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Item 7. Management’s Discussion and Analysis

2023-03-01 compared with 2022-03-01 · 334 added, 282 removed, 511 unchanged (55% of the section changed)

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HIGHLIGHTS FOR 2022

• Net income available to stockholders for the year ended December 31, 2021 was $205.5 million compared to $148.6 million for the year ended 2020, an increase of 38.3 percent.

• Earnings per fully diluted common share for 2021 totaled $3.81 compared to $2.74 for 2020, an increase of 39.1 percent.

• The Corporation experienced organic loan growth of $566.4 million, or 6.6 percent during 2021, which when offset by a $560.5 million decline in Paycheck Protection Program (“PPP”) loans (following forgiveness by the Small Business Administration), resulted in net loan growth of $5.9 million.

• As of December 31, 2021, the Corporation had $12.7 billion in total deposits, representing a $1.4 billion increase from December 31, 2020, or 12.1 percent.

• During 2021, the Corporation repurchased 646,102 of its common shares for $25.4 million at an average price of $39.38.

• During the second quarter of 2021, the Corporation completed its previously-announced banking delivery transformation strategy, which included the consolidation of seventeen banking centers across its footprint.

• On April 1, 2021, the Bank acquired 100 percent of Hoosier Trust Company (“Hoosier”) through a merger of Hoosier with and into the Bank.

The consideration paid to shareholders of Hoosier at closing was $3,225,000 in cash.

Prior to the acquisition, Hoosier was an Indiana corporate trust company, headquartered in Indianapolis, Indiana, with approximately $290 million in assets under management.

Hoosier’s sole office is now being operated by the Bank as a limited service trust office.

• On November 4, 2021, the Corporation and Level One Bancorp, Inc., a Michigan corporation (“Level One”) entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Level One will, subject to the terms and conditions of the Merger Agreement, merge with and into the Corporation (the “Merger”), whereupon the separate corporate existence of Level One will cease and the Corporation will survive.

Immediately following the Merger, Level One's wholly owned subsidiary, Level One Bank, will be merged with and into the Bank, with the Bank as the surviving bank.

Subject to the terms and conditions of the Merger Agreement, upon the Merger becoming effective, the common shareholders of Level One will be entitled to received, for each outstanding share of Level One common stock, (a) a 0.7167 share (the “Exchange Ratio”) of the Corporation’s common stock, in a tax-free exchange, and (b) a cash payment of $10.17.

The Exchange Ratio is subject to adjustments for stock splits, stock dividends, recapitalization, or similar transactions, or as otherwise described in the Merger Agreement.

Based on the number of shares of Level One common stock currently outstanding, the Corporation expects to issue approximately 5.5 million shares of its common stock, and pay approximately $77.7 million in cash, in exchange for all the issued and outstanding shares of Level One common stock.

In addition, the Corporation expects to issue 10,000 shares of a newly created 7.5% non-cumulative perpetual preferred stock, with a liquidation preference of $2,500 per share, in exchange for the outstanding Level One Series B preferred stock.

Based on the closing price of First Merchants’ common stock on November 3, 2021, of $43.50 per share, the implied value for a share of Level One common stock is $41.35.

The aggregate transaction value is estimated at approximately $323.5 million.

The Federal Reserve and the FDIC have granted approvals in connection with the transaction.

However, consummation of the Merger remains subject to the requisite approval of the holders of Level One common stock, the approval of the Indiana DFI, and satisfaction of certain customary closing conditions.

The shareholders of Level One are considering the approval of the Merger Agreement on March 1, 2022, and the Indiana DFI expects to meet during March 2022 to consider the matter.

The parties are diligently pursuing satisfaction of the other closing conditions and expect the closing to occur by early second quarter of 2022, subject to satisfaction of those conditions.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

• Net income available to common stockholders for the year ended December 31, 2022 was $220.7 million compared to $205.5 million for the year ended 2021, an increase of 7.4 percent.

Earnings per fully diluted common share totaled $3.81 for 2022 and 2021.

• The acquisition of Level One Bancorp, Inc.

(“Level One”), with 17 banking center locations in Michigan, became effective on April 1, 2022, with the core system integration being completed in August 2022.

• Adjusted net income available to common stockholders for 2022, excluding income on Paycheck Protection Program ("PPP") loans and acquisition-related costs of the Level One acquisition, was $243.4 million and adjusted diluted earnings per common share totaled $4.20, compared to $182.2 million and $3.38, respectively, in 2021.

These adjusted net income and earnings per share amounts are non-GAAP measures.

For reconciliations of non-GAAP measures to their most comparable GAAP measures, see "NON-GAAP FINANCIAL MEASURES" within the "Results of Operations" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

• Total loans grew $2.8 billion during 2022, which included $1.6 billion from the acquisition of Level One.

Excluding the forgiveness of $145.3 million in PPP loans, organic loan growth totaled $1.3 billion, or 13.9 percent during the year.

• Net interest income totaled $520.2 million in 2022, an increase of $109.5 million, or 26.7 percent over 2021.

• Return on average assets was 1.29 percent and the return on average equity was 11.19 percent.

COVID-19 AND RELATED LEGISLATIVE AND REGULATORY ACTIONS

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In the two years since then, the pandemic has dramatically impacted global health and the economic environment, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, and market volatility.

In response, the U.S.

Congress, through the enactment of the CARES Act in March 2020, and the federal banking agencies, though rulemaking, interpretive guidance and modifications to agency policies and procedures, have taken a series of actions to provide emergency economic relief measures including, among others, the following:

In response to the COVID-19 outbreak, the U.S.

Congress, through the enactment of the CARES Act in March 2020, and the federal banking agencies, though rulemaking, interpretive guidance and modifications to agency policies and procedures, took a series of actions to provide emergency economic relief measures including, among others, the following:

Paycheck Protection Program .

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The Bank actively participated in assisting its customers with PPP funding during all phases of the program.

The vast majority of the Bank’s PPP loans made in 2020 have two-year maturities, while the loans made in 2021 have five-year maturities.

The application period for new PPP loans ended May 31, 2021.

The vast majority of the Bank’s PPP loans made in 2020 had two-year maturities, while the loans made in 2021 had five-year maturities.

Loans under the program earn interest at a fixed rate of 1 percent.

Consistent with the terms of the program, virtually all of the Corporation's PPP loans have been forgiven by the SBA.

As of December 31, 2022, the Corporation had $4.7 million of PPP loans outstanding compared to the December 31, 2021 balance of $106.6 million.

The Corporation will continue to monitor legislative, regulatory, and supervisory developments related to the PPP.

However, it anticipates that the majority of the Bank’s remaining PPP loans will be forgiven by the SBA in accordance with the terms of the program

Loan Modifications and Troubled Debt Restructures .

The CARES Act, as amended by the 2021 Consolidated Appropriations Act (the "2021 CAA"), allowed banks to suspend requirements under GAAP, effectively, through January 1, 2022, for certain loan modifications related to the COVID-19 pandemic.

The CARES Act, as amended by the 2021 CAA, allowed banks to suspend requirements under GAAP, effectively, through January 1, 2022, for certain loan modifications related to the COVID-19 pandemic.

The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 or offer other borrower friendly options.

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These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that were insignificant.

The Corporation did not have any COVID-19 modifications outstanding as of December 31, 2022 or 2021.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Regulatory Capital .

The CARES Act, the 2021 CAA, and certain actions by federal banking regulators resulted in modifications to, or delays in implementation of, various regulatory capital rules applicable to banking organizations.

For additional information, see “Regulatory Capital” under the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

CRITICAL ACCOUNTING ESTIMATE

See “- Capital Adequacy Guidelines for Bank Holding Companies (Basel III)” above for additional information.

CRITICAL ACCOUNTING ESTIMATES

Generally accepted accounting principles require management to apply significant judgment to certain accounting, reporting and disclosure matters.

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Because of the nature of the judgments and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations.

For a complete discussion of the Corporation’s significant accounting policies and the adoption of ASC Topic 326, Financial Instruments – Credit Losses, see NOTE 1.

For a complete discussion of the Corporation’s significant accounting policies see NOTE 1.

NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Allowance for Credit Losses - Loans

As discussed in NOTE 5.

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While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond management’s control, which includes, but is not limited to, the performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting.

Under the acquisition method, assets and liabilities of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the fair value of the net tangible and intangible assets acquired recorded as goodwill.

The Corporation uses significant estimates and assumptions to value such items, including projected cash flows, repayment rates, default rates and losses assuming default, discount rates and realizable collateral values.

The allowance for credit losses for PCD loans is recognized within acquisition accounting.

The allowance for credit losses for non-PCD assets is recognized as provision for credit losses in the same period as the acquisition.

Fair value adjustments are amortized or accreted into the income statement over the estimated life of the acquired assets or assumed liabilities.

The purchase date valuations and any subsequent adjustments determine the amount of goodwill recognized in connection with the acquisition.

The use of different assumptions could produce significantly different valuation results, which could have a positive or negative effect on the Corporation's results of operations.

The determination of fair values is based on valuations using management's assumptions of future growth rates, future attrition, discount rate, and other relevant factors.

In addition, third party specialists are used to assist in the development of fair values.

Preliminary estimates of fair values may be adjusted for a period of time subsequent to the acquisition date if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date.

Adjustments recorded during this period are recognized in the current reporting period.

The Corporation uses various valuation methodologies to estimate the fair value of assets and liabilities, and often involves a significant degree of judgment, particularly when liquid markets do not exist for the particular item being valued.

Changes in these factors as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying value of assets, including goodwill and liabilities, which could result in impairment losses affecting the financial statements.

Results of operations of Level One are included in the income statement from the date of acquisition.

Details of the Corporation's acquisitions are included in NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

RESULTS OF OPERATIONS - 2022

The Corporation reported net income available to common stockholders and diluted earnings per common share for the year ended 2022 of $220.7 million and $3.81 per diluted common share, respectively, compared to $205.5 million and $3.81 per diluted common share, respectively, for the year ended 2021.

