444,753       31.0 %     260,134       33.0 % Home equity     34,284       2.4 %     34,612       5.4 % Commercial real estate     408,375       28.5 %     317,145       31.2 % Construction and land development     150,810       10.5 %     123,822       9.7 % Multifamily     234,267       16.4 %     61,194       5.7 % Consumer     924       0.1 %     582       0.1 % Manufactured Homes     38,636       2.7 %     37,887       1.8 % Commercial business     112,396       7.8 %     115,772       11.4 % Government     8,176       0.6 %     8,991       1.7 % Loans receivable     1,432,621       100.0 %     960,139       100.0 % Plus                                 Net deferred loans origination costs     6,700               6,810           Undisbursed loan funds     407               (229 )         Loans receivable, net of deferred fees and costs   $ 1,439,728             $ 966,720                                             Adjustable rate loans / loans receivable   $ 654,902       45.7 %   $ 542,975       56.6 %       (unaudited)               March 31,     December 31,       2022     2021                     Loans receivable to total assets     68.6 %     59.6 % Loans receivable to earning assets     74.1 %     63.4 % Loans receivable to total deposits     76.0 %     67.4 %   The following table sets forth certain information at March 31, 2022, regarding the dollar amount of loans in the Bancorp’s portfolio based on their contractual terms to maturity. Demand loans, loans having no schedule of repayment and no stated maturity, and overdrafts are reported as due in one year or less. Contractual principal repayments of loans do not necessarily reflect the actual term of the loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which give the Bancorp the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the property subject to the mortgage. The amounts are stated in thousands (000’s).       Maturing     After one     After five                       within     but within     but within     After               one year     five years     fifteen years     fifteen years     Total   Residential real estate   $ 9,363     $ 34,561     $ 107,164     $ 293,665       444,753   Home equity     3,767       21,328       8,826       363       34,284   Commercial real estate     22,631       111,991       270,678       3,075       408,375   Construction and land development     29,207       41,187       63,310       17,106       150,810   Multifamily     16,915       104,713       110,556       2,083       234,267   Farmland     -       -       -       -       -   Consumer     35       861       28       -       924   Manufactured Homes     -       59       10,760       27,817       38,636   Commercial business     44,914       51,377       15,585       520       112,396   Government     195       3,211       4,770       -       8,176   Total loans receivable   $ 127,027     $ 369,288     $ 591,677     $ 344,629     $ 1,432,621     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 three months ended March 31, 2022, the Bancorp originated $15.7 million in new fixed rate mortgage loans for sale, compared to $49.1 million during the three months ended March 31, 2021. Net gains realized from the mortgage loan sales totaled $607 thousand for the three months ended March 31, 2022, compared to $2.0 million for the three months ended March 31, 2021. At March 31, 2022, the Bancorp had $1.4 million in loans that were classified as held for sale, compared to $5.0 million at December 31, 2021.   Non-performing loans include those loans that are 90 days or more past due and those loans that have been placed on non-accrual status. At March 31, 2022, all non-performing loans are also accounted for on a non-accrual basis, except for two commercial business loans totaling $213 thousand, two commercial real estate loans totaling $163 thousand, and two residential real estate loans totaling $117 thousand that remained accruing and more than 90 days past due. The Bancorp at times will continue to classify loans as accruing, despite being over 90 days past due, for short periods of time when management has reason to believe payments are in process of being collected.   29     The Bancorp's nonperforming loans are summarized below: (Dollars in thousands)   (unaudited)           Loan Segment   March 31, 2022     December 31, 2021   Residential real estate   $ 5,827     $ 4,682   Home equity     620       657   Commercial real estate     1,426       1,031   Construction and land development     -       -   Multifamily     447       455   Commercial business     588       436   Consumer     -       -   Manufactured homes     -       -   Government     -       -   Total   $ 8,908     $ 7,261   Nonperforming loans to total loans     0.62 %     0.75 % Nonperforming loans to total assets     0.42 %     0.45 %   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 March 31, 2022 or December 31, 2021.   