What changed in this filing

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Item 8. Financial Statements and Supplementary Data

2021-02-26 compared with 2020-03-02 · 885 added, 686 removed, 1218 unchanged (56% of the section changed)

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Report of Independent Registered Public Accounting Firm

Shareholders and the Board of Directors of

German American Bancorp, Inc.

Shareholders and the Board of Directors of German American Bancorp, Inc.

Jasper, Indiana

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(2013) issued by COSO.

Change in Accounting Principle

As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit losses effective January 1, 2020 due to the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification No.

326, Financial Instruments – Credit Losses (ASC 326).

The Company adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles.

The adoption of the new credit loss standard and its subsequent application is also communicated as a critical audit matter below.

Basis for Opinions

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We believe that our audits provide a reasonable basis for our opinions.

Report of Independent Registered Public Accounting Firm

Definition and Limitations of Internal Control Over Financial Reporting

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and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Report of Independent Registered Public Accounting Firm

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

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Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that:

(i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments.

The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Loan Losses

As described in Notes 1 and 4 to the consolidated financial statements, the Company's allowance for loan losses model is composed of specific and general components.

The specific component relates to loans that have been identified as impaired and are evaluated for collectability based on the present value of estimated cash flows or discounted collateral value.

To estimate the general component, management uses historical loss ratios by portfolio segment and adjusts the calculated expected loss for economic conditions to determine the appropriate level of allowance for non-impaired loans.

For commercial and agricultural loans graded special mention and substandard, management uses a migration analysis technique to calculate the allocation rates.

The audit of the estimate of the allowance for loan losses was identified by us as a critical audit matter because of the necessary judgments applied by us to evaluate the significant subjective and complex judgments made by management.

The migration analysis techniques used to calculate allocation rates and the qualitative factors required especially challenging, subjective, and/or complex auditor judgment to evaluate the following significant judgements related to:

The migration analysis factors are calculated using a transition matrix to determine the likelihood of a customer’s asset quality rating migrating from its current rating to any other rating.

The calculation relies on the accuracy of the loan risk rating at a point in time as well as the accuracy of the movement of loans to the correct risk rating category.

For all loan types, loss rates used are adjusted for qualitative factors.

The selection of qualitative factors and the magnitude of such adjustments is based on management’s judgments regarding factors which impact asset quality.

Completeness and accuracy of data used in the migration analysis calculation is especially challenging given the volume of loan data used in the calculation.

The primary procedures performed to address this critical audit matter included:

Testing the effectiveness of controls over the Company’s asset quality rating;

controls over the preparation and review of the allowance for loan loss calculation, including data used as the basis for adjustments related to the qualitative factors, completeness and accuracy of loan data used in the computations, the development and reasonableness of qualitative factors and mathematical accuracy of the overall calculation;

Substantively testing the accuracy of both the asset quality ratings as well as testing the accuracy of the transition matrix

Substantively testing management’s process for developing the qualitative factors and assessing relevance of data used to develop factors, including evaluating management’s judgments and assumptions for reasonableness.

Substantively testing the mathematical accuracy of the migration analysis calculations including the completeness and accuracy of loan data used in the model.

Accounting for Acquisitions

As more fully described in Note 18 during 2019, the Company completed the acquisition of Citizens First Corporation for stock and cash consideration totaling approximately $65.6 million.

We identified the evaluation of the Company’s acquisition of Citizens First Corporation as a critical audit matter because it involved especially subjective auditor judgment and specialized skills when evaluating management’s judgments with respect to the valuation assertion for loans and core deposit intangibles.

The primary procedures performed to address this critical audit matter included:

Testing the effectiveness of management’s review controls over the accuracy of data and appropriateness of assumptions used in the Company engaged specialist’s valuation report for acquired loans and core deposits.

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that:

(i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments.

The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Credit Losses on Loans

In accordance with Accounting Standards Update (the “ASU”) 2016-13, Financial Instruments —Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments, the Company adopted Accounting Standards Codification (“ASC”) 326 as of January 1, 2020 as described in Notes 1 and 4 of the consolidated financial statements using the modified retrospective method.

Also see explanatory paragraph above.

The ASU requires financial assets, including the Company's loan portfolio, measured at amortized cost, to be presented at the net amount expected to be collected.

Estimates of expected credit losses for loans are based on reasonable and supportable forecast of future economic conditions, historical loss experience and qualitative adjustments for current conditions.

In order to estimate the expected credit losses, the Company implemented new loss estimation models.

The Company disclosed the impact of adoption of this standard on January 1, 2020 with a $15.7 million increase to the allowance for credit losses, a $173 thousand increase for unfunded loan commitments and a $6.7 million decrease to retained earnings for the cumulative effect adjustment recorded upon adoption.

Provision expense for the year ending December 31, 2020 was $17.6 million and the Allowance for Credit Losses at December 31, 2020 was $46.9 million.

The Company utilizes the static pool methodology for determining the allowance for credit losses.

The static pool methodology tracks loan pool by segment over a period of time to calculate a loss rate.

Loss rates are then qualitatively adjusted for current conditions and reasonable and supportable forecast.

Commercial and agricultural loans graded special mention and substandard are also adjusted based on a migration analysis technique.

Loans that no longer exhibit shared risk characteristics are evaluated on an individual basis.

The Allowance for Credit Losses was identified by us as a critical audit matter because of the extent of auditor judgment applied and significant audit effort to evaluate the significant subjective and complex judgments made by management throughout the initial adoption and subsequent application processes.

The principal considerations resulting in our determination included the following:

• Significant audit effort to evaluate the appropriateness of selection of loss estimation models, loan segmentation and historical loss period used in the calculation

• Significant auditor judgement and effort were used in evaluating the qualitative factors used in the calculation.

• Significant auditor judgment in evaluating the selection and application of the reasonable and supportable forecast of economic variables.

• Significant audit effort to test the completeness and accuracy of data used in the migration analysis calculation, including accuracy of loan risk rating, and its application to the commercial and agricultural loan segments.

Report of Independent Registered Public Accounting Firm

Performing analytic procedures comparing the core deposit intangible value to market data in similar acquisitions.

Substantively testing the reasonableness of the Company’s significant assumptions used in valuing core deposits, including discount rates, estimated useful lives, attrition rates and the expected rate of return.

Substantively testing the reasonableness of the Company’s significant assumptions used in valuing acquired loans, including discount rates, prepayment rates and credit loss assumptions, with the use of an auditor employed specialist.

Substantively testing the mathematical accuracy of the core deposit intangible and acquired loan valuation calculations.

The primary procedures performed to address this critical audit matter included:

• Testing the effectiveness of management’s internal controls over the Company’s significant model assumptions and judgments, loan segmentation, reasonable and supportable forecasts, qualitative factor adjustments, information systems and model validation

• Testing the effectiveness of controls over the Company’s preparation and review of the allowance for credit loss calculation, including data used as the basis for adjustments related to the qualitative factors, the development and reasonableness of qualitative factors and mathematical accuracy and appropriateness of the overall calculation;

• Evaluating management’s judgments in the selection and application of reasonable and supportable forecast of economic variables

• Substantively testing management’s process for developing the qualitative factors and assessing reasonableness, relevance and reliability of data used to develop factors, including evaluating their judgments and assumptions for reasonableness

• Testing the effectiveness of controls over the Company’s loan risk rating;

• Substantively testing the accuracy of both the loan risk ratings as well as testing the accuracy of the transition matrix

/s/ Crowe LLP

We have served as the Company's auditor since 1977.