Adjusted net income available to common stockholders for the year ended 2022, excluding income on PPP loans and Level One acquisition-related expenses, was $243.4 million and adjusted diluted earnings per common share totaled $4.20, compared to $182.2 million and $3.38, respectively, for the year ended 2021.

These adjusted net income and earnings per share amounts are non-GAAP measures.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As of December 31, 2022, total assets equaled $17.9 billion, an increase of $2.5 billion from December 31, 2021.

The Corporation acquired Level One on April 1, 2022, which added $2.5 billion in assets at acquisition.

Details of the acquisition are discussed within NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Cash and due from banks and interest-bearing deposits decreased from December 31, 2021 by $44.6 million and $348.1 million, respectively, as excess cash was used to fund organic loan growth.

Total investment securities decreased $260.6 million from December 31, 2021.

The net unrealized gain on the Corporation's available for sale investment securities portfolio of $75.9 million at December 31, 2021 changed to a net unrealized loss of $296.7 million as of December 31, 2022.

The change to a net unrealized loss position was due to changes in interest rates and not credit quality.

Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 4.

INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation's total loan portfolio grew $2.8 billion since December 31, 2021, of which, $1.6 billion was the result of the Level One acquisition.

At acquisition, Level One's loan portfolio included $43.5 million of PPP loans.

As of December 31, 2022, the Corporation's PPP loan portfolio, which included PPP loans from Level One, were primarily in the commercial and industrial loans class and totaled $4.7 million, a decrease of $145.3 million from the December 31, 2021 balance of $106.6 million plus the additional $43.5 million from Level One.

Excluding the decline in PPP loans and the effect of Level One's acquired loans at acquisition date, the Corporation experienced organic loan growth of $1.3 billion, or 13.9 percent since December 31, 2021.

All loan classes experienced increases from December 31, 2021, with the exception of agricultural land, production and other loans to farmers, and the largest increases were in residential real estate, commercial and industrial loans and construction real estate.

Additional details of the changes in the Corporation's loan portfolio are discussed within NOTE 5.

LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

The Corporation’s allowance for credit losses - loans ("ACL - loans") totaled $223.3 million as of December 31, 2022 and equaled 1.86 percent of total loans, compared to $195.4 million and 2.11 percent of total loans at December 31, 2021.

The ACL - loans increased $16.6 million in connection with the Level One acquisition for CECL Day 1 purchased credit deteriorated ("PCD") loans and provision expense of $14.0 million was recorded for CECL Day 1 non-PCD loans.

Additionally, provision expense of $2.8 million was recorded for CECL Day 1 unfunded commitments, which increased other liabilities.

The Corporation did not recognize any provision expense during 2022 and 2021 other than CECL Day 1 expense.

During the year ended December 31, 2022, the Corporation recognized $2.7 million of net charge-offs, compared to net charge-offs of $9.3 million for the year ended December 31, 2021.

Non-accrual loans totaled $42.3 million, a decrease of $738,000 from December 31, 2021, but when considering the non-accrual loans acquired from Level One of $9.4 million, non-accruals decreased $10.1 million.

The coverage ratio of ACL - Loans to non-accrual loans is a robust 527.5 percent.

Additional details of the Corporation's allowance methodology and asset quality are discussed within NOTE 5.

LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K and within the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Several additional asset categories increased from December 31, 2021 primarily due to the acquisition of Level One, including premises and equipment of $11.5 million, FHLB stock of $9.8 million, interest receivable of $27.9 million, goodwill of $166.6 million, other intangibles of $10.4 million and cash surrender value of life insurance of $17.3 million.

OREO totaled $6.4 million as of December 31, 2022 and increased $5.9 million from the December 31, 2021 balance of $558,000, primarily due to a $5.8 million student housing property that was moved into OREO during the first quarter of 2022.

A loss on this project is not expected.

The Corporation’s tax asset, deferred and receivable increased from $35.6 million at December 31, 2021 to $111.2 million at December 31, 2022, which included the Corporation’s net deferred tax asset increasing from $24.3 million at December 31, 2021 to $109.5 million at December 31, 2022.

The $85.2 million increase in the Corporation’s net deferred tax asset was primarily due to accounting for unrealized gains and losses on available for sale securities and an increase in CECL from the acquisition of Level One.

The Corporation's other assets increased $81.5 million from December 31, 2021.

The Corporation's derivative assets (recorded in other assets) and derivative liabilities (recorded in other liabilities) increased $51.9 million and $50.8 million, respectively, from December 31, 2021.

The increase in valuations are due to an increase in the total notional amount outstanding, continual increases in the FOMC’s target fed funds rate resulting in higher nominal rates and increased forward rate expectations.

The remaining increases in other assets relate to the Corporation's investments in community redevelopment funds, which increased $16.0 million since December 31, 2021 and an increase of $3.9 million in receivables due to pending settlements related to asset sales.

The Level One acquisition contributed to an increase in the right of use lease asset of $5.8 million related to the addition of Level One's leased facilities and an increase in mortgage servicing rights of $3.4 million related to Level One's mortgage servicing portfolio.

Deposits increased $1.7 billion from December 31, 2021, of which, the acquisition of Level One contributed $1.9 billion in deposits.

When excluding the deposits related to the acquisition, the Corporation experienced an organic deposit decline of $280.6 million, or 2.2 percent.

Additional details regarding the acquisition are discussed within NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The majority of the organic deposit decline was due to decreases in non-maturity deposits of $513.5 million, which was offset by increases in maturity deposits of $232.9 million when compared to December 31, 2021.

Higher interest rates have resulted in customers migrating funds from non-maturity products into maturity time deposit products.

Total borrowings increased $679.7 million as of December 31, 2022, compared to December 31, 2021.

Federal funds purchased and Federal Home Loan Bank advances increased $171.6 million and $489.6 million, respectively, compared to December 31, 2021 as the Corporation utilized liquidity sources to fund organic loan growth.

The Level One acquisition contributed to the increase in borrowings due to the assumption of $160.0 million of Federal Home Loan Bank advances and $32.6 million of subordinated debentures.

Additional details of the Corporation's borrowings are discussed within NOTE 11.

BORROWINGS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation's other liabilities as of December 31, 2022 increased $28.3 million compared to December 31, 2021.

As noted above, the derivative hedge liability increased $50.8 million from December 31, 2021.

At December 31, 2021, the Corporation accrued $46.1 million of trade date accounting related to loan and investment securities purchases, of which, there was no accrual at December 31, 2022.

The Corporation's liability related to mortgages sold in the secondary market, but with the servicing retained, increased $11.6 million from December 31, 2021.

The Level One acquisition contributed to an increase in the lease liability of $5.7 million related to the addition of Level One's leased facilities and an additional $2.8 million for CECL Day 1 allowance for credit losses on off-balance sheet credit exposures recorded in liabilities.

As part of the Level One acquisition, each outstanding share of 7.5 percent non-cumulative perpetual preferred stock, Series B, of Level One was exchanged for one share of a newly created 7.5 percent non-cumulative perpetual preferred stock, Series A, of the Corporation with a liquidation preference of $2,500 per share.

As a result, the Corporation issued 10,000 shares of Series A preferred stock at the acquisition date resulting in $25.0 million of outstanding preferred stock at December 31, 2022.

The Corporation continued to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized.” Details of the Stock Repurchase Program and regulatory capital ratios are discussed within the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

RESULTS OF OPERATIONS - 2021

Net income available to stockholders for the year ended December 31, 2021 was $205.5 million compared to $148.6 million for the year ended 2020.

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At December 31, 2021, the Corporation's PPP loan portfolio, primarily included in the commercial and industrial loan class, totaled $106.6 million, a decrease of $560.5 million from the December 31, 2020 balance of $667.1 million.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The largest loan classes that experienced increases from December 31, 2020 were public finance and other commercial loans, real estate construction loans and commercial real estate (owner occupied) loans.

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As those consolidations finalized in the second quarter of 2021, the fair value of the closed banking centers of $4.5 million was moved from premises and equipment to assets held for sale (recorded in other assets) while they are marketed for sale.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation’s tax asset, deferred and receivable increased from $12.3 million at December 31, 2020 to $35.6 million at December 31, 2021.

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Additionally, as noted above, the derivative hedge liability decreased $34.4 million from December 31, 2020.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation continued to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized.” Details of the Corporation's stock repurchase program and regulatory capital ratios are discussed within the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

RESULTS OF OPERATIONS - 2020

Net income available to stockholders for the year ended December 31, 2020 was $148.6 million compared to $164.5 million during the same period in 2019.

Earnings per fully diluted common share for 2020 totaled $2.74 compared to $3.19 during the same period in 2019.

As of December 31, 2020, total assets equaled $14.1 billion, an increase of $1.6 billion, or 12.9 percent, from December 31, 2019.

The Corporation's total loan portfolio increased $778.8 million, or 9.2 percent from December 31, 2019.

At December 31, 2020, the Corporation's PPP loan portfolio totaled $667.1 million, net of $12.5 million of deferred processing fee income and costs, which were primarily included in the commercial and industrial loan class.

Other loan segments that experienced large increases from December 31, 2019 were commercial real estate, non-owner occupied and public finance and other commercial loans.

The largest loan segments that experienced a decrease were real estate construction and home equity loans.

Additional details of the changes in the Corporation's loans are discussed within NOTE 5.

LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "LOAN QUALITY" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Interest-bearing deposits increased $274.0 million from December 31, 2019 due to excess liquidity from deposit growth and an increase in wholesale funding.

Additionally, total investment securities increased $550.7 million, or 21.2 percent, from December 31, 2019 as a portion of the excess liquidity from deposit growth and additional wholesale funding was used to invest in the bond portfolio.