The Bancorp's substandard loans are summarized below: (Dollars in thousands)   (unaudited)           Loan Segment   March 31, 2022     December 31, 2021   Residential real estate   $ 6,631     $ 3,722   Home equity     635       632   Commercial real estate     6,451       3,562   Construction and land development     -       -   Multifamily     3,030       384   Commercial business     396       387   Consumer     -       -   Manufactured homes     -       -   Government     -       -   Total.   $ 17,143     $ 8,687     The increase in substandard loans is the result of loans acquired pursuant to the RYFL acquisition.   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)   (unaudited)           Loan Segment   March 31, 2022     December 31, 2021   Residential real estate   $ 2,308     $ 2,940   Home equity     415       415   Commercial real estate     11,391       12,011   Construction and land development     4,403       3,630   Multifamily     1,532       153   Commercial business     3,395       1,915   Consumer     -       -   Manufactured homes     59       59   Government     -       -   Total   $ 23,503     $ 21,123     30     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.   The Bancorp's impaired loans, including purchased credit impaired loans, are summarized below:   (Dollars in thousands)   (unaudited)           Loan Segment   March 31, 2022     December 31, 2021   Residential real estate   $ 3,661     $ 1,771   Home equity     269       284   Commercial real estate     4,461       1,600   Construction and land development     804       -   Multifamily     3,302       556   Commercial business     1,562       1,597   Consumer     21       -   Manufactured homes     -       -   Government     -       -   Total   $ 14,080     $ 5,808     The increase in impaired loans is the result of purchase credit impaired loans acquired pursuant to the RYFL acquisition.   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)   (unaudited)           Loan Segment   March 31, 2022     December 31, 2021   Residential real estate   $ 532     $ 342   Home equity     88       83   Commercial real estate     645       747   Construction and land development     -       -   Multifamily     -       -   Commercial business     681       694   Consumer     -       -   Manufactured homes     -       -   Government     -       -   Total   $ 1,946     $ 1,866     At March 31, 2022, management is of the opinion that there are no loans, 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.   31     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 three months ended are   summarized below:                 (Dollars in thousands)                     (unaudited)           Loan Segment   March 31, 2022     March 31, 2021   Residential real estate   $ (8 )   $ (41 ) Home equity     (3 )     34   Commercial real estate     15       320   Construction and land development     16       182   Multifamily     41       54   Commercial business     (99 )     36   Consumer     38       (7 ) Manufactured homes     -       -   Government     -       -   Total   $ -     $ 578     The Bancorp's charge-off and recovery information is summarized below:           (Dollars in thousands)   (unaudited)       As of March 31, 2022   Loan Segment   Charge-off     Recoveries     Net Charge-offs   Residential real estate   $ -     $ 21     $ 21   Home equity     -       -       -   Commercial real estate     -       -       -   Construction and land development     -       -       -   Multifamily     -       -       -   Commercial business     -       31       31   Consumer     (10 )     2       (8 ) Manufactured homes     -       -           Government     -       -       -   Total   $ (10 )   $ 54     $ 44     The Bancorp's charge-off and recovery information is summarized below:           (Dollars in thousands)   (unaudited)       As of March 31, 2021   Loan Segment   Charge-off     Recoveries     Net Charge-offs   Residential real estate   $ (4 )   $ 10     $ 6   Home equity     (1 )     -       (1 ) Commercial real estate     -       -       -   Construction and land development     -       -       -   Multifamily     -       -       -   Farmland     -       -       -   Commercial business     -       8       8   Consumer     (6 )     4       (2 ) Manufactured homes     -       -           Government     -       -       -   Total   $ (11 )   $ 22     $ 11     32     The Bancorp's allowance to total loans and non-performing loans are   summarized below:                 (Dollars in thousands)   (unaudited)               March 31, 2022     December 31, 2021                     Allowance for loan losses   $ 13,387     $ 13,343   Total loans   $ 1,439,728     $ 966,720   Non-performing loans   $ 8,908     $ 7,261   ALL-to-total loans     0.93 %     1.38 % ALL-to-non-performing loans (coverage ratio)     150.3 %     183.8 %   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 additional reserves 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 March 31, 2022, total purchased credit impaired loan reserves totaled $2.0 million compared to $1.4 million at December 31, 2021. 