What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-08-07 compared with 2020-05-11 · 215 added, 113 removed, 350 unchanged (48% of the section changed)

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GABC) financial holding company based in Jasper, Indiana.

German American, through its banking subsidiary German American Bank, operates 75 banking offices in 20 contiguous southern Indiana counties, eight Kentucky counties and one county in Tennessee.

German American, through its banking subsidiary German American Bank, operates 73 banking offices in 20 contiguous southern Indiana counties and eight Kentucky counties.

The Company also owns an investment brokerage subsidiary (German American Investment Services, Inc.) and a full line property and casualty insurance agency (German American Insurance, Inc.).

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Occasionally, we will refer to the term “parent company” or “holding company” when we mean to refer to only German American Bancorp, Inc.

This section presents an analysis of the consolidated financial condition of the Company as of March 31, 2020 and December 31, 2019 and the consolidated results of operations for the three months ended March 31, 2020 and 2019.

This section presents an analysis of the consolidated financial condition of the Company as of June 30, 2020 and December 31, 2019 and the consolidated results of operations for the three and six months ended June 30, 2020 and 2019.

This discussion should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein and with the financial statements and other financial data, as well as the Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

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Such measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending.

As a result, the demand for the Company’s products and services has been, and will continue to be, significantly impacted.

While many states have lifted quarantine and lock-down orders on a limited basis and with certain social distancing restrictions, commercial activity has not yet returned to the levels existing prior to the pandemic outbreak.

A s a result, the demand for the Company’s products and services has been, and will continue to be, significantly impacted.

Interest Rates

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Among other things, this legislation amends the initial CARES Act program by raising the appropriation level for PPP loans from $349 billion to $670 billion.

The PPP was further modified on June 5, 2020 with the adoption of the Paycheck Protection Program Flexibility Act (the “Flexibility Act”), which extended the maturity date for PPP loans from two years to five years for loans disbursed on or after the date of enactment of the Flexibility Act.

For PPP loans disbursed prior to such enactment, the Flexibility Act permits the borrower and lender to mutually agree to extend the term of the

loan to five years.

The vast majority of the Company's PPP loans have two-year maturities.

PPP loans earn interest at a fixed rate of 1%.

The Bank is actively participating in assisting its customers with applications for resources through the program.

PPP loans have a two-year term and earn interest at 1%.

The Bank anticipates that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.

As of April 30, 2020, the Bank has committed approximately $352.6 million, on 2,669 loan relationships, under this program with processing

fees estimated to total approximately $12.5 million.

The Company anticipates that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.

As of June 30, 2020, the Bank has committed approximately $349.5 million, on 2,998 loan relationships, under this program with processing fees estimated to total approximately $12.6 million ($12.0 million net of processing costs).

Under the terms of the PPP program, the loans are fully guaranteed by the U.S.

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On April 7, 2020, the FRB, the Office of the Comptroller of the Currency (the “OCC”), and the Federal Deposit Insurance Corporation (the “FDIC” and, together with the FRB and OCC, the “federal banking regulators”) issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as troubled debt restructurings and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings.

Similarly, under the CARES Act, provisions were included that allow for loan modifications to not be classified as TDRs if certain criteria are met.

In response to requests from borrowers who have experienced pandemic-related business or personal cash flow interruptions, and in accordance with the recently issued regulatory guidance, the Company has made short-term loan modifications involving both interest-only and full payment deferrals.

As of April 30, 2020 the following payment modifications have been made:

As of June 30, 2020 the following payment modifications have been made:

Type of Loans

Number of Loans

% of Loan Balance

% of Loan Type (excludes PPP Loans)

(dollars in thousands)

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Residential Mortgage Loans

To date, the Company has not experienced significant customer requests for additional loan modifications, within the commercial and industrial loan and commercial real estate loan portfolios, after the initial short-term modifications granted for those customers during the second quarter of 2020.

Lending Exposure to Potentially Impacted Industry Segments

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As a result of the COVID-19 pandemic, the Company has initially identified loan segments that could represent a potentially higher level of credit risk, as many of these customers may have incurred a significant negative impact to their businesses as a result of governmental stay-at-home orders and travel restrictions.

At April 30, 2020, the Company had the following exposure to these potentially sensitive COVID-19 identified loan segments:

At June 30, 2020, the Company had the following exposure to these potentially sensitive COVID-19 identified loan segments:

Industry Segment

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Lodging / Hotels

Retail Shopping / Strip Centers

Student Housing

Retail Shopping / Strip Centers

Regulatory Capital

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Under either framework, the Company and the Bank would be considered well-capitalized under the applicable guidelines.

PPPL Facility .

On April 9, 2020, in order to facilitate use of the PPPL Facility, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program.

Specifically, the agencies have clarified that banking organizations, including the Company and the Bank, are permitted to assign a zero percent risk weight to covered loans pledged to the PPPL Facility for purposes of determining risk-weighted assets and the leverage ratio.

PPP Loans and PPPL Facility .

On April 9, 2020, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program.