Also contributing to the increase in investment securities was a $62.1 million increase in net unrealized gains on the available for sale portfolio.

The net increase in unrealized gains from December 31, 2019 to December 31, 2020 is primarily due to interest rate declines in 2020 as the longer term points on the yield curve have declined since year-end, which increases the fair value of securities in the portfolio.

Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 4.

INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation’s allowance for loan losses totaled $130.6 million as of December 31, 2020 and equaled 1.41 percent of total loans.

For the year ended December 31, 2020, the Corporation's provision expense and net charge-offs were $58.7 million and $8.3 million, respectively, compared to provision expense and net charge-offs of $2.8 million and $3.1 million during the same period in 2019.

For the year ended December 31, 2020, there were charge-offs greater than $500,000 on two commercial relationships, which totaled $7.3 million.

The largest of the two charge-offs was $6.7 million for a university apparel relationship.

For the same period in 2019, there were two commercial charge-offs greater than $500,000 which totaled $3.6 million.

The increase in the allowance for loan losses and provision expense primarily reflects our view of increased credit risk related to the COVID-19 pandemic.

Additional details of the changes in the Corporation's allowance for loan losses are discussed within NOTE 5.

LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "PROVISION EXPENSE AND ALLOWANCE FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Accounting Standards Update No.

2016-13, Financial Instruments - Credit Losses (Topic 326):

Measurement of Credit losses on Financial Instruments ("CECL") had an original adoption date of January 1, 2020, which included a day 1 measurement date of January 1, 2020.

The CARES Act, passed by Congress on March 27, 2020 in response to the COVID-19 pandemic, created an optional deferral of the CECL adoption date.

Pursuant to the CARES Act and the related joint statement of federal banking regulators (which also became effective as of March 27, 2020), and consistent with guidance from the SEC and FASB, the Corporation elected to delay implementation of ASU No.

The 2021 Consolidated Appropriations Act, signed into law on December 27, 2020, provided the annual funding for the federal government and also contained several rules giving further COVID-19 relief, one of which was an extension of the adoption date for CECL to the earlier of January 1, 2022 or the first day of the fiscal year that begins after the termination of the national emergency.

The Corporation elected to adopt CECL on January 1, 2021 with a day one measurement date of January 1, 2021.

As a result of the Corporation’s election, its 2020 financial statements have been prepared under the existing incurred loss model.

Non-accrual loans totaled $61.5 million at December 31, 2020, an increase of $45.6 million from the December 31, 2019 balance of $15.9 million.

The increase in non-accrual loan balances during 2020 was primarily due to four non-owner occupied commercial real estate properties, in the senior and assisted living industry, moving to non-accrual.

The total reported balance of these four loans was $40.0 million.

Additional details of the Allowance for Loan Losses and non-performing loans are discussed within the “LOAN QUALITY" and "PROVISION EXPENSE AND ALLOWANCE FOR CREDIT LOSSES ON LOANS” sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Corporation's other assets increased $45.9 million from December 31, 2019.

The Corporation's derivative asset (recorded in other assets) and derivative liability (recorded in other liabilities) relating to interest rate contracts increased $46.5 million and $47.1 million, respectively, from December 31, 2019.

The increases are primarily due to a $292.7 million increase in the related outstanding notional balance.

Additionally, yield curve rates used for valuation purposes were lower at each term point as of December 31, 2020 compared to December 31, 2019.

This was primarily the result of investors seeking the safety of U.S.

Treasuries, coupled with Federal Reserve purchases of U.S.

Treasuries, as containment efforts related to the COVID-19 outbreak began to significantly reduce economic activity.

As of December 31, 2020, total deposits equaled $11.4 billion, an increase of $1.5 billion, or 15.5 percent, from December 31, 2019.

The Corporation experienced increases from December 31, 2019 in demand and savings accounts of $1.6 billion and $765.5 million, respectively.

A portion of the increase is due to PPP loans that have remained on deposit, in addition to consumer Economic Impact Payments from the IRS that have also remained on deposit.

Offsetting these increases were decreases in certificates of deposit and brokered deposits of $673.2 million and $141.2 million, respectively, from December 31, 2019.

The low interest rate environment has resulted in customers migrating funds from maturing time deposit products into non-maturity products due to similar rates offered for both products.

NON-GAAP FINANCIAL MEASURES

The Corporation's accounting and reporting policies conform to GAAP and general practices within the banking industry.

As a supplement to GAAP, the Corporation provides non-GAAP performance measures, which management believes are useful because they assist investors in assessing the Corporation's performance.

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited.

Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.

Where non-GAAP financial measures are used, the comparable GAAP financial measure, as well as the reconciliation to the comparable GAAP financial measure can be found in the following tables.

Adjusted earnings per share, excluding PPP loans and acquisition-related expenses, are meaningful non-GAAP financial measures for management, as they provide a meaningful foundation for period-to-period and company-to-company comparisons, which management believes will aid both investors and analysts in analyzing our financial measures and predicting future performance.

These non-GAAP financial measures are also used by management to assess the performance of the Corporation's business, because management does not consider these items to be relevant to ongoing financial performance on a per share basis.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Total borrowings decreased $47.8 million as of December 31, 2020, compared to December 31, 2019.

The Corporation's Federal Funds purchased decreased $55 million from December 31, 2019.

The excess liquidity generated from deposit growth reduced the Corporation's need for overnight funding.

Additionally, subordinated debentures and term loans decreased $20.3 million as the Corporation redeemed $20.0 million of subordinated debentures.

Of the redemptions, $10.0 million was for a partial redemption of debentures held by First Merchants Capital Trust II (“FMC Trust II”) and the remaining $10.0 million was for a complete redemption of debentures held by Grabill Capital Trust I ("Grabill Trust").

Both FMC Trust II and Grabill Trust used the proceeds from the redemptions to concurrently redeem like amounts of their capital (preferred) securities, each with an aggregate principal redemption price of $10.0 million.

The common securities of FMC Trust II are, and the common securities of Grabill Trust were, held by the Corporation (recorded in other assets).

Subsequent to the redemption of its capital securities, Grabill Trust was dissolved.

Offsetting these decreases, Federal Home Loan Bank advances increased $38.4 million compared to December 31, 2019.

The Corporation took advantage of the low interest rate environment to lock in longer term FHLB advances at low rates.

The Corporation's other liabilities as of December 31, 2020 increased $50.4 million compared to December 31, 2019.

As noted above, the derivative hedge liability increased $47.1 million from December 31, 2019.

Additionally, the Corporation accrued $6.2 million of trade date accounting related to investment securities purchases as of December 31, 2020, of which, there was no accrual at December 31, 2019.

The Corporation was able to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized.” Details of the Stock Repurchase Programs and regulatory capital ratios are discussed within the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Non-GAAP financial measures such as tangible common equity to tangible assets, tangible earnings per share, return on average tangible assets and return on average tangible equity are important measures of the strength of the Corporation's capital and ability to generate earnings on tangible common equity invested by our shareholders.

These non-GAAP measures provide useful supplemental information and may assist investors in analyzing the Corporation’s financial position without regard to the effects of intangible assets and preferred stock, but do retain the effect of accumulated other comprehensive gains (losses) in shareholder's equity.

Disclosure of these measures also allows analysts and banking regulators to assess our capital adequacy on these same bases.

ADJUSTED EPS EXCLUDING PAYCHECK PROTECTION PROGRAM ("PPP") AND ACQUISITION RELATED EXPENSES - non-GAAP

(Dollars In Thousands, Except Per Share Amounts)

December 31, 2022 December 31, 2021 December 31, 2020

Net Income Available to Common Stockholders - GAAP $ 220,683 $ 205,531 $ 148,600

PPP loan income (3,207) (30,900) (22,418)

Acquisition-related expenses 16,531 — —

Acquisition-related provision expense 16,755 — —

Tax on adjustment (7,376) 7,577 5,497

Adjusted Net Income Available to Common Stockholders - non-GAAP $ 243,386 $ 182,208 $ 131,679

Average Diluted Common Shares Outstanding (in thousands) 57,950 53,984 54,220

Diluted Earnings Per Common Share - GAAP $ 3.81 $ 3.81 $ 2.74

PPP loan income (0.06) (0.57) (0.41)

Acquisition-related expenses 0.28 —

Acquisition-related provision expense 0.30 —

Tax on adjustment (0.13) 0.14 0.10

Adjusted Diluted Earnings Per Common Share - non-GAAP $ 4.20 $ 3.38 $ 2.43

TANGIBLE COMMON EQUITY TO TANGIBLE ASSETS - non-GAAP

(Dollars in thousands, except per share amounts)

December 31, 2022 December 31, 2021

Total Stockholders' Equity (GAAP) $ 2,034,770 $ 1,912,571

Preferred stock (GAAP) (25,125) (125)

Intangible assets (GAAP) (747,844) (570,860)

Tangible common equity (non-GAAP) $ 1,261,801 $ 1,341,586

Total assets (GAAP) $ 17,938,306 $ 15,453,149

Intangible assets (GAAP) (747,844) (570,860)

Tangible assets (non-GAAP) $ 17,190,462 $ 14,882,289

Stockholders' Equity to Assets (GAAP) 11.34 % 12.38 %

Tangible common equity to tangible assets (non-GAAP) 7.34 % 9.01 %

Tangible common equity (non-GAAP) $ 1,261,801 $ 1,341,586

Tax benefit of intangibles (non-GAAP) 7,702 4,875

Tangible common equity, net of tax (non-GAAP) $ 1,269,503 $ 1,346,461

Common Stock outstanding (in thousands) 59,171 53,410

Book Value (GAAP) $ 33.96 $ 35.81

Tangible book value - common (non-GAAP) $ 21.45 $ 25.21

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

TANGIBLE EARNINGS PER SHARE, RETURN ON TANGIBLE ASSETS AND RETURN ON TANGIBLE EQUITY - non-GAAP

(Dollars in thousands, except per share amounts)