Indianapolis, Indiana

March 2, 2020

Louisville, Kentucky

February 26, 2021

Consolidated Balance Sheets

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Interest-bearing Time Deposits with Banks 1,241 1,985

Securities Available-for-Sale, at Fair Value

Securities Available-for-Sale, at Fair Value (Amortized Cost $ 1,172,175 , No Allowance for Credit Losses)

1,217,852 854,825

Other Investments 353 353

Loans Held-for-Sale, at Fair Value 16,904 17,713

Loans 3,091,998 3,081,973

Unearned Income ( 3,926 ) ( 4,882 )

Allowance for Loan Losses

Allowance for Credit Losses ( 46,859 ) ( 16,278 )

Loans, Net 3,041,213 3,060,813

Stock in FHLB of Indianapolis and Other Restricted Stock, at Cost 13,168 13,968

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Other Real Estate 325 425

Goodwill 121,956 121,306

Intangible Assets 8,984 12,656

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Accrued Interest Receivable and Other Assets 43,990 44,210

TOTAL ASSETS $ 4,977,577 $ 4,397,672

Non-interest-bearing Demand Deposits $ 1,183,442 $ 832,985

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TOTAL LIABILITIES 4,352,868 3,823,852

Commitments and Contingencies (Note 14)

Commitments and Contingencies (See Note 14)

SHAREHOLDERS’ EQUITY

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45,000,000 shares authorized

26,502 26,671

Additional Paid-in Capital 274,385 278,954

Retained Earnings 288,447 253,090

Accumulated Other Comprehensive Income (Loss)

Accumulated Other Comprehensive Income 35,375 15,105

TOTAL SHAREHOLDERS’ EQUITY 624,709 573,820

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Years Ended December 31,

2020 2019 2018

INTEREST INCOME

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Interest and Dividends on Securities:

Taxable 10,447 13,910 12,398

Non-taxable 11,882 9,561 8,959

TOTAL INTEREST INCOME 174,369 176,474 133,749

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NET INTEREST INCOME 155,243 145,225 114,610

Provision for Loan Losses

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

Provision for Credit Losses 17,550 5,325 2,070

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 137,693 139,900 112,540

NON-INTEREST INCOME

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Income Tax Expense 12,834 12,017 9,528

NET INCOME $ 62,210 $ 59,222 $ 46,529

Basic Earnings per Share $ 2.34 $ 2.29 $ 1.99

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Years Ended December 31,

2020 2019 2018

NET INCOME $ 62,210 $ 59,222 $ 46,529

Other Comprehensive Income (Loss):

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Reclassification Adjustment for Gains Included in Net Income ( 4,081 ) ( 1,248 ) ( 706 )

Tax Effect ( 5,432 ) ( 6,186 ) 1,218

Net of Tax 20,270 22,432 ( 4,424 )

Postretirement Benefit Obligation:

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Reclassification Adjustment for Amortization of Prior Service Cost and Net Loss Included in Net Periodic Pension Cost — 37 32

Tax Effect — 44 ( 13 )

Net of Tax — ( 229 ) ( 54 )

Total Other Comprehensive Income (Loss) 20,270 22,203 ( 4,478 )

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Dollars in thousands, except per share data

Additional Paid-in Capital

Retained Earnings

Accumulated Other Comprehensive Income (Loss)

Total Shareholders' Equity

Shares Amount Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Shareholders' Equity

Balances, January 1, 2018 22,934,403 $ 22,934 $ 165,288 $ 178,969 $ ( 2,620 ) $ 364,571

Net Income 46,529 46,529

Other Comprehensive Income (Loss) ( 4,478 ) ( 4,478 )

Reclass Upon Adoption of ASU 2018-02 (See Note 1 - Summary of Significant Accounting Policies)

Cash Dividends ($ 0.60 per share)

( 14,074 ) ( 14,074 )

Issuance of Common Stock for:

3-for-2 Stock Split

Acquisition of First Security, Inc.

1,987,698 1,988 62,749 64,737

Restricted Share Grants 45,357 45 1,310 1,355

Balances, December 31, 2018 24,967,458 24,967 229,347 211,424 ( 7,098 ) 458,640

Net Income 59,222 59,222

Other Comprehensive Income (Loss) 22,203 22,203

Cash Dividends ($ 0.68 per share)

( 17,556 ) ( 17,556 )

Issuance of Common Stock for:

Acquisition of First Security Bank

Acquisition of Citizens First Corporation 1,663,954 1,664 48,360 50,024

Restricted Share Grants 39,956 40 1,247 1,287

Balances, December 31, 2019 26,671,368 26,671 278,954 253,090 15,105 573,820

Cumulative Effect of Change in Accounting Principles ( 6,717 ) ( 6,717 )

Balances, January 1, 2020 26,671,368 26,671 278,954 246,373 15,105 567,103

Net Income 62,210 62,210

Other Comprehensive Income (Loss) 20,270 20,270

Cash Dividends ($ 0.76 per share)

( 20,136 ) ( 20,136 )

Issuance of Common Stock for:

Acquisition of Citizens First Bank

Restricted Share Grants 52,701 53 998 1,051

Stock Repurchase ( 221,912 ) ( 222 ) ( 5,567 ) ( 5,789 )

Balances, December 31, 2020 26,502,157 $ 26,502 $ 274,385 $ 288,447 $ 35,375 $ 624,709

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CASH FLOWS FROM OPERATING ACTIVITIES 2020 2019 2018

Net Income $ 62,210 $ 59,222 $ 46,529

Adjustments to Reconcile Net Income to Net Cash from Operating Activities:

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Proceeds from Sales of Loans Held-for-Sale 327,172 189,875 137,417

Provision for Loan Losses

Provision for Credit Losses 17,550 5,325 2,070

Gain on Sale of Loans, net ( 9,908 ) ( 4,633 ) ( 3,004 )

Gain on Securities, net ( 4,081 ) ( 1,248 ) ( 706 )

Gain on Sales of Other Real Estate and Repossessed Assets

Loss (Gain) on Sales of Other Real Estate and Repossessed Assets 28 200 ( 41 )

Loss (Gain) on Disposition and Donation of Premises and Equipment 223 111 ( 36 )

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Proceeds from Sales of Property and Equipment — — 40

Proceeds from Sale of Land

Proceeds from Sale of Land and Building 3,928 1,761 393

Proceeds from Life Insurance 1,082 1,216 765

Acquisition of First Security, Inc.

— — ( 17,566 )

Cash from Acquisition of Bank Branches — — 42,700

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Cash Paid During the Year for

Interest $ 20,484 $ 30,765 $ 18,239

Income Taxes 11,505 7,977 5,920

Supplemental Non Cash Disclosures (See Note 18 for Business Combinations)

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NOTE 1 – Summary of Significant Accounting Policies

Impact of COVID-19

On January 30, 2020, the World Health Organization (“WHO”) announced that the outbreak of the novel coronavirus disease 2019 (COVID-19) constituted a public health emergency of international concern.

On March 11, 2020, WHO declared COVID-19 to be a global pandemic and, on March 13, 2020, the President of the United States declared the COVID-19 outbreak a national emergency.

The health concerns relating to the COVID-19 outbreak and related governmental actions taken to reduce the spread of the virus have significantly impacted the global economy (including the states and local economies in which we operate), disrupted supply chains, lowered equity market valuations, and created significant volatility and disruption in financial markets.

The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns.

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

While quarantine and lock-down orders have been lifted and vaccination efforts are underway, COVID-19 has not yet been contained and commercial activity has not yet returned to the levels existing prior to the pandemic outbreak.

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

Furthermore, the outbreak could negatively impact our employees and customers’ ability to engage in banking and other financial transactions.

The Company also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas.

The fair value of certain assets could be impacted by the effects of COVID-19.

The carrying value of goodwill, right-of-use lease assets, and other real estate owned could decrease resulting in future impairment losses.

Management will continue to evaluate current economic conditions to determine if a triggering event would impact the current valuations for these assets.

As a result, it is not currently possible to ascertain the continued impact of COVID-19 on the Company’s business.

However, if the pandemic continues as a prolonged worldwide health crisis, the disease could have a material adverse effect on the Company’s business, results of operations, financial condition and cash flows.

Description of Business and Basis of Presentation

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Gains and losses on sales are recorded on trade date and determined using the specific identification method.

On January 1, 2018, the Company adopted the new accounting for Financial Instruments, which requires equity investments with readily determinable values (except those accounted for under equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income.

Investments with readily determinable values (except those accounted for under equity method of accounting or those that result in consolidation of the investee) are measured at fair value with changes in fair value recognized in net income.

Equity securities that do not have readily determinable fair values are carried at historical cost and evaluated for impairment on a periodic basis.

The adoption of this guidance impacted one security and resulted in no adjustment to beginning retained earnings and no impact to beginning other comprehensive income.