Specifically, the agencies have clarified that banking organizations, including the Company and the Bank, are permitted to assign a zero percent risk weight to PPP loans for purposes of determining risk-weighted assets and risk-based capital ratios.

Additionally, in order to facilitate use of the PPPL Facility, the agencies further clarified that, for purposes of determining leverage ratios, a banking organization is permitted to exclude from total average assets PPP loans that have been pledged as collateral for a PPPL Facility.

MANAGEMENT OVERVIEW

This updated discussion should be read in conjunction with the Management Overview that was included in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Net income for the quarter ended March 31, 2020 totaled $12,472,000, or $0.47 per share, a decline of 22% on a per share basis compared with the first quarter 2019 net income of $15,067,000, or $0.60 per share.

The decline in net income and earnings per share during the first quarter of 2020 was largely attributable to an increased level of provision for credit losses related to economic uncertainties and stress related to the COVID-19 pandemic.

Net income for the quarter ended June 30, 2020 totaled $14,255,000, or $0.54 per share, a decline of 11% on a per share basis compared with the second quarter 2019 net income of $15,271,000, or $0.61 per share.

Net income for the six months ended June 30, 2020 totaled $26,727,000, or $1.01 per share, a decline of 17% on a per share basis compared with the first half of 2019 net income of $30,338,000, or $1.21 per share.

The decline in net income and earnings per share during the second quarter of 2020 and first six months of 2020 was largely attributable to an increased level of provision for credit losses related to economic uncertainties and stress related to the COVID-19 pandemic.

The Company adopted ASU No.

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In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors.

If this assessment indicates that a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

If this assessment indicates that a credit loss exists, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis.

Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of applicable taxes.

No allowance for credit losses for available-for-sale debt securities was needed at March 31, 2020.

No allowance for credit losses for available-for-sale debt securities was needed at June 30, 2020.

Accrued interest receivable on available-for-sale debt securities is excluded from the estimate of credit losses.

As of March 31, 2020, gross unrealized gains on the securities available-for-sale portfolio totaled approximately $36,889,000 and gross unrealized losses totaled approximately $25,000 net of applicable taxes is included in other comprehensive income.

As of June 30, 2020, gross unrealized gains on the securities available-for-sale portfolio totaled approximately $40,506,000 and gross unrealized losses totaled approximately $126,000 net of applicable taxes is included in other comprehensive income.

Equity securities that do not have readily determinable fair values are carried at cost, less impairment with observable price changes being recognized in earnings.

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Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet.

Based on recent economic developments related to the COVID-19 pandemic, the Company tested Goodwill for impairment as of the March 31, 2020 balance sheet date.

Based on recent economic developments related to the COVID-19 pandemic, the Company tested Goodwill for impairment as of the June 30, 2020 balance sheet date.

No impairment to Goodwill was indicated based on this interim period testing.

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RESULTS OF OPERATIONS

Net Interest Income:

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Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws.

The following table summarizes net interest income (on a tax-equivalent basis) for the three months ended March 31, 2020 and 2019.

The following table summarizes net interest income (on a tax-equivalent basis) for the three months ended June 30, 2020 and 2019.

For tax-equivalent adjustments, an effective tax rate of 21% was used for both periods (1) .

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Three Months Ended

March 31, 2020

June 30, 2020

Three Months Ended

March 31, 2019

June 30, 2019

Principal Balance

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TOTAL INTEREST EARNING ASSETS

Allowance for Loan Losses

Allowance for Credit Losses

LIABILITIES AND SHAREHOLDERS’ EQUITY

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Loans held-for-sale and non-accruing loans have been included in average loans.

Net interest income increased $2,665,000, or 8%, for the quarter ended March 31, 2020 compared with the same quarter of 2019.

During the second quarter of 2020, net interest income totaled $38,459,000, an increase of $4,818,000, or 14%, compared to the second quarter of 2019 net interest income of $33,641,000.

The increase in net interest income during the second quarter of 2020 compared with the second quarter of 2019 was largely attributable to acquisition of Citizens First and an increased level of loans related to the PPP, with a corresponding increase in interest income and fees.

The average balance of PPP loans during the second quarter of 2020 was approximately $276 million while the net fees recognized through interest income on those loans totaled approximately $1.1 million.

The net interest margin represents tax-equivalent net interest income expressed as a percentage of average earning assets.

The tax equivalent net interest margin was 3.74% for the first quarter of 2020 compared to 3.88% during the first quarter of 2019.

The tax equivalent yield on earning assets was 4.48% during the quarter ended March 31, 2020 compared to 4.74% in the same period of 2019, while the cost of funds (expressed as a percentage of average earning assets) was 0.74% during the quarter ended March 31, 2020 compared to 0.86% in the same period of 2019.

The increased level of net interest income during the first quarter of 2020 compared with the first quarter of 2019 was driven primarily by a higher level of average earning assets partially mitigated by a lower net interest margin.

The increased level of average earning assets in the first quarter of 2020 was driven in large part by balance sheet growth through the acquisition of Citizens First on July 1, 2019.