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 totaled $6.4 million at March 31, 2022, compared to $1.1 million at December 31, 2021. Details on these fair value marks and the additional reserves created can be found in Note 5, Loans Receivable.   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 $464.3 million at March 31, 2022, compared to $526.9 million at December 31, 2021, an increase of $62.6 million (11.9%). The decrease is attributable to increased unrealized losses within the portfolio and a return of liquidity from the securities portfolio. At March 31, 2022, the securities portfolio represented 23.9% of interest-earning assets and 22.1% of total assets compared to 34.6% of interest-earning assets and 32.5% of total assets at December 31, 2021.   The Bancorp’s end-of-period investment portfolio and other short-term investments and stock balances were as follows:       (unaudited)                               March 31,             December 31,           (Dollars in thousands)   2022             2021               Balance     % Securities     Balance     % Securities                                     U.S. government sponsored entities   $ 8,202       1.8 %   $ 8,669       1.6 % U.S. treasury securities     199       0.1 %     400       0.1 % Collateralized mortgage obligations and residential mortgage-backed securities     164,123       35.3 %     184,701       35.1 % Municipal securities     290,824       62.6 %     332,127       63.0 % Collateralized debt obligations     972       0.2 %     992       0.2 % Total securities available-for-sale   $ 464,320       100.0 %   $ 526,889       100.0 %       (unaudited)                               March 31,     December 31,     YTD           (Dollars in thousands)   2022     2021     Change               Balance     Balance     $     %                                     Interest bearing deposits in other financial institutions   $ 31,420     $ 19,987     $ 11,433       57.2 % Fed funds sold     1,819       464       1,355       292.0 % Certificates of deposit in other financial institutions     1,731       1,709       22       1.3 % Federal Home Loan Bank stock     3,038       3,247       (209 )     -6.4 %   The net increase in interest bearing deposits in other financial institutions and fed funds sold is primarily the result of the RYFL acquisition.   33     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:       (unaudited)                               March 31,     December 31,     YTD   (Dollars in thousands)   2022     2021     Change       Balance     Balance     $     %                                     Checking   $ 731,340     $ 629,038     $ 102,302       16.3 % Savings     425,634       293,976       131,658       44.8 % Money market     307,850       271,970       35,880       13.2 % Certificates of deposit     430,387       239,217       191,170       79.9 % Total deposits   $ 1,895,211     $ 1,434,201     $ 461,010       32.1 %   The following table presents the average daily amount of deposits and average rates paid on such deposits for the periods indicated. The amounts are stated inthousands (000’s).       March 31, 2022                       (unaudited)     December 31, 2021       Amount     Rate %     Amount     Rate %   Noninterest bearing demand deposits   $ 343,176       -     $ 280,900       -   Interest bearing demand deposits     336,441       0.06       297,012       0.08   MMDA accounts     308,377       0.11       253,468       0.13   Savings accounts     388,087       0.05       277,839       0.06   Certificates of deposit     361,539       0.16       271,882       0.46   Total deposits   $ 1,737,620       0.08     $ 1,381,101       0.18     As of March 31, 2022, and December 31, 2021, approximately $549.7 million and $452.0 million, respectively, of our deposit portfolio was uninsured. The uninsured amounts are estimates based on the methodologies and assumptions used for the Bank's regulatory reporting requirements.   The overall increase in total deposits is a result of the RYFL acquisition, as well as management’s sales efforts along with customer preferences for competitively priced short-term liquid investments.   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:       (unaudited)                               March 31,     December 31,     YTD   (Dollars in thousands)   2022     2021     Change       Balance     Balance     $     %                                     Repurchase agreements   $ 23,239     $ 14,581     $ 8,658       59.4 % Borrowed funds     5       -       5       100.0 % Total borrowed funds   $ 23,244     $ 14,581     $ 8,663       59.4 %   Repurchase agreements increased as part of normal account fluctuations within that product line.   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 other 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.   