December 31, 2022 December 31, 2021 December 31, 2020

Average goodwill (GAAP) $ 671,485 $ 545,374 $ 543,919

Average other intangibles (GAAP) 35,885 27,590 32,106

Average deferred tax on other intangibles (GAAP) (7,567) (5,452) (6,648)

Intangible adjustment (non-GAAP) $ 699,803 $ 567,512 $ 569,377

Average stockholders' equity (GAAP) $ 1,972,445 $ 1,866,632 $ 1,825,135

Average preferred stock (GAAP) (18,875) (125) (125)

Intangible adjustment (non-GAAP) (699,803) (567,512) (569,377)

Average tangible capital (non-GAAP) $ 1,253,767 $ 1,298,995 $ 1,255,633

Average assets (GAAP) $ 17,220,002 $ 14,830,397 $ 13,466,269

Intangible adjustment (non-GAAP) (699,803) (567,512) (569,377)

Average tangible assets (non-GAAP) $ 16,520,199 $ 14,262,885 $ 12,896,892

Net income available to common stockholders (GAAP) $ 220,683 $ 205,531 $ 148,600

Other intangible amortization, net of tax (GAAP) 6,537 4,540 4,730

Preferred stock dividend 1,406 — —

Tangible net income available to common stockholders (non-GAAP) $ 228,626 $ 210,071 $ 153,330

Per Share Data:

Diluted net income available to common stockholders (GAAP) $ 3.81 $ 3.81 $ 2.74

Diluted tangible net income available to common stockholders (non-GAAP) $ 3.95 $ 3.89 $ 2.83

Return on average GAAP capital (ROE) 11.19 % 11.01 % 8.14 %

Return on average tangible capital 18.12 % 16.17 % 12.21 %

Return on average assets (ROA) 1.29 % 1.39 % 1.10 %

Return on average tangible assets 1.38 % 1.47 % 1.19 %

Return on average tangible capital is tangible net income available to common stockholders expressed as a percentage of average tangible capital.

Return on average tangible assets is tangible net income available to common stockholders expressed as a percentage of average tangible assets.

NET INTEREST INCOME

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Therefore, management believes these measures provide useful information for both management and investors by allowing them to make peer comparisons.

Net interest margin, on a tax equivalent basis, decreased 11 basis points to 3.18 percent for 2021 compared to 3.29 percent in 2020.

For the year ended December 31, 2021, the increase in average earning assets of $1.5 billion was primarily attributable to an increase in investment securities of $1.1 billion.

For the year ended December, 31 2022, FTE asset yields increased 50 basis points compared to the same period in 2021.

Average earning assets for the year ended December 31, 2022 increased $2.4 billion compared to the same period in 2021, with loans accounting for $1.8 billion of the increase and investment securities accounting for $852.1 million of the increase.

Of the $1.8 billion increase in average loans, $1.6 billion was attributable to the Level One acquisition on April 1, 2022, and the remaining increase was due to organic loan growth during the period after excluding PPP loans, which averaged approximately $33.2 million for the year ended December 31, 2022 compared to an average of approximately $433.7 million for the same period of 2021.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The increase in interest income, on an FTE basis, of $162.4 million during the year ended December 31, 2022 compared to the same period in 2021 was primarily due to an increase in average earning assets, coupled with the FOMC's interest rate increases of an aggregate 425 basis points in 2022.

Approximately $8.0 billion of the Corporation's loan portfolio, or 67 percent, is variable with 40 percent of the portfolio repricing within one month and 50 percent repricing within three months.

Additionally, due to the FOMC interest rate increases in 2022, the yields on new and renewed loans increased for the twelve months ended December 31, 2022 compared to the same period in 2021.

The PPP loans originated in 2021 and 2020 were recorded at an interest rate of only 1 percent.

The Corporation recognized fee and interest income of $3.2 million on PPP loans in 2022, compared to $30.9 million in 2021, which is included in interest income.

The Corporation also recognized fair value accretion income on purchased loans, which is included in interest income, of $10.1 million, which accounted for 6 basis points of net interest margin in the year ended December 31, 2022.

Comparatively, the Corporation recognized $7.3 million of accretion income for the year ended December 31, 2021, or 5 basis points of net interest margin.

Interest costs increased 37 basis points, which mitigated a majority of the 50 basis point increase in asset yields and resulted in a 13 basis point FTE increase in net interest spread when compared to the same period in 2021.

Interest costs have increased during the quarter due to deposit pricing pressure primarily in the municipal deposit space and a strategic focus on relationship pricing.

Average interest-bearing deposits for the year ended December 31, 2022 increased $1.3 billion compared to the same period in 2021 due to the acquisition of Level One, which included $1.2 billion of interest-bearing deposits, and the remaining increase due to organic growth.

Average non-interest bearing deposits for the year ended December 31, 2022 increased $752.2 million when compared to the same period in 2021 as $738.9 million were acquired from Level One, and the remaining increase due to organic growth.

Non-interest bearing deposits represented 23 percent of the Corporation's total deposit balance as of December 31, 2022 and acts to mitigate deposit yield increases as interest rates rise.

Average borrowings increased $248.6 million for the year ended December 31, 2022 compared to the same period of 2021 due to the additional $194.2 million of borrowings acquired from Level One.

Interest-bearing deposits and borrowing costs for the year ended December 31, 2022 were 0.58 percent and 2.46 percent, respectively, compared to 0.24 percent and 1.97 percent, respectively, during the same period in 2021.

Total cost of funds was 72 basis points for the year ended December 31, 2022 compared to 35 basis points during the same period in 2021.

Net interest margin, on an FTE basis, increased 23 basis points to 3.41 percent for the year ended December, 31 2022 compared to 3.18 percent for the same period in 2021.

In 2021, the increase in average earning assets of $1.5 billion was primarily attributable to an increase in investment securities of $1.1 billion.

Additionally, since the beginning of the PPP in April 2020, the Bank originated over $1.2 billion of PPP loans which averaged $433.7 million in 2021 and $601.8 million in 2020.

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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In 2020, the increases in net interest income and average earning assets were primarily attributable to an increase in loans and investment securities portfolio.

Asset yields decreased 94 basis point FTE and interest costs decreased 67 basis points, resulting in a 27 basis point FTE decrease in net interest spread as compared to 2019.

The decrease in asset yields was primarily a result of the FOMC's interest rate decreases of 50 basis points on March 3, 2020 and 100 basis points on March 16, 2020 at the Committee's special meetings related to COVID-19, and the decline in one-month LIBOR from December 31, 2019 to December 31, 2020 of 162 basis points.

The PPP loans originated in 2020 were recorded at an interest rate of only 1 percent, but the Corporation also recognized fee income of $16.2 million during 2020, which is included in interest income and had a positive impact to net interest margin of 2 basis points for 2020.

Average earning assets increased 2.1 billion in 2020 compared to 2019 primarily due to the September 1, 2019 MBT acquisition being included in the 2020 average balances for an entire year compared to only four months in 2019.

Additionally, the Bank originated over $900 million of PPP loans which averaged $601.8 million for the year.

The increase in the investment securities portfolio was the result of excess liquidity generated from growth in deposits and wholesale funding being used to invest in the bond portfolio.

The Corporation also recognized fair value accretion income on purchased loans, which is included in interest income, of $13.5 million, which accounted for 11 basis points of net interest margin for the year ended December 31, 2020.

Comparatively, the Corporation recognized $12.0 million of fair value accretion income, which accounted for 12 basis points of net interest margin for the year ended December 31, 2019.

Net interest margin is a function of net interest income and the level of average earning assets.

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(5) Net Interest Margin (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average earning assets.

(6) Commercial loans included $106.6 million and $667.1 million of Paycheck Protection Program ("PPP") loans at December 31, 2021 and 2020, respectively.

(6) Commercial loans included $4.7 million, $106.6 million and $667.1 million of Paycheck Protection Program ("PPP") loans at December 31, 2022, 2021 and 2020, respectively.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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Non-interest income totaled $107.9 million in 2022, a decrease of $1.4 million, or 1.3 percent, from 2021.

Customer related fees increased $2.6 million in 2021 compared to 2020 with the largest increase of $4.6 million attributable to fiduciary and wealth management fees of which $3.6 million was organic growth and $1.0 million resulted from the acquisition of Hoosier Trust Company.

Details of the Hoosier Trust Company acquisition can be found in NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Customer related line items where decreases were experienced included net gains and fees on sales of loans of $9.6 million due to lower mortgage origination volume in 2022 compared to 2021, in addition to the $2.9 million gain on the portfolio mortgage loan sale that occurred in the second quarter of 2021, and in derivative hedge fees which decreased $0.5 million due to the rising interest rate environment.

Offsetting these decreases were increases in customer related line items, which totaled $10.2 million, with the most significant increases experienced in service charges on deposit accounts, card payment fees, and fiduciary and wealth management fees, which were all influenced by the larger customer base from the Level One acquisition on April 1, 2022.

Net realized gains on sales of available for sale securities decreased $4.5 million from 2021 and other income decreased $1.1 million in 2022, when compared to 2021, primarily as a result of a $1.9 million write-down of an equity investment in the third quarter of 2022.

Finally, gains on life insurance benefits of $6.0 million increased $3.8 million from 2021 as a result of increased BOLI death benefits.

Non-interest income totaled $109.3 million in 2021, a decrease of $0.6 million, or 0.5 percent, from 2020.

Customer related line items increased $2.6 million in 2021 compared to 2020 with the largest increase of $4.6 million attributable to fiduciary and wealth management fees of which $3.6 million was organic growth and $1.0 million resulted from the acquisition of Hoosier Trust Company.

Additionally, service charges on deposit accounts increased $2.6 million due to both continued organic growth in the deposit customer base and a lesser impact from the COVID-19 pandemic on customer activity than in 2020.