The decline in the net interest margin during the first quarter of 2020 when compared with the first quarter of 2019 was impacted by a decline in earning asset yields driven by lower market interest rates, a decline in the amount of accretion of loan discounts on acquired loans, partially offset with a decline in the Company's cost of funds.

Accretion of loan discounts on acquired loans contributed approximately 14 basis points to the net interest margin on an annualized basis in the first quarter of 2020 compared with 16 basis points in the first quarter of 2019.

The Company's cost of funds declined by 12 basis points in the first quarter of 2020 compared with the first quarter of 2019 due largely to lower short-term market interest rates.

The tax equivalent net interest margin was 3.59% for the second quarter of 2020 compared to 3.84% during the second quarter of 2019.

The tax equivalent yield on earning assets was 4.06% during the quarter ended June 30, 2020 compared to 4.67% in the same period of 2019, while the cost of funds (expressed as a percentage of average earning assets) was 0.47% during the quarter ended June 30, 2020 compared to 0.83% in the same period of 2019.

The lower net interest margin during the second quarter of 2020 compared with the second quarter of 2019 was attributable to lower market interest rates, excess liquidity on the balance sheet that resulted from significant deposit growth during the second quarter of 2020 and the 1% interest rate applicable to the PPP loans.

Accretion of loan discounts on acquired loans contributed approximately 19 basis points to the net interest margin on an annualized basis in the second quarter of 2020 and 12 basis points in the second quarter of 2019.

The following table summarizes net interest income (on a tax-equivalent basis) for the six months ended June 30, 2020 and 2019.

For tax-equivalent adjustments, an effective tax rate of 21% was used for both periods (1) .

Average Balance Sheet

(Tax-equivalent basis / dollars in thousands)

Six Months Ended

June 30, 2020

Six Months Ended

June 30, 2019

Principal Balance

Income / Expense

Principal Balance

Income / Expense

Federal Funds Sold and Other

Short-term Investments

Total Loans and Leases (2)

TOTAL INTEREST EARNING ASSETS

Allowance for Credit Losses

LIABILITIES AND SHAREHOLDERS’ EQUITY

Interest-bearing Demand, Savings

and Money Market Deposits

Time Deposits

FHLB Advances and Other Borrowings

TOTAL INTEREST-BEARING LIABILITIES

Demand Deposit Accounts

Other Liabilities

TOTAL LIABILITIES

Shareholders’ Equity

TOTAL LIBABILITIES AND SHAREHOLDERS' EQUITY

COST OF FUNDS

NET INTEREST INCOME

NET INTEREST MARGIN

Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable.

Loans held-for-sale and non-accruing loans have been included in average loans.

Net interest income increased $7,483,000, or 11%, for the six months ended June 30, 2020 compared with the same period of 2019.

The increased level of net interest income during the first half of 2020 compared with the first half of 2019 was driven primarily by a higher level of average earning assets resulting from the acquisition of Citizens First.

The tax equivalent net interest margin was 3.66% during the first half of 2020 compared to 3.86% during the first half of 2019.

The tax equivalent yield on earning assets was 4.26% during the six months ended June 30, 2020 compared to 4.71% in the same period of 2019, while the cost of funds was 0.60% during the first half of 2020 compared to 0.85% in the same period of 2019.

The lower net interest margin during the first half of 2020 compared with the first half of 2019 was attributable to lower market interest rates, excess liquidity on the balance sheet that resulted from significant deposit growth during the second quarter of 2020 and the 1% interest rate applicable to the PPP loans.

Accretion of loan discounts on acquired loans contributed approximately 17 basis points to the net interest margin on an annualized basis in the six months ended June 30, 2020 and 14 basis points in the same period of 2019.

Provision for Credit Losses:

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The provision is affected by net charge-offs on loans and changes in specific and general allocations of the allowance.

During the quarter ended March 31, 2020, the provision for credit losses totaled $5,150,000 under the CECL methodology adopted during the first quarter of 2020 compared with a $675,000 provision for loan losses during the first quarter of 2019 under the incurred loss model.

The provision for credit losses losses represented approximately 67 basis points of average loans on an annualized basis in the first quarter of 2020 compared a provision for loan losses of 10 basis points of average loans on an annualized basis in the first quarter of 2019.

The increase in the provision for credit losses during the first quarter of 2020 compared to the provision for loan losses during first quarter of 2019 was primarily due to the recent developments related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the Company's CECL model.

Net charge-offs totaled $440,000 or 6 basis points on an annualized basis of average loans outstanding during the three months ended March 31, 2019, compared with $255,000 or 4 basis points on an annualized basis of average loans outstanding during the same period of 2019.

The provision for credit losses losses made during the three months ended March 31, 2020 was made at a level deemed necessary by management to absorb estimated losses in the loan portfolio.

During the quarter ended June 30, 2020, the provision for credit losses totaled $5,900,000 under the CECL methodology adopted during the first quarter of 2020 compared with a $250,000 provision for loan losses during the second quarter of 2019 under the incurred loss model.

The provision for credit losses losses represented approximately 73 basis points of average loans on an annualized basis in the second quarter of 2020 compared a provision for loan losses of 4 basis points of average loans on an annualized basis in the second quarter of 2019.