Upon adoption of the guidance, this equity security is no longer classified as available for sale.

For additional information on this security, see Note 2 - Securities.

Management evaluates debt securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer.

Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis.

If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings.

For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows:

1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income.

The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

Loans Held for Sale

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Net unrealized gains or losses are recorded through earnings.

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 1 – Summary of Significant Accounting Policies (continued)

Mortgage loans held for sale are generally sold on a servicing released basis.

Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

Loans that management originates and has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses.

Interest income is accrued on unpaid principal balance and includes amortization of net deferred loan fees and costs over the loan term without anticipating prepayments.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost.

Amortized cost is the principal balance outstanding, net of purchase premiums and discounts, deferred loan fees and costs.

Accrued interest receivable totaled $ 14,133 at December 31, 2020 and was reported in Accrued Interest Receivable and Other Assets on the Consolidated Balance Sheets.

Interest income is accrued on the unpaid principal balance.

Loan origination fees and costs are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

Purchase Credit Deteriorated (PCD) Loans

The Company has purchased loans, some of which have experienced more than insignificant credit deterioration since origination.

PCD loans are recorded at the amount paid.

An allowance for credit losses on loans is determined using the same methodology as other loans held for investment.

The initial allowance for credit losses on loans determined on a collective basis is allocated to individual loans.

The sum of the loan’s purchase price and allowance for credit losses on loans becomes its initial amortized cost basis.

The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan.

Subsequent changes to the allowance for credit losses on loans are recorded through provision expense.

Allowance for Credit Losses - Loans

The allowance for credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans.

Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed.

Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

The Company estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

Historical loss experience provides the basis for the estimation of expected credit losses.

Adjustments to historical loss information are made for changes in underwriting standards, portfolio mix, delinquency level, changes in environmental conditions, unemployment rates, risk classifications and collateral values.

The Company separately assigns allocations for substandard and special mention commercial and agricultural credits as well as other categories of loans based on migration analysis techniques.

The migration analysis factors are calculated using a transition matrix to determine the likelihood of a customer's asset quality rating migrating from its current rating to any other rating.

The allowance for credit losses is measured on a collective (pooled) basis when similar risk characteristics exist.

The Company has identified the following portfolio segments and measures the allowance for credit losses using the following methods:

Commercial and Industrial Loans - The principal risk of commercial and industrial loans is that these loans are primarily based on the identified cash flow of the borrower and secondarily on the collateral underlying the loans.

Most commercial loans are secured by accounts receivable, inventory and equipment.

If cash flow from business operations is reduced, the borrower's ability to repay the loan may diminish, and over time, it may also be difficult to substantiate current value of inventory and equipment.

Repayment of these loans are more sensitive than other types of loans to adverse conditions in the general economy.

Commercial Real Estate Loans - Commercial real estate lending is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.

Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy.

Commercial real estate loans are collateralized by the borrower's underlying real estate.

Therefore, diminished cash flows not only affects the ability to repay the loan, it may also reduce the underlying collateral value.

Agricultural Loans - This portfolio is diversified between real estate financing, equipment financing and lines of credit in various segments including grain production, poultry production and livestock production.

Mitigating any concentration of risk that may exist in the Company's agricultural loan portfolio is the use of federal government guarantee programs.

Leases - Leases are primarily for equipment leased to varying types of businesses.

If the cash flows from the business operations is reduced, the business's ability to repay the lease is diminished as well.

Notes to the Consolidated Financial Statements

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NOTE 1 – Summary of Significant Accounting Policies (continued)

All classes of loans are generally placed on non-accrual status when scheduled principal or interest payments are past due for 90 days or more or when the borrower’s ability to repay becomes doubtful.

Uncollected accrued interest for each class of loans is reversed against income at the time a loan is placed on non-accrual.

Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.

All classes of loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Loans are typically charged-off at 180 days past due, or earlier if deemed uncollectible.

Exceptions to the non-accrual and charge-off policies are made when the loan is well secured and in the process of collection.

Certain Purchased Loans

The Company purchases individual loans and groups of loans.

Purchased loans that show evidence of credit deterioration since origination are recorded at the amount paid (or allocated fair value in a purchase business combination), such that there is no carryover of the seller’s allowance for loan losses.

After acquisition, incurred losses are recognized by an increase in the allowance for loan losses.

Such purchased loans are accounted for individually.

The Company estimates the amount and timing of expected cash flows for each purchased loan and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan (accretable yield).

The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).

Over the life of the loan, expected cash flows continue to be estimated.

If the present value of expected cash flows is less than the carrying amount, a loss is recorded.

If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable incurred credit losses.

Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

Subsequent recoveries, if any, are credited to the allowance.

Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.

Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.

The allowance consists of specific and general components.

The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or special mention.

The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.

Loan impairment is reported when full repayment under the terms of the loan is not expected.

If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate, or at the fair value of collateral if repayment is expected solely from the collateral.

Commercial and industrial loans, commercial real estate loans, and agricultural loans are evaluated individually for impairment.

Smaller balance homogeneous loans are evaluated for impairment in total.

Such loans include real estate loans secured by one-to-four family residences and loans to individuals for household, family and other personal expenditures.

Individually evaluated loans on non-accrual are generally considered impaired.

Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception.

If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported at the fair value of the collateral net of disposition costs.

For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component of the allowance for loan losses covers non-impaired loans and is based on historical loss experience adjusted for current factors.

The historical loss experience is determined by portfolio segment and risk classifications and is based on the actual loss history experienced by the Company over a 20 quarter average.

The Company separately assigns allocations for substandard and special mention commercial and agricultural credits as well as other categories of loans based on migration analysis techniques.

The migration analysis factors are calculated using a transition matrix to determine the likelihood of a customer's asset quality rating migrating from its current rating to any other rating.This actual loss experience is supplemented with other external and internal factors based on the risks present for each portfolio segment.

These factors include consideration of the following:

levels of and trends in delinquencies and impaired loans;

levels of and trends in charge-offs and recoveries;

trends in volume and terms of loans;

effects of any changes in risk selection and underwriting standards;

other changes in lending policies, procedures, and practices;

experience, ability, and depth of lending management and other relevant staff;

national and local economic trends and conditions;

industry conditions;

and effects of changes in credit concentrations.

The following portfolio segments have been identified:

Commercial Loans and Retail Loans.

Commercial Loans have been classified according to the following risk

Home Equity Loans - Home equity loans are generally secured by 1-4 family residences that are owner-occupied.

Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by unemployment levels in the market area due to economic conditions.

Consumer Loans - Consumer loan repayment is typically dependent on the borrower remaining employed through the life of the loan as well as the borrower maintaining the underlying collateral adequately.

Credit Cards - Credit card loan are unsecured and repayment is primarily dependent on the personal income of the borrower.

Residential Mortgage Loans - Residential mortgage loans are typically secured by 1-4 family residences that are owner-occupied.

Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by unemployment levels in the market area due to economic conditions.

Repayment may also be impacted by changes in residential property values.

Loans that do not share risk characteristics are evaluated on an individual basis.

Loans evaluated individually are also not included in the collective evaluation.

When the borrower is experiencing financial difficulty at the reporting date and repayment is expected to be provided substantially through the operation or sale of the collateral, expected credit losses are based on the fair value of the collateral at the reporting date adjusted for selling costs.

Troubled Debt Restructurings (“TDR”)

A loan for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, is considered to be a TDR.

The allowances for credit losses on loans on a TDR is measured using the same method as all other loans held for investment, except that the original interest rate is used to discount the expected cash flows, not the rate specified within the restructuring.

Loan Modifications and Troubled Debt Restructurings due to COVID-19

On April 7, 2020, the Board of Governors of the Federal Reserve System (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.

This TDR exemption, which was set to expire on December 31, 2020, was extended under the 2021 Consolidated Appropriations Act adopted on December 27, 2020, to the earlier of (i) 60 days after the national emergency concerning the COVID-19 outbreak terminates, and (ii) January 1, 2022.

Allowance for Credit Losses on Available-For-Sale Securities

For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis.

If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income.

For debt securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors.

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, among other factors.

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

Any impairment that has not been recorded through an allowance for credit losses is recorded in other comprehensive income.