Finally, net gains and fees on sales of loans increased $1.4 million during 2021 as volume remained strong and was enhanced by a gain of $2.9 million from a $76.1 million portfolio mortgage loan sale.

The largest offsetting decreases in customer related fees, when comparing 2021 to 2020, were a $3.1 million decline in derivative hedge fees, and a $2.9 million decline in card payment fees that resulted from the first full year impact of the Durbin Amendment to the Dodd-Frank Act, which became effective for the Bank on July 1, 2020.

The largest non-customer related increase in non-interest income, when comparing 2021 to 2020, was a $2.1 million increase in gains on life insurance benefits resulting from BOLI death benefits.

Finally, the largest non-customer related decrease was $6.2 million less net realized gains on sales of available for sale securities in 2021 than 2020.

Non-interest income totaled $109.9 million in 2020, an increase of $23.2 million, or 26.8 percent, over 2019.

The low mortgage interest rate environment and larger customer base resulting from the MBT acquisition on September 1, 2019 combined to produce an increase of $10.4 million in net gains and fees on sales of loans.

Additionally, the larger customer base from the MBT acquisition, in addition to organic growth, resulted in increases in fiduciary and wealth management fees and derivative hedge fees totaling $6.2 million and $1.6 million, respectively.

Finally, net realized gains on the sale of available for sale securities increased $7.5 million when compared to 2019.

These increases were partially offset by a decrease in service charges on deposit accounts of $2.0 million mainly due to higher than normal customer deposit balances as a result of stimulus funds received in response to the COVID-19 pandemic.

This resulted in significantly lower non-sufficient funds and overdraft fees when compared to 2019.

Additionally, card payment fee income decreased $0.7 million when compared to 2019.

While the larger customer base resulting from the MBT acquisition and organic growth resulted in increased transaction volume, the cap placed on interchange fee income as a result of the Durbin Amendment to the Dodd-Frank Act became effective for the Bank July 1, 2020 and resulted in less interchange revenue.

Offsetting these increases were decreases in customer related line items experienced in derivative hedge fees of $3.1 million and $2.9 million in card payment fees that resulted from the first full-year impact of the Durbin Amendment to the Dodd-Frank Act, which became effective for the Bank on July 1, 2020.

Finally, the largest variances in non-customer related line items when comparing 2021 to 2020, were an increase in gains on life insurance benefits of $2.1 million resulting from BOLI death benefits and a decrease in net realized gains on sales of available for sale securities of $6.2 million.

Details of the Level One and Hoosier Trust Company acquisitions can be found in NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

NON-INTEREST EXPENSES

Non-interest expense totaled $355.7 million in 2022, an increase of $76.5 million, or 27.4 percent from 2021.

Level One acquisition-related costs in 2022 totaled $16.5 million, of which $7.1 million was in professional and other outside services, $6.0 million was reflected in salaries and employee benefits, and $2.2 million in equipment expenses and outside data processing expenses.

The acquisition-related expenses were primarily contract termination charges, core system conversion expenses, transaction advisory services, and employee retention bonuses and severance.

Additionally, $20.0 million of post-acquisition non-interest expenses related to Level One operations were recorded during 2022, which primarily included $13.8 million in salaries and employee benefits and $3.1 million in net occupancy expenses.

In addition to the salary and benefits expense increases related to the acquisition of Level One, merit and incentive expense increases contributed to the overall $39.9 million increase in salaries and employee benefits for 2022 compared to 2021.

Increases in other expenses of $7.4 million, in 2022 over 2021, were driven by higher customer-related contingent losses, increased customer related travel and entertainment expenses, and increased mortgage servicing rights amortization.

Equipment and outside data processing expenses increased $4.5 million and $3.4 million, respectively, as the Corporation's investment in customer-facing digital solutions in 2022, such as online account origination, resulted in increased software costs when compared to 2021.

As the Bank continues to grow both organically and via acquisition, FDIC assessments have increased $4.0 million when compared to 2021.

Finally, intangible asset amortization increased $2.5 million due to the core deposit intangible and non-compete amortization related to the Level One acquisition.

Non-interest expense totaled $279.2 million in 2021, an increase of $15.8 million, or 6.0 percent, over 2020.

The largest contributing factor was an $11.1 million increase in salaries and employee benefits primarily due to higher salary and incentive expenses based upon current year financial results along with higher employee benefit costs primarily from rising health insurance costs.

Additionally, other outside data processing fees increased $3.9 million in 2021, when compared to 2020, primarily due to increased loan processing expense and digital platform delivery expenses in 2021, primarily due to the deployment of online account origination technology.

Also, the Corporation recorded reduced expense in 2020 from the sunsetting of a debit rewards program.

Also, professional and other outside services increased $3.0 million in 2021 as projects that were delayed in 2020 due to the onset of the COVID-19 pandemic were resumed.

The Corporation also recorded $0.5 million of expense directly related to the pending Level One Bancorp, Inc.

Details of the merger can be found in NOTE 2.

Additionally, other outside data processing fees increased $3.9 million in 2021, when compared to 2020, primarily due to increased loan processing expense and digital platform delivery expenses in 2021, due to the Corporation's deployment of online account origination technology.

The Corporation also recorded reduced expense in 2020 from the sunsetting of a debit rewards program which contributed to the increase in outside data processing fees in 2021.

Professional and other outside services increased $3.0 million in 2021 as projects that were delayed in 2020, due to the onset of the COVID-19 pandemic, were resumed.

The Corporation also recorded $0.5 million of expense directly related to the acquisition of Level One which contributed to the increase in professional and other outside services in 2021 over 2020.

Finally, other expenses increased $1.3 million primarily due to a $1.4 million increase in amortization of mortgage servicing rights as the mortgage servicing portfolio increased in 2021 resulting from a $76.1 million portfolio mortgage loan sale and an increase in held for sale loans being sold with servicing rights retained.

The $3.4 million decline in net occupancy expenses in 2021 compared to 2020 was primarily driven by elevated expense in 2020, which included a charge of $3.8 million in net occupancy expenses related to the consolidation of seventeen banking centers.

Details of the Level One and Hoosier Trust Company acquisitions can be found in NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Finally, other expenses increased $1.3 million primarily due to a $1.4 million increase in amortization of mortgage servicing rights as the mortgage servicing portfolio increased in 2021 as a result of the $76.1 million portfolio mortgage loan sale and an increase in held for sale loans being sold with servicing rights retained.

Offsetting the increases detailed above was a decline of $3.4 million in 2021 from 2020 in net occupancy.

The decline was primarily driven by elevated expense in 2020, which included a charge of $3.8 million in net occupancy related to the consolidation of seventeen banking centers.

Non-interest expense totaled $263.4 million in 2020, an increase of $16.6 million, or 6.7 percent, over 2019.

The increase was driven by 2020 having a full-year of expense from the larger franchise and growth in customer base resulting from the MBT acquisition when compared to 2019 only containing four months of activity.

While the Corporation experienced increases in several non-interest expense categories the largest increase was in salaries and employee benefits which increased by $11.9 million compared to 2019.

Net occupancy and equipment expenses reflected increases of $7.2 million and $3.1 million, respectively.

In addition to the full-year impact of the larger franchise, the Corporation recorded $4.5 million of expenses in these two categories related to the recent announcement of the consolidation of seventeen banking centers.

Additionally, FDIC assessment expense increased $5.1 million in 2020, when compared to 2019, due to a combination of 2019 reflecting assessment credits issued as a result of the FDIC insurance fund reaching the FDIC's target minimum reserve ratio coupled with increased expense in the current year resulting from the Corporation's FDIC assessment changing to the calculation applicable to banks over $10 billion in total assets.

Finally, the Corporation incurred $2.5 million of additional expense in 2020, compared to 2019, related to actions taken in response to the COVID-19 pandemic which included approximately $1.5 million in net occupancy and equipment costs incurred to enhance social distancing and cleaning protocols and $1.0 million recorded in marketing expense for donations to non-profit organizations in our communities on the front lines of the COVID-19 pandemic efforts.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The increases noted above were partially offset by the Corporation having recorded $13.7 million of acquisition-related expenses in 2019 in connection with MBT, primarily consisting of $5.3 million of contract termination and core system conversion expenses, $5.2 million of employee severance and retention expenses and $1.6 million of professional and other outside services expense.

Additionally, the decrease in outside data processing fees of $2.0 million in 2020, compared to 2019, is mainly related to the sunsetting of a debit rewards program.

Finally, the Corporation also realized a decrease in other real estate owned and foreclosure expenses of $2.1 million when compared to 2019.

INCOME TAX EXPENSE

The Corporation’s federal statutory income tax rate for 2022 is 21 percent and its state tax rate varies from 0 to 9.5 percent depending on the state in which the subsidiary company operates.

The Corporation’s effective tax rate, which was 13.1 percent in 2022 and 14.6 percent in 2021, is lower than the blended effective statutory federal and state rates primarily due to the Corporation’s income on tax-exempt securities and loans, income generated by the subsidiaries operating in a state with no state or local income tax, income tax credits generated from investments in affordable housing projects, and tax-exempt earnings from bank-owned life insurance contracts.

Income tax expense in 2022 was $33.6 million on pre-tax income of $255.7 million, or 13.1 percent.

For 2021, income tax expense was $35.3 million on pre-tax income of $240.8 million, or 14.6 percent.

The lower effective income tax rate in 2020 compared to 2021 was primarily driven by two factors.

The first factor was an abnormally high level of loan provision expense in 2020 as a result of the economic impact of the COVID-19 pandemic.

Second, the CARES Act from 2020 provided for the carryback of certain federal net operating losses to a prior period with a rate differential between the 2020 statutory rate of 21 percent and the rate in effect during the carryback year.

Additionally, an increase in state taxes in 2021 contributed to the increase in the effective tax rate.