During the six months ended June 30, 2020, the provision for credit losses totaled $11,050,000 under the CECL methodology compared with a $925,000 provision for loan losses during the same period of 2019 under the incurred loss model.

The provision for credit losses losses represented approximately 70 basis points of average loans on an annualized basis in the first six months of 2020 compared a provision for loan losses of 7 basis points of average loans on an annualized basis in the same period of 2019.

The increase in the provision for credit losses during the three and six months ended June 30, 2020 compared to the provision for loan losses during the same periods of 2019 was primarily due to the recent developments related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the Company's CECL model.

Net charge-offs totaled $110,000 or 1 basis point on an annualized basis of average loans outstanding during the three months ended June 30, 2020, compared with $254,000 or 4 basis points on an annualized basis of average loans outstanding during the same period of 2019.

Net charge-offs totaled $550,000 or 3 basis point on an annualized basis of average loans outstanding during the first half of 2020, compared with $509,000 or 4 basis points on an annualized basis of average loans outstanding during the same period of 2019.

The provision for credit losses losses made during the three and six months ended June 30, 2020 was made at a level deemed necessary by management to absorb estimated losses in the loan portfolio.

A detailed evaluation of the adequacy of the allowance for credit losses is completed quarterly by management, the results of which are used to determine provision for credit losses.

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Non-interest Income:

During the quarter ended March 31, 2020, non-interest income totaled $14,081,000, an increase of $2,423,000, or 21%, compared with the first quarter of 2019.

During the quarter ended June 30, 2020, non-interest income totaled $12,423,000, an increase of $1,914,000, or 18%, compared with the second quarter of 2019.

Non-interest Income

(dollars in thousands)

Ended March 31,

Ended June 30,

Trust and Investment Product Fees

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Total Non-interest Income

Trust and investment product fees increased $464,000, or 30%, during the first quarter of 2020 compared with the first quarter of 2019.

Service charges on deposit accounts declined $659,000, or 33%, during the second quarter of 2020 compared with the second quarter of 2019.

The decline during the second quarter of 2020 was largely related to the economic impacts of the COVID-19 pandemic and resulting change in deposit customer activity.

Other operating income increased $421,000, or 91%, during the quarter ended June 30, 2020 compared with the second quarter of 2019.

The increase during the second quarter of 2020 was largely attributable to lower fair value adjustments on interest rate swap transactions and the acquisition of Citizens First.

Net gains on sales of loans increased $1,624,000, or 158%, during the second quarter of 2020 compared with the second quarter of 2019.

The increase during the second quarter of 2020 was generally attributable to a higher sales volume, higher pricing levels on loans sold and an increased level of commitments to originate loans which resulted in a higher fair value adjustment on those commitments.

Loan sales totaled $79.7 million during the second quarter of 2020, compared with $39.6 million during the second quarter of 2019.

The Company realized $993,000 in gains on sales of securities during the second quarter of 2020 compared with $516,000 during the second quarter of 2019.

The sales of securities in both periods was done as part of modest shifts in the allocations within the securities portfolio.

During the six months ended June 30, 2020, non-interest income totaled $26,504,000, an increase of $4,337,000, or 20%, compared with the first half of 2019.

Non-interest Income

(dollars in thousands)

Ended June 30,

Trust and Investment Product Fees

Service Charges on Deposit Accounts

Insurance Revenues

Company Owned Life Insurance

Interchange Fee Income

Other Operating Income

Net Gains on Sales of Loans

Net Gains on Securities

Total Non-interest Income

Trust and investment product fees increased $418,000, or 12%, during the first half of 2020 compared with the first half of 2019.

The increase was primarily attributable to fees generated from increased assets under management in the Company's wealth management group.

Service charges on deposit accounts increased $337,000, or 18%, during the first quarter of 2020 compared with the first quarter of 2019.

The increase during the first quarter of 2020 compared with first quarter of 2019 was largely attributable to the acquisition completed during 2019.

Insurance revenues remained relatively stable, increasing $24,000, or 1%, during the quarter ended March 31, 2020, compared with the first quarter of 2019.

Contingency revenue during the first quarter of 2020 totaled $1,319,000 compared with $1,375,000 during the first quarter of 2019.

Contingency revenue is reflective of claims and loss experience with insurance carriers that the Company represents through its property and casualty insurance agency.

Typically, the majority of contingency revenue is recognized during the first quarter of the year.

Company owned life insurance revenue increased $338,000, or 38%, during the quarter ended March 31, 2020, compared with the first quarter of 2019.

The increased revenue in the first quarter of 2020 was largely related to death benefits of $838,000 received from life insurance policies during the first quarter of 2020 compared with $554,000 received from life insurance policies during the first quarter of 2019.

Interchange fees increased $387,000, or 18%, during the first quarter of 2020 compared with the first quarter of 2019.

The increase was largely attributable to increased card utilization by customers and the acquisition completed during 2019.

Other operating income declined $444,000, or 51%, during the quarter ended March 31, 2020 compared with the first quarter of 2019.

The decline during the first quarter of 2020 was largely attributable to fair value adjustments associated with interest rate swap transactions with loan customers.