Changes in the allowance for credit losses are recorded as provision for, or reversal of, credit loss expense.

Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

Notes to the Consolidated Financial Statements

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NOTE 1 – Summary of Significant Accounting Policies (continued)

characteristics:

Commercial and Industrial Loans and Leases, Commercial Real Estate, and Agricultural Loans.

Commercial and Industrial loans are primarily based on the cash flows of the business operations and secured by assets being financed and other assets such as accounts receivable and inventory.

Commercial Real Estate Loans and Agricultural Loans are primarily based on cash flow of the borrower and their business and further secured by real estate.

All types of commercial and agricultural (real estate secured and non-real estate) may also come with personal guarantees of the borrowers and business owners.

Retail Loans have been classified according to the following risk characteristics:

Home Equity Loans, Consumer Loans and Residential Mortgage Loans.

Retail loans are generally dependent on personal income of the customer, and repayment is dependent on borrower’s personal cash flow and employment status which can be affected by general economic conditions.

Additionally, collateral values may fluctuate based on the impact of economic conditions on residential real estate values and other consumer type assets such as automobiles.

Loans or portions of loans shall be charged off when there is a distinct probability of loss identified.

A distinct probability of loss exists when it has been determined that any remaining sources of repayment are insufficient to cover all outstanding principal.

The probable loss is immediately calculated based on the value of the remaining sources of repayment and charged to the allowance for loan loss.

Servicing Rights

When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans.

Fair value is based on market prices for comparable mortgage servicing contracts when available or, alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.

All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

Through the acquisition of River Valley Bancorp in 2016, the Company acquired a portfolio of servicing rights on mortgage loans.

The Company also acquired a portfolio of servicing rights on mortgage loans through the acquisition of five branch locations of First Financial Bancorp (formerly branch locations of Mainsource Financial Group, Inc.

prior to its merger with First Financial Bancorp on April 1, 2018).

The fair value of mortgage servicing rights were $ 663 and $ 995 at December 31, 2019 and 2018, respectively.

On a quarterly basis, loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount.

The valuation model utilizes interest rate, prepayment speed, and default rate assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data.

Servicing fee income is reported on the income statement as other operating income.

The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned.

The amortization of mortgage servicing right is netted against loan servicing fee income.

Allowance for Credit Losses on Off-Balance Sheet Credit Exposures

The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company.

The allowance for credit losses on off-balance sheet credit exposures is adjusted as a provision for credit loss expense included in other expense on the consolidated income statement.

The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life.

Expected utilization rates are compared to the current funded portion of the total commitment amount as a practical expedient for funded exposure at default.

Federal Home Loan Bank (FHLB) Stock

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Operating costs after acquisition are expensed.

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 1 – Summary of Significant Accounting Policies (continued)

Goodwill and Other Intangible Assets

Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired.

Goodwill arising from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.

Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.

Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually.

14 unchanged sentences

Such financial instruments are recorded when they are funded.

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 1 – Summary of Significant Accounting Policies (continued)

Restrictions on Cash

At December 31, 2019 and 2018, respectively, the Company was required to have $ 24,560 and $ 15,170 on deposit with the Federal Reserve, or as cash on hand.

At December 31, 2020, the Company was no t required to have balance on deposits with the Federal Reserve, or as cash on hand.

At December 31, 2019, the Company was required to have $ 24,560 on deposit with the Federal Reserve, or as cash on hand.

Long-term Assets

12 unchanged sentences

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.

The amount recognized is the largest amount of tax benefit that is

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 1 – Summary of Significant Accounting Policies (continued)

greater than 50% likely of being realized on examination.

The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.

For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

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Recently Adopted Accounting Guidance

In February 2016, the FASB amended existing guidance (ASU No.

2016-02, Leases (Topic 842)) that requires lessees recognize the following for all leases (with the exception of short-term leases) at the commencement date (1) A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis;

and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

Under the new guidance, lessor accounting is largely unchanged.

The Company adopted the amendments to Topic 842 on January 1, 2019, utilizing the modified retrospective approach and the transition option issued under ASU 2018-11, Leases (Topic 842) Targeted Improvements.

The Company elected to apply the package of practical expedients permitting entities to not reassess (1) expired or existing contracts that may contain leases;

(2) lease classification of expired or existing leases;

or (3) initial direct costs for existing leases as well as the practical expedient for land easements.

The Company also elected certain optional relief for accounting policy elections under ASU 2016-02 (1) to not separate the lease and non-lease components and instead use them for a single lease component for leases related to office equipment and (2) the option to not recognize right-of-use assets and liabilities that arise from short-term leases.

Upon adoption of this guidance on January 1, 2019, the Company recorded a right-of-use asset and corresponding lease liability of $ 9,034 on the consolidated balance sheet.

No cumulative effect adjustment to retained earnings resulted from the adoption of this guidance.

For additional details on this recently adopted accounting guidance, see Note 13 - Leases.

In February 2018, the FASB issued new guidance (ASU No.

2018-02, Income Statement - Reporting Comprehensive Income (Topic 220)) to allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act.

The amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users.

This amendment was effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.

The Company early adopted this guidance in 2017 and it did not have a material impact on the Company's operating results or financial condition.

In March 2017, the FASB amended existing guidance (ASU No.

2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20)) to amend the amortization period for certain purchased callable debt securities held at a premium.

The amortization period has been shortened to the earliest call date.

Under current generally accepted accounting principles, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument.

These amendments are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15,

In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology.

The measurement of

Notes to the Consolidated Financial Statements

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NOTE 1 – Summary of Significant Accounting Policies (continued)

The Company early adopted this guidance in 2017 and it did not have a material impact on the Company's operating results or financial condition.

Accounting Guidance Issued But Not Yet Adopted

In June 2016, the FASB issued guidance (ASU No.

2016-13, Financial Instruments - Credit Losses (Topic 326)) to replace the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model.

The CECL model is applicable to the measurement of credit losses on financial assets measured at amortized cost, including loan receivables, held-to-maturity debt securities, and reinsurance receivables.

It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor.

This standard will be effective for public business entities for fiscal years beginning after December 15, 2019, including interim periods within that reporting period.

The transition to the new standard will be applied as follows:

For debt securities with other-than-temporary impairment (OTTI), the guidance will be applied prospectively.

Existing purchased credit impaired (PCI) assets will be grandfathered and classified as purchased credit deteriorated (PCD) assets at the date of adoption.

The asset will be grossed up for the allowance for expected credit losses for all PCD assets at the date of adoption and will continue to recognize the noncredit discount in interest income based on the yield of such assets as of the adoption date.

Subsequent changes in expected credit losses will be recorded through the allowance.

For all other assets within the scope of CECL, a cumulative-effect adjustment will be recognized in retained earnings as of the beginning of the first reporting period in which the guidance is effective.

As previously disclosed, the Company formed a cross-functional committee that assessed data and system needs, selected a vendor to provide modeling needs, and implemented new software.

The Company has completed parallel runs comparing its existing allowance for loan loss model with the CECL model and determined eight loan segments for which models have been developed.

The Company has also determined the significant qualitative factors that will be utilized in the CECL model, but continue to assess their impact on the model.

As of year end, the Company has not completed finalizing the results of its CECL estimate.

Model validation testing is currently being performed and internal controls over financial reporting specifically related to CECL are in final design stage and are currently being evaluated.

The Company expects to recognize a one-time cumulative adjustment to the allowance for credit losses in the first quarter of 2020.

Although the Company does not have the approval from its internal governing committee, the Company is estimating an increase to its allowance for loan losses of approximately $ 12 million to $ 20 million upon adoption.

The increase is primarily related to the Company's acquired loan portfolio.

Under the current accounting guidance, any remaining unamortized loan discount on an individual loan can be used to offset a charge-off for that loan, so the allowance for loan losses needed for the acquired loans is reduced by the remaining loan discounts.

The new accounting under this ASU removes the ability to offset a charge-off against the remaining loan discount and requires an allowance for credit losses to be recognized in addition to the loan discount.

This estimate and the ongoing impact of adopting this ASU are dependent on various factors, including credit quality, macroeconomic forecasts and conditions, composition of our loans and securities portfolios, and other management judgements.