The lower effective income tax rate in 2022 compared to 2021 was primarily driven by an increases in tax-exempt earnings and gains on life insurance, which are also non-taxable.

The detailed reconciliation of federal statutory to actual tax expense is shown in NOTE 19.

INCOME TAX of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Additional income tax expense details are discussed within the “INCOME TAXES” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Stockholders' Equity

As discussed previously, the Corporation adopted the current expected credit losses ("CECL") model for calculating the allowance for credit losses on January 1, 2021.

Stockholders' Equity - CECL Adjustment

The Corporation adopted the current expected credit losses ("CECL") model for calculating the allowance for credit losses on January 1, 2021.

CECL replaces the previous "incurred loss" model for measuring credit losses, which encompassed allowances for current known and inherent losses within the portfolio, with an "expected loss" model for measuring credit losses, which encompasses allowances for losses expected to be incurred over the life of the portfolio.

As of the adoption and day one measurement date of January 1, 2021, the Corporation recorded a one-time cumulative-effect adjustment to retained earnings, net of income taxes, of $68.0 million.

See additional details of the Corporation's CECL adoption in NOTE 1.

NATURE OF OPERATIONS AND SUMMARY OR SIGNIFICANT ACCOUNTING POLICIES and NOTE 5.

LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Stock Repurchase Programs

On September 3, 2019, the Board of Directors of the Corporation approved a stock repurchase program of up to 3 million shares of the Corporation's outstanding common stock;

provided, however, that the total aggregate investment in shares repurchased under the program was not to exceed $75 million.

On a share basis, the amount of common stock subject to the repurchase program represented approximately 5 percent of the Corporation's outstanding shares.

During the first quarter of 2020, the Corporation repurchased 1,634,437 of its common shares for $55.9 million at an average price of $34.21, which resulted in the aggregate investment in share repurchases of $75.0 million, the maximum allowable under the plan.

As such, the September 2019 program terminated upon its own terms following the repurchases.

Preferred Stock

As part of the Level One acquisition, the Corporation issued 10,000 shares of newly created 7.5 percent non-cumulative perpetual preferred stock, with a liquidation preference of $2,500 per share, in exchange for the outstanding Level One Series B preferred stock, and as part of that exchange, each outstanding Level One depositary share representing a 1/100th interest in a share of the Level One preferred stock was converted into a depositary share of the Corporation representing a 1/100th interest in a share of its newly issued preferred stock.

As a result of the issuance, the Corporation had $25.0 million of outstanding preferred stock at December 31, 2022.

During the twelve months ended December 31, 2022, the Corporation declared and paid dividends of $46.88 per share (equivalent to $0.4688 per depositary share) equal to $1.4 million.

The Series A preferred stock qualifies as Tier 1 capital for purposes of the regulatory capital calculations.

Stock Repurchase Program

On January 27, 2021, the Board of Directors of the Corporation approved a stock repurchase program of up to 3,333,000 shares of the Corporation's outstanding common stock;

provided, however, that the total aggregate investment in shares repurchased under the program may not exceed $100,000,000.

On a share basis, the amount of common stock subject to the repurchase program represents approximately 6 percent of the Corporation's outstanding shares.

During 2021, the Corporation repurchased 646,102 of its common shares for $25.4 million at an average price of $39.38.

On a share basis, the amount of common stock subject to the repurchase program represented approximately 6 percent of the Corporation's outstanding shares at the time the program became effective.

During 2022, the Corporation did not repurchase any shares of its common stock pursuant to the repurchase program.

As of December 31, 2022, the C orporation had approximately 2.7 million shares at a maximum aggregate value of $74.5 million available to repurchase under the program.

In August 2022, the Inflation Reduction Act of 2022 (the “IRA”) was enacted.

Among other things, the IRA imposes a new 1 percent excise tax on the fair market value of stock repurchased after December 31, 2022 by publicly traded U.S.

corporations (like the Corporation).

With certain exceptions, the value of stock repurchased is determined net of stock issued in the year, including shares issued pursuant to compensatory arrangements.

Regulatory Capital

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Classification of a bank in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank's operations.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total risk-based capital, tier 1 capital and common equity tier 1 capital, in each case, to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the regulations.

Banks with lower capital levels are deemed to be “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized”, depending on their actual levels.

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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Basel III was effective for the Corporation on January 1, 2015 and requires the Corporation and the Bank to maintain the minimum capital and

leverage ratios as defined in the regulation and as illustrated in the table below, which capital to risk-weighted asset ratios include a 2.5 percent capital conservation buffer.

Basel III requires the Corporation and the Bank to maintain the minimum capital and leverage ratios as defined in the regulation and as illustrated in the table below, which capital to risk-weighted asset ratios include a 2.5 percent capital conservation buffer.

Under Basel III, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a 2.5 percent capital conservation buffer above the adequately capitalized CET1 to risk-weighted assets ratio (which buffer is reflected in the required ratios below).

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At December 31, 2022 and 2021, risk-weighted assets included $4.7 million and $106.6 million, respectively, of PPP loans at a zero risk weight.

Management believes that all of the above capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation.

Basel III permits banks with less than $15 billion in assets to continue to treat trust preferred securities as tier 1 capital.

This treatment is permanently grandfathered as tier 1 capital even if the Corporation should ever exceed $15 billion in assets due to organic growth but not following certain mergers or acquisitions.

As a result, while the Corporation’s total assets exceeded $15 billion as of December 31, 2021, the Corporation has continued to treat its trust preferred securities as tier 1 capital as of such date.

However, under certain amendments to the “transition rules” of Basel III, if a bank holding company that held less than $15 billion of assets as of December 31, 2009 (which would include the Corporation) acquires a bank holding company with under $15 billion in assets at the time of acquisition (which would include Level One), and the resulting organization has total consolidated assets of $15 billion or more as reported on the resulting organization’s call report for the period in which the transaction occurred, the resulting organization must begin reflecting its trust preferred securities as tier 2 capital at such time.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As a result, effective with the April 1, 2022 consummation of the Level One merger, the Corporation began reflecting all of its trust preferred securities as tier 2 capital.

Management believes the disclosed capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation.

Traditionally, the banking regulators have assessed bank and bank holding company capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations.

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Tier I regulatory capital consists primarily of total stockholders’ equity and subordinated debentures issued to business trusts categorized as qualifying borrowings, less non-qualifying intangible assets and unrealized net securities gains or losses.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

A reconciliation of GAAP measures to regulatory measures (non-GAAP) are detailed in the following table for the periods indicated.

December 31, 2022 December 31, 2021

First Merchants Corporation First Merchants Bank First Merchants Corporation First Merchants Bank

(Dollars in Thousands) First Merchants Corporation First Merchants Bank First Merchants Corporation First Merchants Bank

Total Risk-Based Capital

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(1) Includes net unrealized gains or losses on available for sale securities, net gains or losses on cash flow hedges, and amounts resulting from the application of the applicable accounting guidance for defined benefit and other postretirement plans.

Additionally, management believes the following tables are also meaningful when considering performance measures of the Corporation.

GAAP financial measures such as tangible common equity to tangible assets, return on average tangible capital and return on average tangible

assets are important measures of the strength of the Corporation's capital and ability to generate earnings on tangible common equity invested

by our shareholders.

These non-GAAP measures provide useful supplemental information and may assist investors in analyzing the

Corporation’s financial position without regard to the effects of intangible assets and preferred stock.

Disclosure of these measures also allows

analysts and banking regulators to assess our capital adequacy on these same bases.

Because these measures are not defined in GAAP or federal banking regulations, they are considered non-GAAP financial measures.

GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited.

Although these non-GAAP

financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be

considered in isolation, or as a substitute for analyses of results as reported under GAAP.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation had a strong capital position as evidenced by the tangible common equity to tangible assets ratio of 9.01 percent at December 31, 2021, and 9.65 percent at December 31, 2020.

Tangible Common Equity to Tangible Assets (non-GAAP)

(Shares and Dollars in Thousands, Except Per Share Amounts) December 31, 2021 December 31, 2020

Total Stockholders' Equity (GAAP) $ 1,912,571 $ 1,875,645

Cumulative preferred stock (GAAP) (125) (125)

Intangible assets (GAAP) (570,860) (572,893)

Tangible common equity (non-GAAP) $ 1,341,586 $ 1,302,627

Total assets (GAAP) $ 15,453,149 $ 14,067,210

Intangible assets (GAAP) (570,860) (572,893)

Tangible assets (non-GAAP) $ 14,882,289 $ 13,494,317

Stockholders' Equity to Assets (GAAP) 12.38 % 13.33 %

Tangible common equity to tangible assets (non-GAAP) 9.01 % 9.65 %

Tangible common equity (non-GAAP) $ 1,341,586 $ 1,302,627

Tax Benefit of intangibles (non-GAAP) 4,875 5,989

Tangible common equity, net of tax (non-GAAP) $ 1,346,461 $ 1,308,616

Common Stock outstanding $ 53,410 $ 53,922

Book Value (GAAP) $ 35.81 $ 34.78

Tangible book value - common (non-GAAP) $ 25.21 $ 24.27

The following table details and reconciles tangible earnings per share, return on tangible capital and tangible assets to traditional GAAP measures for the periods ended December 31, 2021 and 2020.