Net gains on sales of loans increased $882,000, or 90%, during the first quarter of 2020 compared with the first quarter of 2019.

The increase during the first quarter of 2020 compared with the first quarter of 2019 was generally attributable to higher sales volumes and an increased level of commitments to originate loans which resulted in a higher fair value adjustment on those commitments.

Loan sales totaled $56.2 million during the first quarter of 2020 and $28.9 million during the first quarter of 2019.

During the first quarter of 2020, the Company realized a net gain on the sale of securities of $590,000 compared with gains of $155,000 on sales of securities during the first quarter of 2019.

Service charges on deposit accounts declined $322,000, or 8%, during the first quarter of 2020 compared with the first half of 2019.

The decline during the the first half of 2020 compared with first half of 2019 was largely related to the economic impacts of the COVID-19 pandemic and resulting change in deposit customer activity, partially mitigated by the acquisition of Citizens First.

Company owned life insurance revenue increased $390,000, or 33%, during the six months ended June 30, 2020, compared with the first half of 2019.

The increase was largely related to death benefits received from life insurance policies.

Interchange fees increased $531,000, or 12%, during the first half of 2020 compared with the first half of 2019.

The increase during the first half of 2020 compared with the first half of 2019 was largely attributable to the acquisition of Citizens First and increased card utilization by customers.

Net gains on sales of loans increased $2,506,000, or 125%, during the first half of 2020 compared with the first half of 2019.

The increase in the net gain on sales of loans during the first half of 2020 compared with 2019 was generally attributable to a higher sales volume, higher pricing levels on loans sold and an increased level of commitments to originate loans which resulted in a higher fair value adjustment on those commitments.

Loan sales totaled $136.0 million during the first half of 2020 and $68.4 million during the first half of 2019.

The Company realized $1,583,000 in gains on sales of securities during first six months of 2020 compared with $671,000 during the same period of 2019.

The sales of securities in both periods was done as part of modest shifts in the allocations within the securities portfolio.

Non-interest Expense:

During the quarter ended March 31, 2020, non-interest expense totaled $30,328,000, an increase of $3,569,000, or 13%, compared with the first quarter of 2019.

The increased level of non-interest expense during the first quarter of 2020 compared with the first quarter of 2019 was largely attributable to the acquisition of Citizens First on July 1, 2019.

During the quarter ended June 30, 2020, non-interest expense totaled $28,088,000, an increase of $2,470,000, or 10%, compared with the second quarter of 2019.

Non-interest Expense

(dollars in thousands)

Ended March 31,

Ended June 30,

Salaries and Employee Benefits

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Total Non-interest Expense

Salaries and benefits increased $2,356,000, or 16%, during the quarter ended March 31, 2020 compared with the first quarter of 2019.

The increase in salaries and benefits during the first quarter of 2020 compared with the first quarter of 2019 was primarily attributable to an increased number of full-time equivalent employees due in part to the acquisition of Citizens First.

Occupancy, furniture and equipment expense increased $362,000, or 11%, during the first quarter of 2020 compared with the first quarter of 2019.

The increase was primarily due to the operating costs of the Citizens First branch network.

FDIC premiums declined $288,000, or 100%, during the first quarter of 2020 compared with the first quarter of 2019.

The decline in FDIC premiums is attributable to credits received from the FDIC during the first quarter of 2020.

Salaries and benefits increased $1,765,000, or 13%, during the quarter ended June 30, 2020 compared with the second quarter of 2019.

The increase in salaries and benefits during the second quarter of 2020 compared with the second quarter of 2019 was primarily attributable to the acquisition of Citizens First.

Occupancy, furniture and equipment expense increased $269,000, or 8%, during the second quarter of 2020 compared with the second quarter of 2019.

The increase during the second quarter of 2020 compared with the second quarter of 2019 was primarily due to the operating costs of the Citizens First branch network.

FDIC premiums declined $122,000, or 50%, during the second quarter of 2020 compared with the second quarter of 2019.

The decline in FDIC premiums is attributable to credits received from the FDIC during the second quarter of 2020.

The credits received were due to the reserve ratio of the deposit insurance fund exceeding the FDIC targeted levels.

Professional fees declined $243,000, or 18%, during the first quarter of 2020 compared with the first quarter of 2019.

The decline during the first quarter of 2020 compared to the first quarter of 2019 was due primarily to acquisition-related professional fees expensed in the first quarter of 2019.

Advertising and promotion expense increased $201,000, or 23%, in the first quarter of 2020 compared with the first quarter of 2019.

The increase in advertising and promotion expense during the first quarter of 2020 compared with the first quarter of 2019 was largely related to general advertising costs related to the Company's expanded footprint from the merger and acquisition activity during 2018 and 2019.

Intangible amortization increased $117,000, or 14%, during the quarter ended March 31, 2020 compared with the first quarter of 2019.

The increase in intangible amortization in the first quarter of 2020 compared with the first quarter of 2019 was attributable to the Citizens First acquisition completed during 2019.

Other operating expenses increased $961,000, or 27%, during the first quarter of 2020 compared with the first quarter of 2019.

The increase in the first quarter of 2020 compared with first quarter of 2019 was impacted by the Citizens First acquisition.

Intangible amortization increased $107,000, or 13%, during the quarter ended June 30, 2020 compared with the second quarter of 2019.

The increase in intangible amortization in the second quarter of 2020 was attributable to the Citizens First acquisition completed during 2019.

Other operating expenses increased $637,000, or 19%, during the second quarter of 2020 compared with the second quarter of 2019.

The increase in the second quarter of 2020 compared with second quarter of 2019 was largely attributable to the Citizens First acquisition.

During the six months ended June 30, 2020, non-interest expense totaled $58,416,000, an increase of $6,039,000, or 12%, compared with the first half of 2019.

The increase in the first half of 2019 was largely impacted by the inclusion of operating expenses related to the acquisition of Citizens First.

Non-interest Expense

(dollars in thousands)

Ended June 30,

Salaries and Employee Benefits

Occupancy, Furniture and Equipment Expense

FDIC Premiums

Data Processing Fees

Professional Fees

Advertising and Promotion

Intangible Amortization

Other Operating Expenses

Total Non-interest Expense

Salaries and benefits increased $4,121,000, or 14%, during the six months ended June 30, 2020 compared with the first half of 2019.

The increase in salaries and benefits during the first half of 2020 compared with the first half of 2019 was largely attributable to an increased number of full-time equivalent employees due in part to the acquisition of Citizens First.

Occupancy, furniture and equipment expense increased $631,000, or 10%, during the first half of 2020 compared with the first half of 2019.

The increase during the first half of 2020 compared with the first half of 2019 was primarily due to operating costs related to the Citizens First acquisition.

FDIC premiums declined $410,000, or 77%, during the first half of 2020 compared with the first half of 2019.

The decline in FDIC premiums is attributable to credits received from the FDIC during the first half of 2020.

The credits received were due to the reserve ratio of the deposit insurance fund exceeding the FDIC targeted levels.

Professional fees declined $335,000, or 13%, during the first half of 2020 compared with the first half of 2019.

The first half of 2019 included significant acquisition professional fees related to the Citizens First acquisition which resulted in the overall decline in professional fees when comparing the first half of 2020 with the first half of 2019.

Intangible amortization increased $224,000, or 14%, during the six months ended June 30, 2020 compared with the first half of 2019.

The increase in intangible amortization was attributable to the previously discussed Citizens First acquisition.

Other operating expenses increased $1,598,000, or 23%, during the first half of 2020 compared with the first half of 2019.

The increase during the first half of 2020 compared with the first half of 2019 was largely impacted by the recent acquisition activity.

Income Taxes:

The Company’s effective income tax rate was 16.1% and 15.4%, respectively, during the three months ended March 31, 2020 and 2019.

The Company’s effective income tax rate was 15.6% and 16.5%, respectively, during the three months ended June 30, 2020 and 2019.

The Company’s effective income tax rate was 15.8% and 16.0%, respectively, during the six months ended June 30, 2020 and 2019.

The effective tax rate in all periods presented was lower than the blended statutory rate resulting primarily from the Company’s tax-exempt investment income on securities, loans and company-owned life insurance, income tax credits generated from affordable housing projects, and income generated by subsidiaries domiciled in a state with no state or local income tax.

FINANCIAL CONDITION

Total assets for the Company totaled $4.324 billion at March 31, 2020, representing a decline of $73.8 million, or 7% on an annualized basis, compared with December 31, 2019.

The decline in total assets was largely related to a decline in loans outstanding

partially offset by an increase in the Company's securities portfolio.

March 31, 2020 total loans declined $63.6 million, or 8% on an annualized basis, compared with December 31, 2019.

The decline in loans during the first quarter of 2020 compared with year-end 2019 was impacted by elevated pay-offs and reduced line utilization within the commercial loan portfolio, a seasonal decline in the agricultural loan portfolio and continued pay-downs in the Company's residential loan portfolio related to the current interest rate environment.

Total assets for the Company totaled $4.851 billion at June 30, 2020, representing an increase of $453.4 million, or 21% on an annualized basis, compared with December 31, 2019.

The increase in total assets during the first half of 2020 has been impacted by the Company's participation in the PPP and by significant growth of deposits during the second quarter of 2020.

As of June 30, 2020 compared with December 31, 2019, federal funds sold and other short-term investments increased by $181.4 million and the Company's securities available for sale portfolio increased by $107.4 million.

These increases were largely driven by the increased level of deposits during the second quarter of 2020.

In addition, loans increased $189.0 million as of the end of June 30, 2020 compared with December 31, 2019 impacted primarily by the Company's participation in the PPP.

June 30, 2020 total loans increased $189.0 million, or 12% on an annualized basis, compared with December 31, 2019.

The increase in loans during the first half of 2020 compared with year-end 2019 was primarily the result in the Company's participation in the PPP.

Excluding the $349.5 million in PPP loans ($338.7 million net of deferred fees) at June 30, 2020, total loans declined by $149.7 million, or 10% on an annualized basis, during the first half of 2020 compared with year-end 2019.

The decline in total loans, excluding the PPP loans, was impacted by continued elevated pay-offs within the commercial real estate loan portfolio, reduced line utilization within the commercial loan portfolio partially attributable to the PPP loan originations during the second quarter of 2020, and continued pay-downs in the Company's residential and home equity loan portfolios related to the current interest rate environment.

End of Period Loan Balances:

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Total Allowance for Credit Losses

The Company’s allowance for credit losses totaled $36.6 million at March 31, 2020 compared to $16.3 million at December 31, 2019.

The allowance for credit losses represented 1.22% of period-end loans at March 31, 2020 compared with 0.53% of period-end loans at December 31, 2019.

The Company’s allowance for credit losses totaled $42.4 million at June 30, 2020 compared to $16.3 million at December 31, 2019.

The allowance for credit losses represented 1.30% of period-end loans at June 30, 2020 compared with 0.53% of period-end loans at December 31, 2019.

Total PPP loans included in the Commercial and Industrial Loan category totaled $349.5 million at June 30, 2020.

These loans are guaranteed by the SBA and have minimal impact on the allowance for credit losses.

The Company adopted ASU No.

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Under the CECL model, certain acquired loans continue to carry a fair value discount as well as an allowance for credit losses.

As of March 31, 2020, the Company held net discounts on acquired loans of $12.0 million.

In addition, the allowance for credit losses increased during the quarter ended March 31, 2020, as a result of the Company recording a $5.2 million provision for credit losses while recording net charge-offs of approximately $440,000.

The provision for credit losses was elevated in the first quarter of 2020 primarily due to the recent developments related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the CECL model.

The following is an analysis of the Company’s non-performing assets at March 31, 2020 and December 31, 2019:

As of June 30, 2020, the Company held net discounts on acquired loans of $9.8 million.

In addition, the allowance for credit losses increased during the six months ended June 30, 2020, as a result of the Company recording an $11.1 million provision for credit losses while recording net charge-offs of approximately $550,000.

The provision for credit losses was elevated in the first half of 2020 primarily due to the recent developments related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the CECL model.

The following is an analysis of the Company’s non-performing assets at June 30, 2020 and December 31, 2019:

Non-performing Assets:

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or More & Still Accruing

March 31, 2020

June 30, 2020

December 31, 2019

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Residential Mortgage Loans

Non-performing assets totaled $19.1 million at March 31, 2020 compared to $14.4 million at December 31, 2019.

Non-performing assets represented 0.44% of total assets at March 31, 2020 and 0.33% at December 31, 2019.

Non-performing loans totaled $18.5 million at March 31, 2020 compared to $14.0 million at December 31, 2019.

Non-performing loans represented 0.61% of total loans at March 31, 2020 compared to 0.45% at December 31, 2019.

The increase in the level of non-performing assets and non-performing loans at March 31, 2020 compared with year-end 2019 was attributable to the $6.9 million gross-up of purchase credit deteriorated loans upon the adoption of the CECL standard.

March 31, 2020 total deposits increased $48.5 million, or 6% on an annualized basis, compared to December 31, 2019.

Non-performing assets totaled $19.6 million at June 30, 2020 compared to $14.4 million at December 31, 2019.

Non-performing assets represented 0.40% of total assets at June 30, 2020 and 0.33% at December 31, 2019.

Non-performing loans totaled $19.1 million at June 30, 2020 compared to $14.0 million at December 31, 2019.

Non-performing loans represented 0.59% of total loans at June 30, 2020 compared to 0.45% at December 31, 2019.

The increase in the level of non-performing assets and non-performing loans at June 30, 2020 compared with year-end 2019 was attributable to the $6.9 million gross-up of purchase credit deteriorated loans upon the adoption of the CECL standard.

June 30, 2020 total deposits increased $549.4 million, or 32% on an annualized basis, compared to December 31, 2019.

The increase in total deposits at June 30, 2020 compared with year-end 2019 was partially attributable the Company's participation in the PPP and a seasonal increase in public fund operating deposits as well as an overall inflow of customer deposits during the second quarter of 2020.

End of Period Deposit Balances:

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At the time it approved the new plan, the Board also terminated a similar program that had been adopted in 2001.

At the time of its termination, the Company had been authorized to purchase up

to 409,184 shares of common stock under the 2001 program.

The Company repurchased 173,089 shares common stock under the 2020 repurchase plan during the first quarter of 2020 at an average price of $25.97 per share.

As of March 31, 2020, shareholders’ equity increased by $9.7 million to $583.5 million compared with $573.8 million at year-end 2019.

At the time of its termination, the Company had been authorized to purchase up to 409,184 shares of common stock under the 2001 program.

The Company repurchased 44,166 shares of common stock under the 2020 repurchase plan during the second quarter of 2020 at an average price of $26.46 per share.

The Company repurchased 217,255 shares of common stock under the 2020 repurchase plan during the first half of 2020 at an average price of $26.07 per share.

As of June 30, 2020, shareholders’ equity increased by $20.9 million to $594.7 million compared with $573.8 million at year-end 2019.

The increase in shareholders' equity was largely attributable to an increase of $16.0 million in accumulated other comprehensive income primarily related to the increase in value of the Company's available-for-sale securities portfolio.

In addition, retained earnings increased $0.7 million due to first quarter 2020 net income of $12.7 which was largely offset by the payment of $5.1 million in shareholder dividends and a $6.7 million charge relating to the implementation of CECL on January 1, 2020.

Also impacting total shareholders' equity was the repurchase of common stock under the Company's share repurchase plan which totaled $4.5 million during the first quarter of 2020.

Shareholders’ equity represented 13.5% of total assets at March 31, 2020 and 13.0% of total assets at December 31, 2019.

Shareholders’ equity included $133.0 million of goodwill and other intangible assets at March 31, 2020 compared to $134.0 million of goodwill and other intangible assets at December 31, 2019.

In addition, retained earnings increased $9.9 million due to first half of 2020 net income of $26.7 which was partially offset by the payment of $10.1 million in shareholder dividends and a $6.7 million charge relating to the implementation of CECL on January 1, 2020.

Also impacting total shareholders' equity was the repurchase of common stock under the Company's share repurchase plan which totaled $5.7 million during the first half of 2020.

Shareholders’ equity represented 12.3% of total assets at June 30, 2020 and 13.0% of total assets at December 31, 2019.

Shareholders’ equity included $132.7 million of goodwill and other intangible assets at June 30, 2020 compared to $134.0 million of goodwill and other intangible assets at December 31, 2019.

Federal banking regulations provide guidelines for determining the capital adequacy of bank holding companies and banks.

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The capital conservation buffer was phased in from 0.00% in 2015 to 2.50% in 2019.

For both March 31, 2020 and December 31, 2019, the capital conservation buffer was 2.50%.

At March 31, 2020, the capital levels for the Company and its subsidiary bank remained well in excess of the minimum amounts needed for capital adequacy purposes and the Bank's capital levels met the necessary requirements to be considered well-capitalized.

For both June 30, 2020 and December 31, 2019, the capital conservation buffer was 2.50%.

At June 30, 2020, the capital levels for the Company and its subsidiary bank remained well in excess of the minimum amounts needed for capital adequacy purposes and the Bank's capital levels met the necessary requirements to be considered well-capitalized.

The table below presents the Company’s consolidated and the subsidiary bank's capital ratios under regulatory guidelines:

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On March 27, 2020, in an action related to the CARES Act, the federal banking regulators announced an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL.

The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-

year transition period (five-year transition option).

The Company is adopting the capital transition relief over the permissible five-year period.

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The first of the April 2020 interim final rules provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework.

It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater.

It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR

requirement, so long as the banking organization maintains a leverage ratio of 7% or greater.

The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement.

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Under either framework, the Company and the Bank would be considered well-capitalized under the applicable guidelines.

The Consolidated Statement of Cash Flows details the elements of changes in the Company’s consolidated cash and cash equivalents.

Total cash and cash equivalents decreased $13.7 million during the three months ended March 31, 2020 ending at $90.1 million.

During the three months ended March 31, 2020, operating activities resulted in net cash inflows of $23.9 million.

Investing activities resulted in net cash inflows of $65.0 million during the three months ended March 31, 2020.

Financing activities resulted in net cash outflows for the three months ended March 31, 2020 of $102.6 million.

Total cash and cash equivalents increased $174.5 million during the six months ended June 30, 2020 ending at $278.4 million.

During the six months ended June 30, 2020, operating activities resulted in net cash inflows of $42.7 million.

Investing activities resulted in net cash outflows of $272.0 million during the six months months ended June 30, 2020 primarily resulting from the investment of excess liquidity into the available for sale securities portfolio and loan portfolio growth resulting from the Company's participation in the PPP.

Financing activities resulted in net cash inflows for the six months ended June 30, 2020 of $403.8 million primarily related to growth in the Company's deposit portfolio.

The parent company is a corporation separate and distinct from its bank and other subsidiaries.

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The parent company has in recent years supplemented the dividends received from its subsidiaries with borrowings.

As of March 31, 2020, the parent company had approximately $57.9 million of cash and cash equivalents available to meet its cash flow needs.

As of June 30, 2020, the parent company had approximately $65.1 million of cash and cash equivalents available to meet its cash flow needs.

FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

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The discussions in this Item 2 list some of the factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statements.

uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any forward-looking statement include the unknown future direction of interest rates and the timing and magnitude of any changes in interest rates;

Other risks, uncertainties, and factors that could cause the Company’s actual results to vary materially from those expressed or implied by any

forward-looking statement include the unknown future direction of interest rates and the timing and magnitude of any changes in interest rates;

changes in competitive conditions;

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the severity and duration of the COVID-19 pandemic and its impact on general economic and financial market conditions and our business, results of operations, and financial condition;

our participation as a lender in the PPP;

capital management activities, including possible future sales of new securities, or possible repurchases or redemptions by the Company of outstanding debt or equity securities;

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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-Q

Item 2. Management’s Discussion and Analysis