The transition adjustment to record the allowance for credit losses, which remains subject to further review and analysis by the Company's management team, may fall outside of the estimated range based on material changes in these factors.

Federal banking regulators have approved rules that provide banking organizations the option to phase in the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard over a three-year period.

The Company anticipates adopting the capital transition relief over the permissible three-year period.

expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities.

It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments).

The new CECL model requires an estimate of expected credit losses, measured over the contractual life of an instrument, which considers reasonable and supportable forecasts of future economic conditions in addition to information about past events and current conditions.

The standard provides significant flexibility and requires a high degree of judgement with regards to pooling financial assets with similar risk characteristics and adjusting the relevant historical loss information in order to develop an estimate of expected lifetime losses.

The Company adopted ASC 326 on January 1, 2020 using the modified restrospective approach.

Results for reporting periods after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.

The Company recorded a net reduction of retained earnings of $ 6,717 upon adoption.

The Company adopted ASC 326 using the prospective transition approach for financial assets purchased with credit deterioration (PCD) that were previously classified as purchased credit impaired (PCI) and accounted for under ASC 310-30.

In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption.

On January 1, 2020, the amortized cost basis of the PCD assets were adjusted to reflect the addition of $ 6,886 of the allowance for credit losses.

The remaining noncredit discount (based on the adjusted amortized cost basis) will be accreted into interest income at the effective interest rate as of January 1, 2020.

The Company expanded the loan portfolio segments used to determine the allowance for credit losses for loans into eight loan segments as opposed to six loan segments under the incurred loss methodology.

The following table illustrates the impact of the segment expansion as of January 1, 2020.

(dollars in thousands) December 31, 2019 Statement Balance Segment Portfolio Reclassifications December 31, 2019 After Reclassification

Commercial and Industrial Loans $ 589,758 $ ( 57,257 ) $ 532,501

Commercial Real Estate Loans 1,495,862 N/A 1,495,862

Agricultural Loans 384,526 N/A 384,526

Leases N/A 57,257 57,257

Home Equity Loans 225,755 N/A 225,755

Consumer Loans 81,217 ( 11,953 ) 69,264

Credit Cards N/A 11,953 11,953

Residential Mortgage Loans 304,855 N/A 304,855

Total Loans $ 3,081,973 $ — $ 3,081,973

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 1 – Summary of Significant Accounting Policies (continued)

The following table illustrates the impact of ASC 326:

(dollars in thousands) December 31, 2019 After Reclassification Impact of ASC 326 Adoption January 1, 2020 Post-ASC 326 Adoption

Commercial and Industrial Loans $ 532,501 $ 2,191 $ 534,692

Commercial Real Estate Loans 1,495,862 4,385 1,500,247

Agricultural Loans 384,526 128 384,654

Leases 57,257 — 57,257

Home Equity Loans 225,755 35 225,790

Consumer Loans 69,264 — 69,264

Credit Cards 11,953 — 11,953

Residential Mortgage Loans 304,855 147 305,002

Allowance for Credit Losses on Loans ( 16,278 ) ( 15,653 ) ( 31,931 )

Allowance for Credit Losses on Unfunded Loan Commitments $ — $ ( 173 ) $ ( 173 )

In December 2018, federal banking regulators approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL.

The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard.

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.

In January 2017, the FASB issued ASU No.

2017-04, Intangibles - Goodwill and Other:

Simplifying the Test for Goodwill Impairment.

To simplify the subsequent measurement of goodwill, the amendments eliminate Step 2 from the goodwill impairment test.

The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount.

An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value;

however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.

In addition, the income tax effects of tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable.

The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform Step 2 of the goodwill impairment test.

An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.

The amendments should be applied on a prospective basis.

The nature of and reason for the change in accounting principle should be disclosed upon transition.

The amendments in this update became effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 and did not have a material impact on the Company's financial statements.

In August 2018, the FASB issued ASU No.

2018-13, Fair Value Measurement (Topic 820):

Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.

The amendment removes certain disclosures required by Topic 820 related to transfers between Level 1 and Level 2 of the fair value hierarchy;

the policy for timing of transfers between levels;

and the valuation processes for Level 3 fair value measurements.

The update also adds certain disclosure requirements related to changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements.

The amendments in this update became effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2019 and did not have a material impact on the Company's financial statements.

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 1 – Summary of Significant Accounting Policies (continued)

Accounting Guidance Issued But Not Yet Adopted

In March 2020, the FASB issued ASU No.

2020-04, Reference Rate Reform (Topic 848):

Facilitation of the Effects of Reference Rate Reform on Financial Reporting.

These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform.

The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued.

It is intended to help stakeholders during the global market-wide reference rate transition period.

The guidance is effective for all entities as of March 12, 2020 through December 31, 2022.

The Company is evaluating the impact of adopting the new guidance on the consolidated financial statements on an ongoing basis with no material expected impact at this time.

NOTE 2 – Securities

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Securities Available-for-Sale:

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value

Obligations of State and Political Subdivisions $ 548,273 $ 33,077 $ ( 103 ) $ 581,247

MBS/CMO 535,526 12,806 ( 25 ) 548,307

US Gov't Sponsored Entities & Agencies 88,376 120 ( 198 ) 88,298

Total $ 1,172,175 $ 46,003 $ ( 326 ) $ 1,217,852

Obligations of State and Political Subdivisions $ 307,943 $ 16,366 $ ( 9 ) $ 324,300

MBS/CMO 526,907 5,414 ( 1,796 ) 530,525

US Gov't Sponsored Entities & Agencies — — — —

Total $ 834,850 $ 21,780 $ ( 1,805 ) $ 854,825

All mortgage-backed securities in the above table (identified above and throughout this Note 2 as "MBS/CMO") are residential and multi-family mortgage-backed securities and guaranteed by government sponsored entities.

The US Gov't Sponsored Entities & Agencies in the above table have underlying collateral of equipment, machinery and commercial real estate.

The amortized cost and fair value of securities at December 31, 2020 by contractual maturity are shown below.

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Due after ten years 454,757 482,169

MBS/CMO 535,526 548,307

US Gov't Sponsored Entities & Agencies 88,376 88,298

Total $ 1,172,175 $ 1,217,852

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 2 – Securities (continued)

2020 2019 2018

Proceeds from the Sales of Securities are summarized below:

for-Sale Available-

Proceeds from Sales $ 125,106 $ 82,601 $ 91,013

3 unchanged sentences

Below is a summary of securities with unrealized losses as of year-end 2020 and 2019, presented by length of time the securities have been in a continuous unrealized loss position:

Less than 12 Months

12 Months or More

Less than 12 Months 12 Months or More Total

Value Unrealized

December 31, 2020

Obligations of State and Political Subdivisions $ 10,652 $ ( 103 ) $ — $ — $ 10,652 $ ( 103 )

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 2 – Securities (continued)

Less than 12 Months

12 Months or More

MBS/CMO 19,631 ( 25 ) — — 19,631 ( 25 )

US Gov't Sponsored Entities & Agencies 59,054 ( 198 ) — — 59,054 ( 198 )

Total $ 89,337 $ ( 326 ) $ — $ — $ 89,337 $ ( 326 )

Less than 12 Months 12 Months or More Total

Value Unrealized

December 31, 2019

Obligations of State and Political Subdivisions $ 4,631 $ ( 9 ) $ — $ — $ 4,631 $ ( 9 )

Securities are written down to fair value when a decline in fair value is not considered temporary.

In estimating other-than-temporary losses, management considers many factors, including:

(1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.

The Company doesn’t intend to sell or expect to be required to sell these securities, and the decline in fair value is largely due to changes in market interest rates;

therefore, the Company does not consider these securities to be other-than-temporarily impaired.

All mortgage-backed securities and collateralized mortgage obligations (MBS/CMO) in the Company’s portfolio are guaranteed by government sponsored entities, are investment grade, and are performing as expected.

MBS/CMO 89,267 ( 241 ) 155,989 ( 1,555 ) 245,256 ( 1,796 )

US Gov't Sponsored Entities & Agencies — — — — — —

Total $ 93,898 $ ( 250 ) $ 155,989 $ ( 1,555 ) $ 249,887 $ ( 1,805 )

Available-for-sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly.

For available-for-sale debt securities in an unrealized loss position, the Company assesses whether we intend to sell, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis.

If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income.

For available-for sale debt securities that do not meet the criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or 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 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 December 31, 2020.

Accrued interest receivable on available-for-sale debt securities totaled $ 5,954 at December 31, 2020 and is excluded from the estimate of credit losses.

The Company’s equity securities are listed as Other Investments on the Consolidated Balance Sheets and consist of one non-controlling investment in a single banking organization at December 31, 2020 and 2019.

1 unchanged sentence

The Company's equity securities are considered not to have readily determinable fair value and are carried at cost and evaluated for impairment.

At December 31, 2019, there was no additional impairment recognized through earnings.

There was no additional impairment recognized through earnings during 2020 or 2019.

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 3 – Derivatives

9 unchanged sentences

The following table reflects the fair value hedges included in the Consolidated Balance Sheets as of:

December 31, 2019

December 31, 2018

December 31, 2020 December 31, 2019

Amount Fair Value Notional

Amount Fair Value

Included in Other Assets:

2 unchanged sentences

Interest Rate Swaps $ 117,621 $ 9,353 $ 102,351 $ 2,829

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 3 – Derivatives (continued)

The following table presents the effect of derivative instruments on the Consolidated Statements of Income for the years ended December 31, 2020, 2019 and 2018 is as follows:

2020 2019 2018

Interest Rate Swaps:

2 unchanged sentences

Loans were comprised of the following classifications at December 31:

Commercial and Industrial Loans and Leases

Commercial and Industrial Loans $ 638,773 $ 532,501

Commercial Real Estate Loans 1,467,397 1,495,862

Agricultural Loans 376,186 384,526

Leases 55,664 57,257

Home Equity Loans 219,348 225,755

Consumer Loans 66,717 69,264

Credit Cards 11,637 11,953

Residential Mortgage Loans 256,276 304,855

Subtotal 3,091,998 3,081,973

Unearned Income ( 3,926 ) ( 4,882 )

Allowance for Loan Losses

As further described in Note 18, during 2019 the Company acquired loans at fair value as part of a business combination.

The table below summarizes the loans acquired in the current year.

Acquired Loan Balance

Fair Value Discounts

Bank Acquisition

The table below summarizes the remaining carrying amount of acquired loans included in the December 31, 2019 table above.

Loan Balance at December 31, 2019

Fair Value Discount at December 31, 2019

Bank Acquisition

The following tables present the activity in the allowance for loan losses by portfolio class for the years ended December 31, 2019, 2018, and 2017:

December 31, 2019

Beginning Balance

Provision for Loan Losses

Allowance for Credit Losses ( 46,859 ) ( 16,278 )

Loans, net $ 3,041,213 $ 3,060,813

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 4 – Loans (continued)

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was signed into law, providing an approximately $2 trillion stimulus package that includes direct payments to individual taxpayers, economic stimulus to significantly impacted industry sectors, emergency funding for hospitals and providers, small business loans, increased unemployment benefits, and a variety of tax incentives.

For small businesses, eligible nonprofits and certain others, the CARES Act established a Paycheck Protection Program (“PPP”), which is administered by the Small Business Administration (“SBA”).

On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was enacted.

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% and are fully guaranteed by the U.S.

During 2020, the Bank originated loans totaling approximately $ 351.3 million ($ 339.3 million net of deferred fees) in principal amount, on 3,070 PPP loan relationships under this program.

As a result of the forgiveness of PPP loans which began in the fourth quarter of 2020 for the Company, remaining PPP loans outstanding totaled $ 186.0 million ($ 182.0 million net of deferred fees) as of December 31, 2020 and are included above in the Commercial and Industrial Loan category.

Allowance for Credit Losses for Loans

The following table presents the activity in the allowance for credit losses by portfolio segment for the year ended December 31, 2020:

December 31, 2020 Commercial

Loans Commercial

Loans Agricultural

Loans Leases Consumer

Loans Home Equity Loans Credit Cards Residential

Loans Unallocated Total

Allowance for Credit Losses:

Beginning balance prior to adoption of ASC 326 $ 4,799 $ 4,692 $ 5,315 $ — $ 434 $ 200 $ — $ 333 $ 505 $ 16,278

Impact of adopting ASC 326 2,245 3,063 1,438 105 ( 59 ) 762 124 1,594 ( 505 ) 8,767

Impact of adopting ASC 326 - PCD Loans 2,191 4,385 128 — — 35 — 147 — 6,886

Provision for credit loss expense ( 694 ) 17,645 ( 125 ) 95 527 66 131 ( 95 ) — 17,550

Initial allowance on loans purchased with credit deterioration — — — — — — — — — —

Loans Charged-off ( 2,119 ) ( 36 ) — — ( 766 ) ( 67 ) ( 109 ) ( 39 ) — ( 3,136 )

Ending Balance

Recoveries collected 23 129 — — 354 — 4 4 — 514

Total ending allowance balance $ 6,445 $ 29,878 $ 6,756 $ 200 $ 490 $ 996 $ 150 $ 1,944 $ — $ 46,859

The Company utilizes the Static Pool methodology in determining expected future credit losses.

Static pool analysis means segmenting and tracking loans over a period of time based on similar risk characteristics such as loan structure, collateral type, industry of borrower and concentrations, contractual terms and credit risk indicators.

Static pool calculates a loss rate on a closed pool of loans that existed on a specified start date based upon the remaining life of each segment.

The Company's expected loss estimate is anchored in historical credit loss experience, with an emphasis on all available portfolio data.

The Company's historical look-back period includes January 2014 through the current period, on a monthly basis.

Qualitative reserves reflect management’s overall estimate of the extent to which current expected credit losses on collectively evaluated loans will differ from historical loss experience.

The analysis takes into consideration industry and collateral concentrations, acquired loan portfolio characteristics and other credit-related analytics as deemed appropriate.

Management attempts to quantify qualitative reserves whenever possible.

For the year ended December 31, 2020, the allowance for credit losses increased primarily due to macroeconomic factors surrounding the COVID-19 pandemic.

While there continues to be great uncertainty related to COVID-19 on our borrowers and communities, we have recognized significant declines in employment and gross domestic product which are key indicators utilized in our forecasting for our allowance calculations.

Based on the potential increased losses related to the economic impact

Notes to the Consolidated Financial Statements

1 unchanged sentence

NOTE 4 – Loans (continued)

of the COVID-19 pandemic, the bank has considered this loss experience may align with loss experience from the recessionary period from 2008-2011 and qualitative adjustments have been made accordingly.

Since PPP loans are guaranteed by the Small Business Administration (SBA), they have minimal impact on the allowance for credit losses.

All classes of loans, including loans acquired with deteriorated credit quality, are generally placed on non-accrual status when scheduled principal or interest payments are past due for 90 days or more or when the borrower’s ability to repay becomes doubtful.

For purchased loans, the determination is made at the time of acquisition as well as over the life of the loan.

Uncollected accrued interest for each class of loans is reversed against income at the time a loan is placed on non-accrual.

Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.

All classes of loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Loans are typically charged-off at 180 days past due, or earlier if deemed uncollectible.

Exceptions to the non-accrual and charge-off policies are made when the loan is well secured and in the process of collection.

The following table presents the amortized cost basis of loans on non-accrual status and loans past due over 89 days still accruing as of December 31, 2020:

Non-Accrual With No Allowance for Credit Loss (1)

Non-Accrual Loans Past Due Over 89 Days Still Accruing

Commercial and Industrial Loans $ 4,571 $ 8,133 $ —

Commercial Real Estate Loans 3,152 10,188 —

Agricultural Loans 1,291 1,915 —

Home Equity Loans 271 271 —

Consumer Loans 77 84 —

Credit Cards 86 86 —

Residential Mortgage Loans 671 830 —

Total $ 10,119 $ 21,507 $ —

(1) Includes non-accrual loans with no allowance for credit loss and are also included in Non-Accrual loans totaling $ 21,507 .

Interest income on non-accrual loans recognized during the year ended December 31, 2020 total $ 28 .

The following table presents the amortized cost basis of collateral-dependent loans by class of loans as of December 31, 2020:

Real Estate Equipment Accounts Receivable Other Total

Commercial and Industrial Loans $ 4,943 $ 3,014 $ 669 $ 154 $ 8,780

Commercial Real Estate Loans 11,877 — — 1,530 13,407

Agricultural Loans 3,064 — — — 3,064

Leases — — — — —

Home Equity Loans 416 — — — 416

Consumer Loans 4 4 — 3 11

Credit Cards — — — — —

Residential Mortgage Loans 817 — — — 817

Total $ 21,121 $ 3,018 $ 669 $ 1,687 $ 26,495

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 4 – Loans (continued)

The following table presents the aging of the amortized cost basis in past due loans by class of loans as of December 31, 2020:

Past Due 60-89 Days

Past Due Greater Than 89 Days Past Due Total

Past Due Loans Not

Past Due Total

December 31, 2020

Commercial and Industrial Loans $ 477 $ 909 $ 2,441 $ 3,827 $ 634,946 $ 638,773

Commercial Real Estate Loans 5 4,877 3,682 8,564 1,458,833 1,467,397

Agricultural Loans — — 651 651 375,535 376,186

Leases — — — — 55,664 55,664

Home Equity Loans 672 5 271 948 218,400 219,348

Consumer Loans 233 84 65 382 66,335 66,717

Credit Cards 95 80 86 261 11,376 11,637

Residential Mortgage Loans 3,737 1,590 529 5,856 250,420 256,276

Total $ 5,219 $ 7,545 $ 7,725 $ 20,489 $ 3,071,509 $ 3,091,998

Troubled Debt Restructurings:

In certain instances, the Company may choose to restructure the contractual terms of loans.

A troubled debt restructuring occurs when the Bank grants a concession to the borrower that it would not otherwise consider due to a borrower’s financial difficulty.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification.

This evaluation is performed under the Company’s internal underwriting policy.

The Company uses the same methodology for loans acquired with deteriorated credit quality as for all other loans when determining whether the loan is a troubled debt restructuring.

As of December 31, 2020 and 2019, the Company had trouble debt restructurings totaling $ 111 and $ 116 , respectively.

The Company had no specific allocation of allowance for these loans at December 31, 2020.

The Company had no t committed to lending any additional amounts during 2020 or 2019 to customers with outstanding loans that are classified as trouble debt restructurings.

During the years ended December 31, 2020 and 2019, the Company had no loans modified as troubled debt restructurings.

Additionally, there were no loans modified as trouble debt restructurings for which there was a payment default within twelve months following the modification during the years ended December 31, 2020 and 2019.

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

Loan Modifications and Troubled Debt Restructurings due to COVID-19

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.

This TDR exemption, which was set to expire on December 31, 2020, was extended under the CAA to the earlier of (i) 60 days after the national emergency concerning the COVID-19 outbreak terminates, and (ii) January 1, 2022.

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 4 – Loans (continued)

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

The table below shows the payment modifications that were still in effect as of December 31, 2020, with the majority of these credit relationships making full interest payments.

The outstanding loan balance subject to payment modifications as of December 31, 2020 was substantially reduced from the comparable balances as of June 30, 2020 and September 30, 2020.

% of Loan Category

(Excludes PPP Loans)

Type of Loans

(dollars in thousands) Number of Loans Outstanding Balance

As of 12/31/2020

As of 9/30/2020

Commercial & Industrial Loans 9 $ 4,311 0.8 % 1.2 %

Commercial Real Estate Loans 15 43,951 3.0 % 5.7 %

Agricultural Loans — — — % — %

Consumer Loans 9 80 n/m (1)

Residential Mortgage Loans 4 218 0.1 % 0.5 %

Total 37 $ 48,560 1.7 % 3.1 %

(1) n/m = not meaningful

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as:

current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.

The Company classifies loans as to credit risk by individually analyzing loans.

This analysis includes commercial and industrial loans, commercial real estate loans, and agricultural loans with an outstanding balance greater than $ 250 .

This analysis is typically performed on at least an annual basis.

The Company uses the following definitions for risk ratings:

Special Mention.

Loans classified as special mention have a potential weakness that deserves management’s close attention.

If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.

Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.

They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 4 – Loans (continued)

Based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

Term Loans Amortized Cost Basis by Origination Year

As of December 31, 2020 2020 2019 2018 2017 2016 Prior Revolving Loans Amortized Cost Basis Total

Commercial and Industrial:

Pass $ 260,027 $ 88,273 $ 46,681 $ 31,612 $ 21,025 $ 48,508 $ 109,228 $ 605,354

Special Mention 618 1,102 2,756 1,739 206 1,972 9,948 18,341

Substandard 143 164 1,283 1,530 607 5,416 5,935 15,078

Doubtful — — — — — — — —

Total Commercial & Industrial Loans $ 260,788 $ 89,539 $ 50,720 $ 34,881 $ 21,838 $ 55,896 $ 125,111 $ 638,773

Commercial Real Estate:

Pass $ 296,265 $ 215,226 $ 179,129 $ 183,703 $ 171,016 $ 295,641 $ 29,634 $ 1,370,614

Special Mention 883 9,361 15,232 23,489 7,578 20,294 147 76,984

Substandard — 1,131 1,735 1,692 4,292 10,849 100 19,799

Doubtful — — — — — — — —

Total Commercial Real Estate Loans $ 297,148 $ 225,718 $ 196,096 $ 208,884 $ 182,886 $ 326,784 $ 29,881 $ 1,467,397

Agricultural:

Pass $ 49,242 $ 25,449 $ 31,285 $ 32,368 $ 22,702 $ 64,890 $ 75,871 $ 301,807

Special Mention 11,503 9,911 3,111 8,767 2,707 10,125 16,318 62,442

Substandard 578 73 394 1,228 4,466 5,198 — 11,937

Doubtful — — — — — — — —

Total Agricultural Loans $ 61,323 $ 35,433 $ 34,790 $ 42,363 $ 29,875 $ 80,213 $ 92,189 $ 376,186

Pass $ 18,258 $ 17,517 $ 9,176 $ 5,415 $ 1,605 $ 3,693 $ — $ 55,664

Special Mention — — — — — — — —

Substandard — — — — — — — —

Doubtful — — — — — — — —

Total Leases $ 18,258 $ 17,517 $ 9,176 $ 5,415 $ 1,605 $ 3,693 $ — $ 55,664

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 4 – Loans (continued)

The Company considers the performance of the loan portfolio and its impact on the allowance for credit losses.

For residential, home equity and consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.

The following table presents the amortized cost in residential, home equity and consumer loans based on payment activity.

Term Loans Amortized Cost Basis by Origination Year

As of December 31, 2020 2020 2019 2018 2017 2016 Prior Revolving Loans Amortized Cost Basis Total

Payment performance

Performing $ 33,857 $ 16,486 $ 8,456 $ 2,115 $ 910 $ 2,245 $ 2,563 $ 66,632

Nonperforming — — 11 2 14 23 35 85

Total Consumer Loans $ 33,857 $ 16,486 $ 8,467 $ 2,117 $ 924 $ 2,268 $ 2,598 $ 66,717

Payment performance

Performing $ — $ — $ 34 $ 46 $ 67 $ 490 $ 218,440 $ 219,077

Nonperforming — — — — — — 271 271

Total Home Equity Loans $ — $ — $ 34 $ 46 $ 67 $ 490 $ 218,711 $ 219,348

Residential Mortgage:

Payment performance

Performing $ 45,945 $ 26,536 $ 28,050 $ 28,764 $ 25,155 $ 100,998 $ — $ 255,448

Nonperforming — — — — — 828 — 828

Total Residential Mortgage Loans $ 45,945 $ 26,536 $ 28,050 $ 28,764 $ 25,155 $ 101,826 $ — $ 256,276

The Company considers the performance of the loan portfolio and its impact on the allowance for credit losses.

For certain retail loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.

The following table presents the recorded investment in retail loans based on payment activity:

As of December 31, 2020

Performing $ 11,551

Nonperforming 86

Total $ 11,637

The following tables present loans purchased and/or sold during the year by portfolio segment:

Commercial and Industrial Loans Commercial Real Estate Loans Agricultural Loans Leases Consumer Loans Home Equity Loans Credit Cards Residential Mortgage Loans Total

December 31, 2020

Purchases $ — $ — $ — $ — $ — $ — $ — $ — $ —

Sales — 3,128 — — — — — — 3,128

December 31, 2019

Purchases $ 2,051 $ — $ — $ — $ — $ — $ — $ — $ 2,051

Sales — — — — — — — — —

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 4 – Loans (continued)

Certain directors, executive officers, and principal shareholders of the Company, including their immediate families and companies in which they are principal owners, were loan customers of the Company during 2020.

A summary of the activity of these loans follows:

2020 Additions Changes in Persons Included Deductions Balance

Collected Charged-off

$ 26,243 $ 24,482 $ — $ ( 17,981 ) $ — $ 32,744

Allowance for Loan Losses

Prior to the adoption of ASC 326 on January 1, 2020, the Company calculated the allowance for loan losses using the incurred loss methodology.

The following tables are disclosures related to the allowance for loan losses in prior periods.

The following tables present the activity in the allowance for loan losses by portfolio class for the years ended December 31, 2019 and 2018:

Leases Commercial

Loans Agricultural

Loans Consumer

Loans Residential

Loans Unallocated Total

December 31, 2019

Beginning Balance $ 2,953 $ 5,291 $ 5,776 $ 229 $ 420 $ 472 $ 682 $ 15,823

Provision for Loan Losses 5,600 ( 308 ) ( 461 ) ( 27 ) 727 ( 29 ) ( 177 ) 5,325

Recoveries 56 29 — 8 432 7 — 532

Loans Charged-off ( 3,810 ) ( 320 ) — ( 10 ) ( 1,145 ) ( 117 ) — ( 5,402 )

Ending Balance $ 4,799 $ 4,692 $ 5,315 $ 200 $ 434 $ 333 $ 505 $ 16,278

Leases Commercial

Loans Agricultural

Loans Consumer

Loans Residential

Loans Unallocated Total

December 31, 2018

1 unchanged sentence

Provision for Loan Losses ( 423 ) 729 862 ( 52 ) 608 167 179 2,070

Recoveries 141 20 20 12 375 37 — 605

Loans Charged-off ( 1,500 ) ( 49 ) — ( 61 ) ( 861 ) ( 75 ) — ( 2,546 )

Ending Balance $ 2,953 $ 5,291 $ 5,776 $ 229 $ 420 $ 472 $ 682 $ 15,823

In determining the adequacy of the allowance for loan loss, general allocations are made for pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss.

General allocations of the allowance are primarily made based on historical averages for loan losses for these portfolios, judgmentally adjusted for current economic factors and portfolio trends.

Loan impairment is reported when full repayment under the terms of the loan is not expected.

This methodology is used for all loans, including loans acquired with deteriorated credit quality if such loans perform worse than what was expected at the time of acquisition.

For purchased loans, the assessment is made at the time of acquisition as well as over the life of loan.

Commercial and industrial loans, commercial real estate loans, and agricultural loans are evaluated individually for impairment.

Smaller balance homogeneous loans are evaluated for impairment in total.

Such loans include real estate loans secured by one-to-four family residences and loans to individuals for household, family and other personal expenditures.

Individually evaluated loans on non-accrual are generally considered impaired.

Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Specific allocations on impaired loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds.

Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be greater than historical averages, including non-performing consumer or residential real estate loans.

Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values.

Notes to the Consolidated Financial Statements

1 unchanged sentence

NOTE 4 – Loans (continued)

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio class and based on impairment method as of December 31, 2019 and 2018:

December 31, 2019

Loans and Leases

Real Estate Loans

Agricultural Loans

Consumer Loans

Mortgage Loans

Allowance for Loan Losses:

Ending Allowance Balance Attributable to Loans:

Individually Evaluated for Impairment

Collectively Evaluated for Impairment

Acquired with Deteriorated Credit Quality

Total Ending Allowance Balance

Loans Individually Evaluated for Impairment

Loans Collectively Evaluated for Impairment

Loans Acquired with Deteriorated Credit Quality

Total Ending Loans Balance (1)

(1) Total recorded investment in loans includes $ 13,929 in accrued interest.

(2) n/m = not meaningful

December 31, 2018

Loans and Leases

Real Estate Loans

Agricultural Loans

Consumer Loans

Mortgage Loans

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class and based on impairment method as of December 31, 2019:

December 31, 2019 Total Commercial

Loans and Leases Commercial

Real Estate Loans Agricultural Loans Home

Equity Loans Consumer Loans Residential

Mortgage Loans Unallocated

Allowance for Loan Losses:

4 unchanged sentences

Total Ending Allowance Balance $ 16,278 $ 4,799 $ 4,692 $ 5,315 $ 200 $ 434 $ 333 $ 505

Loans Individually Evaluated for Impairment

Loans Collectively Evaluated for Impairment

Loans Acquired with Deteriorated Credit Quality

Loans Individually Evaluated for Impairment $ 6,269 $ 4,707 $ 1,562 $ — $ — $ — $ — n/m (2)

Loans Collectively Evaluated for Impairment 3,076,835 585,328 1,491,090 387,710 226,406 81,429 304,872 n/m (2)

Loans Acquired with Deteriorated Credit Quality 12,798 1,368 7,212 3,161 369 — 688 n/m (2)

Total Ending Loans Balance (1)

$ 3,095,902 $ 591,403 $ 1,499,864 $ 390,871 $ 226,775 $ 81,429 $ 305,560 n/m (2)

(1) Total recorded investment in loans includes $ 13,929 in accrued interest.

(2) n/m = not meaningful

Notes to the Consolidated Financial Statements

Dollars in thousands, except per share data

NOTE 4 – Loans (continued)

The following tables present loans individually evaluated for impairment by class of loans as of December 31, 2019 and 2018:

Allowance for

December 31, 2019

With No Related Allowance Recorded:

Commercial and Industrial Loans and Leases

Commercial Real Estate Loans

Agricultural Loans

With An Allowance Recorded:

Commercial and Industrial Loans and Leases

Commercial Real Estate Loans

Agricultural Loans

Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above)

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above)

(1) Unpaid Principal Balance is the remaining contractual payments gross of partial charge-offs and discounts.

Allowance for

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2019:

Investment Allowance for

December 31, 2019

3 unchanged sentences

Agricultural Loans 3,294 2,738 —

Subtotal 11,670 5,320 —

With An Allowance Recorded:

2 unchanged sentences

Agricultural Loans — — —

Subtotal 7,229 6,386 3,371

Total $ 18,899 $ 11,706 $ 3,371

Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above) $ 9,994 $ 4,624 $ —

4 unchanged sentences

NOTE 4 – Loans (continued)

The following tables present loans individually evaluated for impairment by class of loans for the years ended December 31, 2019, 2018 and 2017:

The following tables present the average balance and related interest income of loans individually evaluated for impairment by class of loans for the years ended December 31, 2019 and 2018:

Investment Interest

Recognized Cash

December 31, 2019

3 unchanged sentences

Agricultural Loans 1,790 1 —

Subtotal 5,912 101 2

With An Allowance Recorded:

2 unchanged sentences

Agricultural Loans — — —

Subtotal 6,894 — 2

Total $ 12,806 $ 101 $ 4

Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above) $ 4,321 $ 61 $ 3

Loans Acquired With Deteriorated Credit Quality With An Additional Allowance Recorded (Included in the Total Above) $ 1,766 $ — $ —

Investment Interest

Recognized Cash

December 31, 2018

3 unchanged sentences

Agricultural Loans 770 — —

Subtotal 4,097 133 39

With An Allowance Recorded:

2 unchanged sentences

Agricultural Loans — — —

Subtotal 7,636 20 9

Total $ 11,733 $ 153 $ 48

Loans Acquired With Deteriorated Credit Quality With No Related Allowance Recorded (Included in the Total Above) $ 875 $ 21 $ —

3 unchanged sentences

NOTE 4 – Loans (continued)

December 31, 2017