(Dollars in Thousands, Except Per Share Amounts) December 31, 2021 December 31, 2020

Average goodwill (GAAP) $ 545,374 $ 543,919

Average intangibles (GAAP) 27,590 32,106

Average deferred tax on intangibles (GAAP) (5,452) (6,648)

Intangible adjustment (non-GAAP) $ 567,512 $ 569,377

Average stockholders' equity (GAAP) $ 1,866,632 $ 1,825,135

Average cumulative preferred stock (GAAP) (125) (125)

Intangible adjustment (non-GAAP) (567,512) (569,377)

Average tangible capital (non-GAAP) $ 1,298,995 $ 1,255,633

Average assets (GAAP) $ 14,830,397 $ 13,466,269

Intangible adjustment (non-GAAP) (567,512) (569,377)

Average tangible assets (non-GAAP) $ 14,262,885 $ 12,896,892

Net income available to common stockholders (GAAP) $ 205,531 $ 148,600

Intangible amortization, net of tax (GAAP) 4,540 4,730

Tangible net income available to common stockholders (non-GAAP) $ 210,071 $ 153,330

Per Share Data:

Diluted net income available to common stockholders (GAAP) $ 3.81 $ 2.74

Diluted tangible net income available to common stockholders (non-GAAP) $ 3.89 $ 2.83

Return on average capital (ROE) (GAAP) 11.01 % 8.14 %

Return on average tangible capital (non-GAAP) 16.17 % 12.21 %

Return on average assets (ROA) (GAAP) 1.39 % 1.10 %

Return on average tangible assets (non-GAAP) 1.47 % 1.19 %

Return on average tangible capital is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible capital.

Return on average tangible assets is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible assets.

In management's view, certain non-GAAP financial measures, when taken together with the corresponding GAAP financial measures and ratios, provide meaningful supplemental information regarding our performance.

We believe investors benefit from referring to these non-GAAP financial measures and ratios in assessing our operating results and related trends, and when forecasting future periods.

However, these non-GAAP financial measures should be considered in addition to, and not a substitute for or preferable to, financial measures and ratios presented in accordance with GAAP.

The Corporation's tangible common equity measures are capital adequacy metrics that are meaningful to the Corporation, as well as analysts and investors, in assessing the Corporation's use of equity and in facilitating period-to-period and company-to-company comparisons.

Tangible common equity to tangible assets ratio was 7.34 percent at December 31, 2022, and 9.01 percent at December 31, 2021.

The decrease in tangible common equity and tangible assets is primarily due to the decline in mark-to-market values associated with our available for sale investment securities portfolio.

At December 31, 2021, the available for sale portfolio had a net unrealized gain of $75.9 million compared to a net unrealized loss of $296.7 million at December 31, 2022.

This decline in value is due to interest rate changes and not due to credit quality.

These non-GAAP measures provide useful supplemental information and may assist investors in analyzing the Corporation’s financial position without regard to the effects of intangible assets and preferred stock, but retain the effect of accumulated other comprehensive gains (losses) in shareholder's equity.

Disclosure of these measures also allows analysts and banking regulators to assess our capital adequacy on these same bases.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The tables within the “NON-GAAP FINANCIAL MEASURES” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations reconcile traditional GAAP measures to these non-GAAP financial measures at December 31, 2022 and December 31, 2021.

LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS

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The performance of any loan can be affected by external factors such as economic conditions, or internal factors specific to a particular borrower, such as the actions of a customer's internal management.

At December 31, 2021, non-performing loans totaled $43.4 million, a decrease of $21.3 million from December 31, 2020.

Loans not accruing interest income totaled $43.1 million at December 31, 2021, a decrease of $18.4 million from December 31, 2020.

The decrease in non-accrual loans was primarily attributed to the payoff of one senior living sector relationship totaling $23.4 million.

Other real estate owned and repossessions, totaling $558,000 at December 31, 2021, decreased $382,000 from December 31, 2020.

At December 31, 2022, non-performing loans totaled $42.5 million, a decrease of $843,000 from December 31, 2021.

Non-accrual loans totaled $42.3 million at December 31, 2022, a decrease of $738,000 from December 31, 2021.

Other real estate owned and repossessions, totaling $6.4 million at December 31, 2022, increased $5.9 million from December 31, 2021.

The increase is primarily related to a student housing property with a carrying value of $5.8 million.

For other real estate owned, current appraisals are obtained to determine fair value as management continues to aggressively market these real estate assets.

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NPAs and loans 90-days or more delinquent $ 50,716 $ 44,912

The non-accrual balances in the table above include troubled debt loan restructures totaling $13.7 million and $1.7 million as of December 31, 2021 and December 31, 2020, respectively.

The increase is primarily due to one relationship in the non-owner occupied commercial real estate loan class, totaling $12.5 million, that was restructured during 2021.

The non-accrual balances in the table above include troubled debt loan restructures totaling $11.1 million and $13.7 million as of December 31, 2022 and 2021, respectively.

The composition of non-performing assets plus accruing loans 90-days or more delinquent is reflected in the following table.

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Individual's loans for household and other personal expenditures 110 3

Public finance and other commercial loans — —

Non-performing assets and loans 90-days or more delinquent $ 50,716 $ 44,912

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The CARES Act, as amended by the 2021 CAA, allowed banks to suspend requirements under GAAP, effectively, through January 1, 2022, for certain loan modifications related to the COVID-19 pandemic.

The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 or offer other borrower friendly options.

In accordance with such guidance, the Bank made various short-term modifications for borrowers who were current and otherwise not past due.

These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that were insignificant.

At December 31, 2021, the Corporation did not have any outstanding COVID modifications, compared to $120.3 million on 87 loans at December 31, 2020.

PROVISION EXPENSE AND ALLOWANCE FOR CREDIT LOSSES ON LOANS

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The determination of the provision amount and the adequacy of the allowance in any period is based on management’s continuing review and evaluation of the loan portfolio.

The Corporation’s total loan balance increased $2.8 billion, ending December 31, 2022 at $12.0 billion.

The Level One acquisition added $1.6 billion to the total loan balance.

Through the acquisition of Level One, the Bank acquired an additional $43.5 million of PPP loans as of the acquisition date.

As of December 31, 2022, the Corporation had $4.7 million of PPP loans outstanding compared to the December 31, 2021 balance of $106.6 million.

The Corporation will continue to monitor legislative, regulatory, and supervisory developments related to the PPP.

However, it anticipates that the majority of the Bank’s remaining PPP loans will be forgiven by the SBA in accordance with the terms of the program.

Additional details of the Level One acquisition are included in NOTE 2.

ACQUISITIONS of these Notes to Consolidated Financial Statements.

At December 31, 2022, the allowance for credit losses totaled $223.3 million, which represents an increase of $27.9 million from December 31, 2021.

The acquisition of Level One added $16.6 million in allowance for credit losses on PCD loans and an additional $14.0 million in provision for credit losses on non-PCD loans.

The allowance was offset by $2.7 million in net charge offs for the twelve months ended December 31, 2022.

As a percentage of loans, the allowance for credit losses was 1.86 percent at December 31, 2022, compared to 2.11 percent at December 31, 2021 and 1.41 percent at December 31, 2020.

The allowance for credit losses as a percentage of total loans less PPP loans was 1.86 percent as of December 31, 2022.

The Corporation deems the current estimate for loan portfolio credit exposure as appropriate.

The Corporation's credit loss experience is presented in the table below for the years indicated.

8 unchanged sentences

Provision for loan/credit losses — — 58,673

CECL Day 1 non-PCD provision for credit losses 13,955 — —

CECL Day 1 PCD ACL 16,599 — —

Ending balance, December 31, 2021 $ 223,277 $ 195,397 $ 130,648

2 unchanged sentences

Ratio of allowance for credit losses - loans to total loans outstanding 1.86 % 2.11 % 1.41 %

The Corporation’s total loan bala nce remained relatively level year over year ending December 31, 2021 at $ 9.2 billion.

PPP loans accounted for $106.6 million of the total loan balance at December 31, 2021 versus a balance of $667.1 million at December 31, 2020.

The Bank anticipates that the majority of its remaining PPP loans will be forgiven by the SBA in accordance with the terms of the program.

At December 31, 2021, the allowance for credit losses totaled $195.4 million, which represents an increase of $64.7 million from December 31, 2020.

The increase in the allowance was primarily due to the $74.1 million cumulative effect adjustment related to the adoption of CECL on January 1, 2021, offset by net charge-offs during the twelve months ended December 31, 2021 of $9.3 million.

As a percentage of loans, the allowance for credit losses was 2.11 percent at December 31, 2021, compared to 1.41 percent at December 31, 2020 and 0.95 percent at December 31, 2019.

The allowance for credit losses as a percentage of total loans less PPP loans was 2.14 percent as of December 31, 2021.

The extent to which COVID-19 continues to impact the Corporation’s loan portfolio, will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and severity of the pandemic, the potential for seasonal or other resurgences, actions taken by governmental authorities and other third parties to contain and treat the virus, and how quickly and to what extent normal economic and operating conditions can resume.

The Corporation deems the current estimate for loan portfolio credit exposure as appropriate.

There was no provision for credit losses for the twelve months ended December 31, 2021 compared to $58.7 million for the same period of 2020.

The provision for the twelve months ended December 31, 2020 primarily reflected the Corporation's view of increased credit risk related to the COVID-19 pandemic and the estimated impact on the economy and the credit quality of our loan portfolio.

There was $16.8 million in provision for credit losses for the twelve months ended December 31, 2022, compared to no provision for credit losses for the twelve months ended December 31, 2021.

The provision is entirely due to the acquisition of Level One.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Net charge-offs totaling $2.7 million, $9.3 million, and $8.3 million were recognized for the twelve months ended December 31, 2022, 2021, and 2020, respectively.

For the twelve months ended December 31, 2022, there was one individual charge-off greater than $500,000 that totaled $2.8 million.

For the twelve months ended December 31, 2022, there were two individual recoveries greater than $500,000 that totaled $1.2 million.

For the twelve months ended December 31, 2021, there were four individual charge-offs greater than $500,000 that totaled $9.0 million.

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The determination of the provision for credit losses in any period is based on management’s continuing review and evaluation of the loan portfolio, and its judgment as to the impact of current economic conditions on the portfolio.