34     During the three months ended March 31, 2022, cash and cash equivalents increased by $21.3 million compared to a $48.1 million increase for the three months ended March 31, 2021. The primary sources of cash and cash equivalents were cash and cash equivalents from acquisition activity, the sale of loans originated for sale, proceeds from the sale of securities, and proceeds from the maturity and paydown of securities. The primary uses of cash and cash equivalents were the purchase of securities, loan originations, and change in deposits. Cash provided by operating activities totaled $722 thousand for the three months ended March 31, 2022, compared to cash provided of $16.4 million for the three months ended March 31, 2021. Cash provided from operating activities was primarily a result of net income and sale of loans originated for sale, offset by loans originated for sale and net change in accrued expenses and other liabilites. Cash inflows from investing activities totaled $27.2 million for the current period, compared to cash outflows of $27.6 million for the three months ended March 31, 2021. Cash inflows from investing activities for the current three months were primarily related to the cash and cash equivalents from acquisition activity, net, and proceeds from the sales and maturities of securities, offset against the net change in loans receivable and purchase of securiites. Net cash outflows from financing activities totaled $6.6 million during the current period compared to net cash provided of $59.3 million for the three months ended March 31, 2021. The net cash outflows from financing activities were primarily a result of net change in deposits, offset against the change in other borrowed funds. On a cash basis, the Bancorp paid dividends on common stock of $1.1 million for the three months ended March 31, 2022 and March 31, 2021.   At March 31, 2022, outstanding commitments to fund loans totaled $241.7 million. Approximately 53.0% of the commitments were at variable rates. Standby letters of credit, which are conditional commitments issued by the Bancorp to guarantee the performance of a customer to a third party, totaled $11.5 million at March 31, 2022. Management believes that the Bancorp has sufficient cash flow and borrowing capacity to fund all outstanding commitments and letters of credit, while maintaining proper levels of liquidity.   Management strongly believes that maintaining a high level of capital enhances safety and soundness. During the three months ended March 31, 2022, stockholders' equity increased by $1.0 million (0.7%). During the three months ended March 31, 2022, stockholders’ equity was primarily increased by additional paid in capital related to the RYFL acquisition, offset against increased unrealized losses on available for sale securities. Increasing stockholders’ equity was net income of $2.1 million. On April 24, 2014 the Bancorp’s Board of Directors authorized a stock repurchase program to repurchase up to 50,000 shares of the Bancorp’s outstanding common stock, from time to time and subject to market conditions, on the open market or in privately negotiated transactions. The stock repurchase program does not expire and is only limited by the number of shares that can be purchased. The stock repurchase program will be reviewed annually by the Board of Directors. No shares were repurchased under the program during the first three months of 2022 or 2021. During 2022, 10,863 restricted stock shares vested under the Bancorp’s 2015 Stock Option and Incentive Plan outlined in Note 9 of the financial statements, of which 2,336 of these shares were withheld in the form of a net surrender to cover the withholding tax obligations of the vesting employees. The repurchase of these surrendered shares is considered outside of the scope of the formal stock repurchase program.   The Bank is subject to risk-based capital guidelines adopted by the FDIC. The regulations divide capital into multiple tiers. The first tier (Common Equity Tier 1 Capital) includes common shareholders’ equity, after deductions for various items including goodwill and certain other intangible assets, and after certain other adjustments. Common Equity Tier 1 Capital also includes accumulated other comprehensive income (for organizations that do not make opt-out elections). The next tier (Tier 1 Capital) is comprised of Common Equity Tier 1 Capital plus other qualifying capital instruments such as perpetual noncumulative preferred stock and junior subordinated debt issued to trusts, and other adjustments. The third tier (Tier 2 Capital) includes instruments such as subordinated debt that have a minimum original maturity of at least five years and are subordinated to the claims of depositors and general creditors, total capital minority interest not included in Tier 1 Capital, and limited amounts of the allowance for loan losses, less applicable regulatory adjustments and deductions. The Bank are required to maintain a Common Equity Tier 1 Capital ratio of 4.5%, a Tier 1 Capital ratio of 6%, and a Total Capital ratio (comprised of Tier 1 Capital plus Tier 2 Capital) of 8%. In addition, the capital regulations provide for a minimum leverage ratio (Tier 1 capital to adjusted average assets) of 4%.   In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions by the institution and certain discretionary bonus payments to management if an institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements.   35     The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required the FRB to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository subsidiaries. However, under the FRB’s “Small Bank Holding Company” exemption from consolidated bank holding company capital requirements, bank holding companies and savings and loan holding companies with less than $3 billion in consolidated assets, such as the Bancorp, are exempt from consolidated regulatory capital requirements, unless the FRB determines otherwise in particular cases.   During the three months ended March 31, 2022, the Bancorp’s and Bank’s regulatory capital ratios continued to be negatively impacted by regulatory requirements regarding collateralized debt obligations. The regulatory requirements state that for collateralized debt obligations that have been downgraded below investment grade by the rating agencies, increased risk based asset weightings are required. The Bancorp currently holds pooled trust preferred securities with a cost basis of $2.2 million. These investments currently have ratings that are below investment grade. As a result, approximately $8.6 million of risk-based assets are generated by the trust preferred securities in the Bancorp’s and Bank’s total risk based capital calculation.   In addition, the following table shows that, at March 31, 2022, and December 31, 2021, the Bank’s capital exceeded all applicable 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 March 31, 2022   Amount     Ratio     Amount     Ratio     Amount     Ratio   Common equity tier 1 capital to risk-weighted assets   $ 156.8       10.9 %   $ 65.0       4.5 %   $ 93.9       6.5 % Tier 1 capital to risk-weighted assets   $ 156.8       10.9 %   $ 86.7       6.0 %   $ 115.6       8.0 % Total capital to risk-weighted assets   $ 170.2       11.8 %   $ 115.6       8.0 %   $ 144.5       10.0 % Tier 1 capital to adjusted average assets   $ 156.8       8.2 %   $ 77.7       4.0 %   $ 97.2       5.0 %   (Dollars in millions)                                   Minimum Required To Be                       Minimum Required For     Well Capitalized Under Prompt       Actual     Capital Adequacy Purposes     Corrective Action Regulations   At December 31, 2021   Amount     Ratio     Amount     Ratio     Amount     Ratio   Common equity tier 1 capital to risk-weighted assets   $ 136.6       13.0 %   $ 47.4       4.5 %     N/A       N/A   Tier 1 capital to risk-weighted assets   $ 136.6       13.0 %   $ 63.3       6.0 %     N/A       N/A   Total capital to risk-weighted assets   $ 149.8       14.2 %   $ 84.3       8.0 %     N/A       N/A   Tier 1 capital to adjusted average assets   $ 136.6       8.6 %   $ 64.2       4.0 %     N/A       N/A     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 2022, without the need for qualifying for an exemption or prior DFI approval, is its 2022 net profits plus $21.4 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 February 25, 2022, the Board of Directors of the Bancorp declared a first quarter dividend of $0.31 per share. The Bancorp’s first quarter dividend was paid to shareholders on April 4, 2022.   Results of Operations - Comparison of the Three Months Ended March 31, 2022, to the Three Months Ended March 31, 2021   For the three months ended March 31, 2022, the Bancorp reported net income of $2.1 million, compared to net income of $4.5 million for the three months ended March 31, 2021, a decrease of $2.4 million (53.0%). For the three months ended March 31, 2022, the ROA was 0.44%, compared to 1.18% for the three months ended March 31, 2021. The ROE was 5.01% for the three months ended March 31, 2022, compared to 11.94% for the three months ended March 31, 2021.   36     Net interest income for the three months ended March 31, 2022, was $15.5 million, an increase of $3.5 million (29.0%), compared to $12.0 million for the three months ended March 31, 2021. The weighted-average yield on interest-earning assets was 3.49% for the three months ended March 31, 2022, compared to 3.59% for the three months ended March 31, 2021. The weighted-average cost of funds for the three months ended March 31, 2022 was 0.08% compared to 0.20% for the three months ended March 31, 2021. The impact of the 3.49% return on interest earning assets and the 0.08% cost of funds resulted in an interest rate spread of 3.41% for the current three months, an increase from the 3.39% spread for the three months ended March 31, 2021. The net interest margin on earning assets was 3.41% for the three months ended March 31, 2022, and 3.40% for the three months ended March 31, 2021. On a tax equivalent basis, the Bancorp’s net interest margin was 3.63% for the three months ended March 31, 2022, compared to 3.59% for the three months ended March 31, 2021. The Bancorp believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully-taxable equivalent basis, as these measures provide useful information to make peer comparisons. Tax adjusted net interest margin represents a non-GAAP financial measure. See the non-GAAP reconciliation table immediately below and the section captioned “Non-GAAP Financial Measures” for further disclosure regarding non-GAAP financial measures.     (Dollars in thousands)   Three Months Ended   (unaudited)   March 31, 2022     March 31, 2021                     Calculation of tax adjusted net interest margin                 Net interest income   $ 15,535     $ 12,046   Tax adjusted interest on securities and loans     966       677   Adjusted net interest income     16,501       12,723   Total average earning assets     1,820,588       1,417,462   Tax adjusted net interest margin     3.63 %     3.59 %     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.   Quarter-to-Date                                                 (Dollars in thousands)   Average Balances, Interest, and Rates   (unaudited)   March 31, 2022     March 31, 2021       Average Balance     Interest     Rate (%)     Average Balance     Interest     Rate (%)   ASSETS           `                                   Interest bearing deposits in other financial institutions   $ 22,295     $ 8       0.14     $ 51,688     $ 12       0.09   Federal funds sold     8,015       -       -       788       -       -   Certificates of deposit in other financial institutions     1,725       3       0.70       1,598       8       2.00   Securities available-for-sale     510,119       2,575       2.02       383,877       1,941       2.02   Loans receivable*     1,274,407       13,286       4.17       975,593       10,746       4.41   Federal Home Loan Bank stock     4,027       22       2.19       3,918       20       2.04   Total interest earning assets     1,820,588     $ 15,894       3.49       1,417,462     $ 12,727       3.59   Cash and non-interest bearing deposits in other financial institutions     20,183                       33,719                   Allowance for loan losses     (13,367 )                     (12,662 )                 Other noninterest bearing assets     127,943                       98,316                   Total assets   $ 1,955,347                     $ 1,536,835                                                                     LIABILITIES AND STOCKHOLDERS' EQUITY                                                 Total deposits   $ 1,737,620     $ 337       0.08     $ 1,348,160     $ 651       0.19   Repurchase agreements     19,390       16       0.33       14,479       10       0.28   Borrowed funds     6,091       6       0.39       2,967       20       2.70   Total interest bearing liabilities     1,763,101     $ 359       0.08       1,365,606     $ 681       0.20   Other noninterest bearing liabilities     21,872                       19,049                   Total liabilities     1,784,973                       1,384,655                   Total stockholders' equity     170,374                       152,180                   Total liabilities and stockholders' equity   $ 1,955,347                     $ 1,536,835                                                                     Net intrest spread     3.41 %                     3.39 %                 Net interest margin**     3.41 %                     3.40 %                 Ratio of interest-earning assets to interest-bearing liabilities   1.03 x                   1.04 x                   * Non-accruing loans have been included in the average balances. ** Net interest income divided by average interest-earning assets.   The increase in interest earning asset income for the three months ended March 31, 2022, compared to the three months ended March 31, 2021, is primarily a result of the RYFL acquisition. The decrease in interest bearing liability expense is primarily the result of the Bancorp adjusting deposit pricing to align with the current interest rate cycle.   37     The following table shows the change in noninterest income for the three months ending March 31, 2022, and March 31, 2021.   (Dollars in thousands)   Quarter Ended March 31,     3/31/2022 vs. 3/31/2021       2022     2021     $ Change     % Change   Noninterest income:                                 Fees and service charges     1,304       1,066       238       22.3 % Gain on sale of loans held-for-sale, net     607       2,049       (1,442 )     -70.4 % Wealth management operations     595       607       (12 )     -2.0 % Gain on sale of securities, net     381       417       (36 )     -8.6 % Increase in cash value of bank owned life insurance     252       169       83       49.1 % Gain (loss) on sale of foreclosed real estate     -       (9 )     9       -100.0 % Other     5       14       (9 )     -64.3 %                                   Total noninterest income     3,144       4,313       (1,169 )     -27.1 %   The decrease in gain on sale of loans is the result of significant refinance activity which started in 2020 and continued into the following year due to the economic and low rate environment, which resulted in more loans originated and sold. We anticipate the demand for mortgage loans will continue to revert to normal levels as borrowing rates on loans increase. The increase in fees and service charges for the three-month period ended March 31, 2022 compared to the three-month period ended March 31, 2021 is primarily the result of changes in customer usage of bank services.   The following table shows the change in noninterest expense for the three months ending March 31, 2022, and March 31, 2021.   (Dollars in thousands)   Quarter Ended March 31,     3/31/2022 vs. 3/31/2021       2022     2021     $ Change     % Change   Noninterest expense:                                 Compensation and benefits     7,367       5,685       1,682       29.6 % Data processing     3,054       674       2,380       353.1 % Occupancy and equipment     1,500       1,372       128       9.3 % Marketing     651       199       452       227.1 % Federal deposit insurance premiums     219       180       39       21.7 % Other     3,478       2,383       1,095       46.0 %                                   Total noninterest expense     16,269       10,493       5,776       55.0 %   For the three months ended March 31, 2022, the increase in compensation and benefits is primarily the result of the RYFL acquisition and management’s continued focus on talent management and retention. The increase in data processing expense in primarily the result of data conversion expenses related to the acquisition of RYFL, increased system utilization due to growth of the Bank, and continued investment in technological advancements such as Salesforce and nCino. The increase in occupancy and equipment expense is primarily related to the RYFL acquisition and related assets acquired in the transaction. The increase in marketing expense is primarily the result of the RYFL acquisition. The increase in other operating expenses is primarily the result of one-time expenses related to the acquisition of RYFL and continued investments in strategic initiatives focusing on growth of the organization.   Income tax expenses for the three months ended March 31, 2022, totaled $275 thousand, compared to income tax expense of $745 thousand for the three months ended March 31, 2021, a decrease of $470 thousand (63.1%). The combined effective federal and state tax rates for the Bancorp was 11.4% for the three months ended March 31, 2022, compared to 14.1% for the three months ended March 31, 2021. The Bancorp’s lower current period effective tax rate is a result of a greater 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 critical accounting policies from December 31, 2021 remain unchanged.   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, merger and acquisition activities, 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, including those identified in the Bancorp’s 2021 Form 10-K.   38     Non-GAAP Financial Measures This filing includes certain financial measures that are identified as non-GAAP, including adjusted net interest income and tax adjusted net interest margin. The Bancorp provides these non-GAAP performance measures because they are used by management to evaluate and measure the Bancorp’s performance, which the Bancorp believes also is useful to assist investors in assessing the Bancorp’s operating performance. Where non-GAAP financial measures are used in this report, the most comparable GAAP measure, as well as the reconciliation to the most comparable GAAP measure, can be found in the tables referenced herein.   The adjusted net interest income and tax-adjusted net interest margin measures recognize the income tax savings when comparing taxable and tax-exempt assets. Interest income and yields on tax-exempt securities and loans are presented using the current federal income tax rate of 21%. Management believes that it is standard practice in the banking industry to present net interest income and net interest margin on a fully tax-equivalent basis and that it may enhance comparability for peer comparison purposes.   Although these non-GAAP financial measures are frequently used by investors to evaluate a financial institution’s business and performance, they have limitations as analytical tools and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP. In addition, these non-GAAP financial measures may differ from those used by other financial institutions to assess their business operations and performance.   Item 3. Quantitative and Qualitative Disclosures about Market Risk Not applicable.