As of October 1, 2021, the Corporation performed its annual goodwill impairment testing and, in the valuation, the fair value exceeded the Corporation's carrying value;

therefore, it was concluded that goodwill was not impaired.

The Hoosier acquisition on April, 1, 2021 resulted in $1,467,000 of additional goodwill during the year.

Details regarding the Hoosier acquisition are discussed in NOTE 2.

As of October 1, 2022 and October 1, 2021, the Corporation performed its annual goodwill impairment testing and in each valuation, the fair value exceeded the Corporation's carrying value;

therefore, it was concluded goodwill was not impaired as of either date.

The Level One acquisition on April 1, 2022 resulted in $166.6 million of goodwill.

In addition, the Hoosier acquisition on April, 1, 2021 resulted in $1.5 million of additional goodwill during that year.

Details regarding the Level One and Hoosier acquisitions are discussed in NOTE 2.

ACQUISITIONS of these Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

As of October 1, 2020, the Corporation performed its annual goodwill impairment test which included various valuation considerations including comparable peer data, precedent transaction comparables, discounted cash flow analysis, overall financial performance, share price of the Corporation's common stock and other factors.

The testing for 2020 resulted in a conclusion that it was not more likely than not that the fair value of the Corporation had declined below its carrying value and no impairment loss was recorded in 2020.

Liquidity management is the process by which the Corporation ensures that adequate liquid funds are available for the holding company and its subsidiaries.

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Liquidity of the Bank is derived primarily from core deposit growth, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources.

The principal source of asset-funded liquidity is investment securities classified as available for sale, the market values of which totaled $2.3 billion at December 31, 2021, an increase of $425.4 million, or 22.2 percent, from December 31, 2020.

The principal source of asset-funded liquidity is investment securities classified as available for sale, the market values of which totaled $2.0 billion at December 31, 2022, a decrease of $367.9 million, or 15.7 percent, from December 31, 2021.

Securities classified as held to maturity that are maturing within a short period of time can also be a source of liquidity.

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Federal Home Loan Bank advances 460,097 363,577 823,674

Federal Funds Purchased 171,560 — 171,560

Subordinated debentures and term loans 1,183 150,115 151,298

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Interest-bearing deposits $ 9,880,678 $ 760,835 $ 118,931 $ 448,884 $ 11,209,328

Federal funds purchased 171,560 — — — 171,560

Securities sold under repurchase agreements 167,413 — — — 167,413

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These changes are immediate and parallel changes to the base case scenario.

In the current rate environment, many drivers are at or near historical lows due to the FOMC's rate reductions in March 2020 in response to COVID-19.

Results for rising 200 basis points and falling 100 basis points interest rate scenarios are listed below based upon the Corporation’s rate sensitive assets and liabilities at December 31, 2022.

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Earning assets increased by $2.2 billion, or 15.1 percent, during the twelve months ended December 31, 2022.

Deposit growth of $1.4 billion, coupled with proceeds from SBA forgiveness of PPP loans, generated excess liquidity.

The Corporation primarily used the excess liquidity to purchase investment securities, which increased $1.4 billion from December 31, 2020.

Additionally, a portion of the excess liquidity was held in interest bearing deposits, which increased $81.8 million from December 31, 2020.

The April 1, 2022 acquisition of Level One contributed to increases in several categories.

Additional details of the Level One acquisition can be found in NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Interest bearing deposits decreased $348.1 million from December 31, 2021 to December 31, 2022 as excess liquidity was used to fund organic loan growth.

Total investment securities decreased $260.6 million from December 31, 2021.

The change to a net unrealized loss position was due to changes in interest rates and not credit quality.

Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 4.

INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation's total loan portfolio increased $5.9 million from December 31, 2020.

At December 31, 2021, the Corporation's PPP loan portfolio, primarily in the commercial and industrial loan class, totaled $106.6 million, a decrease of $560.5 million from the December 31, 2020 balance of $667.1 million.

The Corporation experienced organic loan growth of $566.4 million, or 6.6 percent during 2021, which when offset by the decline in PPP loans, resulted in net loan growth of $5.9 million.

The largest loan classes that experienced increases from December 31, 2020 were public funds and other commercial loans, real estate construction loans and commercial real estate (owner occupied) loans.

The decline in PPP loans was offset by organic loan growth in the commercial and industrial loan class of $498.4 million, resulting in a net decrease in commercial and industrial.

Other loan classes that experienced significant decreases from December 31, 2020 were commercial real estate (non-owner occupied) loans, residential real estate loans and agricultural land, production and other loans to farmers.

The Corporation's total loan portfolio increased $2.8 million from December 31, 2021, with $1.6 billion of the increase resulting from the acquisition of Level One.

At December 31, 2022, the Corporation's PPP loan portfolio, which included PPP loans from Level One, were primarily in the commercial and industrial loan class and totaled $4.7 million, a decrease of $145.4 million from the December 31, 2021 balance of $106.6 million plus the additional $43.5 million from Level One.

Additional details of the changes in the Corporation's loan portfolio are discussed within NOTE 5.

Federal Home Loan Bank Stock increased $9.8 million from December 31, 2021.

The Level One acquisition contributed $11.7 million to the increase, which was offset by the repurchase of excess stock by the FHLB of $1.9 million.

December 31, December 31,

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Total deposits 14,382,745 12,732,577

Federal funds purchased 171,560 —

Securities sold under repurchase agreements 167,413 181,577

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Deposits increased $1.7 billion from December 31, 2021.

The Corporation experienced increases from December 31, 2020 in demand and savings deposits accounts of $883.0 million and $673.1 million, respectively.

A portion of the increase is due to PPP loans that have remained on deposit, in addition to consumer Economic Impact Payments from the IRS that have also remained on deposit.

Offsetting these increases were decreases in certificates of deposits and brokered deposits of $142.2 million and $42.9 million, respectively, from December 31, 2020.

The low interest rate environment has resulted in customers migrating from maturing time deposit products into non-maturity products due to similar rates offered for both products.

Federal Home Loan Bank advances decreased $55.4 million compared to December 31, 2020 as the Corporation utilized excess liquidity from deposit growth to pay off maturing advances.

The acquisition of Level One contributed $1.9 billion in deposits, resulting in an organic deposit decline of $280.6 million, or 2.2 percent.

Additional details regarding the acquisition are discussed within NOTE 2.

ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Higher interest rates have resulted in customers migrating funds from non-maturity products into maturity time deposit products.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Federal Home Loan Bank advances increased $489.6 million compared to December 31, 2021 as the Corporation utilized liquidity from FHLB advances to fund organic loan growth.

The Corporation has leveraged its capital position with FHLB advances, as well as repurchase agreements, which are pledged against acquired investment securities as collateral for the borrowings.

Further discussion regarding FHLB advances is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “LIQUIDITY”.

Further discussion regarding FHLB advances is included in NOTE 11.

BORROWINGS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10K and Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “LIQUIDITY”.

Additionally, the interest rate risk is included as part of the Corporation’s interest simulation discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK”.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation’s federal statutory income tax rate for 2021 is 21 percent and its state tax rate varies from 0 to 9.5 percent depending on the state in which the subsidiary company operates.

The Corporation’s effective tax rate, which was 14.6 percent in 2021 and 12.6 percent in 2020, is lower than the blended effective statutory federal and state rates primarily due to the Corporation’s income on tax-exempt securities and loans, income generated by the subsidiaries operating in a state with no state or local income tax, income tax credits generated from investments in affordable housing projects, and tax-exempt earnings from bank-owned life insurance contracts.

The reconciliation of federal statutory to actual tax expense is shown in NOTE 19.

INCOME TAX of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

The Corporation’s tax asset, deferred and receivable increased from $12.3 million at December 31, 2020 to $35.6 million at December 31, 2021.

The Corporation’s net deferred tax asset increased from $4.3 million at December 31, 2020 to $24.3 million at December 31, 2021.

The $20.0 million increase in the Corporation’s net deferred tax asset was due to a combination of an increase in deferred tax assets and a decrease in deferred tax liabilities.

The largest net deferred tax asset increases were associated with the tax effect of the implementation and accounting for CECL of $21.1 million and accounting for unrealized gains and losses on available for sale securities of $7.5 million.

Offsetting the increases to the net deferred tax asset were net deferred tax decreases associated with accounting for loan fees and accounting for pensions and employee benefits of $2.3 million and $3.3 million respectively.

Subordinated debentures and term loans increased $32.7 million compared to December 31, 2021 due to the acquisition of Level One.

Additional details regarding Level One's subordinated debentures and other borrownings are discussed within NOTE 2.

ACQUISITIONS and NOTE 11.

BORROWINGS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10K.

The Corporation’s financial statements are presented in accordance with GAAP, which requires the measurement of financial position and operating results primarily in terms of historic dollar values.

Changes in the relative value of money due to inflation or recession are generally not considered.

The primary effect of inflation on the Corporation’s operations is reflected in increased operating costs.

In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate.

While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate.

Interest rates are highly sensitive to many factors that are beyond the Corporation’s control, including changes in the expected rate of inflation, the influence of general and local economic conditions and governmental monetary and fiscal policies.

Historically, changes in interest rates have affected the financial condition of a financial institution to a far greater degree than changes in the inflation rate.

However, with inflation reaching the highest level in decades, the impact of such on the financial institution is more direct.

The most direct effect of inflation on the Corporation’s operations is reflected in increased operating costs.

The impact of inflation on operating costs in 2022 is reflected primarily in higher labor and vendor costs.

During 2022, the Federal Reserve engaged in the tightening of monetary policy to address inflation by increasing the target federal funds rate by 425 basis points.

The Corporation's sensitivity to interest rate changes are presented in this Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK”.

This rapid increase in interest rates can impact consumer spending as goods and services cost more thereby causing deposit balances to decline.

In addition, the Corporation’s loan growth could moderate as customers respond to the impact of higher interest rates, high costs and a slowing economy.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis