GERMAN AMERICAN BANCORP, INC. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. INTRODUCTION German American Bancorp, Inc. is a Nasdaq-traded (symbol: GABC) financial holding company based in Jasper, Indiana. German American, through its banking subsidiary German American Bank, operates 77 banking offices in 19 contiguous southern Indiana counties and 14 counties in Kentucky. The Company also owns an investment brokerage subsidiary (German American Investment Services, Inc.) and a full line property and casualty insurance agency (German American Insurance, Inc.). Throughout this Management’s Discussion and Analysis, as elsewhere in this Report, when we use the term “Company”, we will usually be referring to the business and affairs (financial and otherwise) of the Company and its subsidiaries and affiliates as a whole. Occasionally, we will refer to the term “parent company” or “holding company” when we mean to refer to only German American Bancorp, Inc., and the term “Bank” when we mean to refer to only the Company’s bank subsidiary. This Management’s Discussion and Analysis includes an analysis of the major components of the Company’s operations for the years 2019 through 2021 and its financial condition as of December 31, 2020 and 2021. This information should be read in conjunction with the accompanying consolidated financial statements and footnotes contained elsewhere in this Report and with the description of business included in Item 1 of this Report (including the cautionary disclosure regarding “Forward Looking Statements and Associated Risks”). Financial and other information by segment is included in Note 16 (Segment Information) of the Notes to the Consolidated Financial Statements included in Item 8 of this Report and is incorporated into this Item 7 by reference. The statements of management’s expectations and goals concerning the Company’s future operations and performance that are set forth in the following Management Overview and in other sections of this Item 7 are forward-looking statements, and readers are cautioned that these forward-looking statements are based on assumptions and are subject to risks, uncertainties, and other factors. Actual results may differ materially from the expectations of the Company that is expressed or implied by any forward-looking statement. This Item 7, as well as the discussions in Item 1 (“Business”) entitled “Forward-Looking Statements and Associated Risks” and in Item 1A (“Risk Factors”) (which discussions are incorporated in this Item 7 by reference) list some of the factors that could cause the Company’s actual results to vary materially from those expressed or implied by any such forward-looking statements. Any statements of management’s expectations and goals concerning the Company’s future operations and performance, and future financial condition, liquidity and capital resources that are set forth in the following Management Overview and in other sections of this Item 7 are forward-looking statements, and readers are cautioned that these forward-looking statements are based on assumptions and are subject to risks, uncertainties, and other factors. Actual results may differ materially from the expectations of the Company that is expressed or implied by any forward-looking statement. This Item 7, as well as the discussions in Item 1 (“Business”) entitled “Forward-Looking Statements and Associated Risks” and in Item 1A (“Risk Factors”) (which discussions are incorporated in this Item 7 by reference) list some of the factors that could cause the Company’s actual results to vary materially from those expressed or implied by any such forward-looking statements. MANAGEMENT OVERVIEW Net income for the year ended December 31, 2021 totaled $84,137,000, or $3.17 per share, an increase of $21,927,000, or approximately 35% on a per share basis, from the year ended December 31, 2020 net income of $62,210,000, or $2.34 per share. The net income growth during 2021 compared with 2020 was driven by a number of factors including improved net interest income, lower provision for credit losses and increased non-interest revenue which was partially offset by a modestly higher level of non-interest expense. Net income for the year ended December 31, 2020 totaled $62,210,000, or $2.34 per share, an increase of $2,988,000, or approximately 2% on a per share basis, from the year ended December 31, 2019 net income of $59,222,000, or $2.29 per share. As previously disclosed, in March 2021, the Company commenced an operating optimization plan, pursuant to which its banking subsidiary, German American Bank, would consolidate seven branch offices and implement various staff reductions during 2021. In making its decision to consolidate these branches, which were generally integrated with other nearby bank branches, the Company considered, among other factors, the operating costs of the branches, certain physical limitations impacting the bank facilities, and their proximity to other branch locations. In addition, the Company’s evaluation of the branch 30 consolidations and the reductions in staff also took into consideration the numbers and types of transactions being conducted by its customers and the increased usage of online and mobile banking. Also as part of the operating optimization plan, in September 2021, German American Bank sold its two branches located in Lexington, Kentucky to The Home Savings and Loan Company of Kenton, Ohio (“HSLC”). HSLC assumed approximately $17.6 million in total deposits and purchased approximately $17.8 million in total loans as part of the sale. On January 1, 2022, the Company completed the acquisition of Citizens Union Bancorp of Shelbyville, Inc. (“CUB”) through the merger of CUB with and into the Company. Immediately following completion of the CUB holding company merger, CUB's subsidiary bank, Citizen Union Bank of Shelbyville, Inc., was merged with and into the Company’s subsidiary bank, German American Bank. CUB, headquartered in Shelbyville, Kentucky operated 15 retail banking offices located in Shelby, Jefferson, Spencer, Bullitt, Oldham, Owen, Gallatin and Hardin counties in Kentucky through Citizens Union Bank of Shelbyville, Inc. in Kentucky. As of the closing of the transaction, CUB had total assets of approximately $1.109 billion, total loans of approximately $683.8 million, and total deposits of approximately $930.5 million. The Company issued approximately 2.9 million shares of its common stock, and paid approximately $50.8 million in cash, in exchange for all of the issued and outstanding shares of common stock of CUB. For further information regarding this merger and acquisition transaction, see Note 20 (Subsequent Events) in the Notes to the Consolidated Financial Statements included in Item 8 of this Report. On July 1, 2019, the Company completed the acquisition of Citizens First Corporation (“Citizens First”) through the merger of Citizens First with and into the Company. Immediately following completion of the Citizens First holding company merger, Citizens First's subsidiary bank, Citizen First Bank, Inc., was merged with and into the Company’s subsidiary bank, German American Bank. Citizens First, headquartered in Bowling Green, Kentucky operated eight retail banking offices through Citizens First Bank, Inc. in Barren, Hart, Simpson and Warren Counties in Kentucky. As of the closing of the transaction, Citizens First had total assets of approximately $456.0 million, total loans of approximately $364.6 million, and total deposits of approximately $370.8 million. The Company issued approximately 1.7 million shares of its common stock, and paid approximately $15.5 million in cash, in exchange for all of the issued and outstanding shares of common stock of Citizens First. For further information regarding this merger and acquisition transaction, see Note 18 (Business Combinations) in the Notes to the Consolidated Financial Statements included in Item 8 of this Report. COVID-19 PANDEMIC BUSINESS UPDATE The novel coronavirus disease 2019 (COVID-19) pandemic continued to impact our operations during 2021. While uncertainty remains as to the future effects of the pandemic, an improving business climate, supported by unprecedented fiscal stimulus, an accommodative Federal Reserve, and modest increases in COVID-19 vaccination rates, has helped to mitigate the negative impacts of the pandemic on our financial condition and results of operations, despite the challenges presented by very low interest rates, muted loan growth, and excess liquidity. CARES Act and the Paycheck Protection Program As previously disclosed, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was signed into law in March 2020, providing an approximately $2 trillion stimulus package that included 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”), a lending program administered by the Small Business Administration (“SBA”) that is intended to incentivize participants to retain their employees by providing them with loans that are fully guaranteed by the U.S. government and subject to forgiveness if program guidelines are met. The PPP was later extended and modified by the Paycheck Protection Program and Health Care Enhancement Act in April 2020 and the Paycheck Protection Program Flexibility Act in June 2020, with PPP funding under this initial round expiring on August 8, 2020. In December 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act was signed into law as part of the Consolidated Appropriations Act, 2021 (the “CAA”). In addition to direct stimulus payments and other aid, this Act provided for a second round of PPP loans through March 31, 2021. Under the American Rescue Plan Act of 2021 and the PPP Extension Act of 2021, which were both enacted during March 2021, additional funds were provided for the program and the deadline for applying for PPP loans was extended through May 31, 2021 (with the SBA having been given until June 30, 2021 to process loan applications). 31 The Company actively participated in both rounds of the PPP, lending funds primarily to its existing loan and/or deposit customers. The PPP loans carry an interest rate of 1.00% and included a processing fee that varied depending on the balance of the loan at origination (which fee is recognized over the life of the loan). The vast majority of the Company’s PPP loans made during 2020 had two-year maturities, while PPP loans made during 2021 have five-year maturities. Under the first round of the PPP (i.e., the 2020 round), the Company originated loans totaling approximately $351.3 million in principal amount, with approximately $12.0 million of related net processing fees on 3,070 PPP loan relationships. As of December 31, 2021, $349.2 million of those first round PPP loans had been forgiven by the SBA and repaid to the Company pursuant to the terms of the program or repaid by customers, with approximately $12.0 million in net processing fees having been recognized by the Company. Under the second round of the PPP (i.e., the 2021 round), the Company originated loans totaling approximately $157.0 million in principal amount, with approximately $9.0 million of related net processing fees, on 2,601 PPP loan relationships. As of December 31, 2021, $138.8 million of second round PPP loans had been forgiven by the SBA and repaid to the Company, with $8.1 million in net processing fees having been recognized by the Company. As a result of the forgiveness of the first and second round PPP loans, $20.3 million of total PPP loans remain outstanding as of December 31, 2021, with approximately $0.9 million of net fees remaining deferred on that date. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The financial condition and results of operations for the Company presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this Report, are, to a large degree, dependent upon the Company’s accounting policies. The selection of and application of these policies involve estimates, judgments, and uncertainties that are subject to change. The critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term relate to the determination of the allowance for credit losses, the valuation of securities available for sale, income tax expense, and the valuation of goodwill and other intangible assets. Allowance for Credit Losses The Company maintains an allowance for credit losses to cover the estimated expected credit losses over the expected contractual life of the loan portfolio. 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. 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. A provision for credit losses is charged to operations based on management’s periodic evaluation of the necessary allowance balance. Evaluations are conducted at least quarterly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control. The Company has an established process to determine the adequacy of the allowance for credit losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on individually analyzed loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, reasonable and supportable forecasts and other factors, all of which may be susceptible to significant change. The allowance consists of two components of allocations, specific and general. These two components represent the total allowance for credit losses deemed adequate to cover expected credit losses over the expected life of the loan portfolio. Commercial and agricultural loans are subject to a standardized grading process administered by an internal loan review function. The need for specific reserves is considered for credits when: (a) the customer’s cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or (d) other reasons where the ultimate collectability of the loan is in question, or the loan characteristics require special monitoring. Specific reserves on individually analyzed 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 individually analyzed but for which the rate of loss is expected to be greater than other similar type loans, including non-performing consumer or residential real estate loans. Such allocations are based on past loss experience, reasonable and supportable forecasts and information about specific borrower situations and estimated collateral values. 32 General allocations are made for commercial and agricultural loans that are graded as substandard and special mention, but are not individually analyzed for specific reserves as well as other 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 along with reasonable and supportable forecasts, judgmentally adjusted for economic, external and internal quantitative and qualitative factors and portfolio trends. Economic factors include evaluating changes in international, national, regional and local economic and business conditions that affect the collectability of the loan portfolio. Internal factors include evaluating changes in lending policies and procedures; changes in the nature and volume of the loan portfolio; and changes in experience, ability and depth of lending management and staff. The allowance for credit losses for loans represents management’s estimate of all expected credit losses over the expected contractual life of the loan portfolio. Determining the appropriateness and adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio may result in significant changes in the allowance for credit losses in future periods. Securities Valuation 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. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors. If this assessment indicates that a credit loss exists, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of applicable taxes. No allowance for credit losses for available-for-sale debt securities was needed at December 31, 2021. Accrued interest receivable on available-for-sale debt securities is excluded from the estimate of credit losses. As of December 31, 2021, gross unrealized gains on the securities available-for-sale portfolio totaled approximately $36,068,000 and gross unrealized losses totaled approximately $15,649,000 net of applicable taxes is included in other comprehensive income. Equity securities that do not have readily determinable fair values are carried at cost, less impairment with observable price changes being recognized in earnings. Income Tax Expense Income tax expense involves estimates related to the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations presumed to occur. A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized. In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carry-back and carry-forward periods, including consideration of available tax planning strategies. Tax-related loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the views of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management’s intended response to any assessment. Goodwill and Other Intangible Assets Goodwill resulting from business combinations represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations 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. The 33 Company has selected December 31 as the date to perform the annual impairment test. Goodwill is the only intangible asset with an indefinite life on the Company’s balance sheet. No impairment to Goodwill was indicated based on year-end testing. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Other intangible assets consist of core deposit and acquired customer relationship intangible assets. They are initially measured at fair value and then are amortized over their estimated useful lives, which range from 6 to 10 years. RESULTS OF OPERATIONS NET INCOME Net income for the year ended December 31, 2021 totaled $84,137,000, or $3.17 per share, an increase of $21,927,000, or approximately 35% on a per share basis, from the year ended December 31, 2020 net income of $62,210,000, or $2.34 per share. Net income for the year ended December 31, 2020 totaled $62,210,000, or $2.34 per share, an increase of $2,988,000, or approximately 2% on a per share basis, from the year ended December 31, 2019 net income of $59,222,000, or $2.29 per share. NET INTEREST INCOME Net interest income is the Company’s single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds. Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes. Many factors affecting net interest income are subject to control by management policies and actions. Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws. During the year ended December 31, 2021, net interest income totaled $160,830,000, representing an increase of $5,587,000, or 4%, from the year ended December 31, 2020 net interest income of $155,243,000. The increase in net interest income during 2021 compared with 2020 was largely attributable to an increase in average earning assets, a higher level of fees recognized related to PPP loans which were partially offset by a lower level of accretion of loan discounts on acquired loans, and a decreased level of interest expense on interest bearing liabilities related to lower interest rates. During the year ended December 31, 2020, net interest income totaled $155,243,000, representing an increase of $10,018,000, or 7%, from the year ended December 31, 2019 net interest income of $145,225,000. The increased level of net interest income during 2020 compared with 2019 was largely attributable to a higher level of average earning assets resulting from the acquisition of Citizens First on July 1, 2019, significant deposit growth during 2020 and participation in the PPP. In addition, the recognition of fees related to PPP loans also contributed to higher levels of net interest income, but was partially mitigated by a lower level of accretion of discounts on acquired loans. The net interest margin represents tax-equivalent net interest income expressed as a percentage of average earning assets. The net interest margin for the year ended December 31, 2021 was 3.31% compared to 3.63% in 2020 and 3.92% in 2019. Historically low market interest rates impacted the Company's net interest margin in both 2021 and 2020. Lower market interest rates have negatively impacted earning asset yields during 2021 and 2020, with these declines being partially mitigated by a lower cost of funds. Also contributing to the lower net interest margin has been excess liquidity the Company has carried on the balance sheet that resulted from significant deposit growth during 2021 and 2020, PPP loan forgiveness and somewhat muted loan growth. The Company’s net interest margin in 2021 and 2020 has been impacted by fees recognized as a part of the PPP and impacted in all periods presented by the accretion of discounts on acquired loans. Fees recognized on PPP loans through net interest income totaled $12,196,000 during 2021 and $7,978,000 during 2020. The fees recognized related to the PPP contributed approximately 24 basis points to the net interest margin in 2021 and 18 basis points in 2020. Accretion of discounts on acquired loans contributed approximately 7 basis points to the net interest margin during 2021, 13 basis points during 2020 and 23 basis points in 2019. Accretion of discounts on acquired loans totaled $3,476,000 during 2021, $5,769,000 during 2020 and $8,559,000 during 2019. 34 The following table summarizes net interest income (on a tax-equivalent basis) for each of the past three years. For tax-equivalent adjustments, an effective tax rate of 21% was used for all periods presented (1) . Average Balance Sheet (Tax-equivalent basis, dollars in thousands) Twelve Months Ended December 31, 2021 Twelve Months Ended December 31, 2020 Twelve Months Ended December 31, 2019 Principal Balance Income / Expense Yield / Rate Principal Balance Income / Expense Yield / Rate Principal Balance Income / Expense Yield / Rate ASSETS Federal Funds Sold and Other Short-term Investments $ 390,362 $ 488 0.12 % $ 209,012 $ 382 0.18 % $ 27,166 $ 522 1.92 % Securities: Taxable 824,204 12,962 1.57 % 555,961 10,447 1.88 % 546,191 13,910 2.55 % Non-taxable 728,765 22,504 3.09 % 420,294 15,040 3.58 % 305,266 12,096 3.96 % Total Loans and Leases ⁽²⁾ 3,072,302 139,378 4.54 % 3,185,542 151,946 4.77 % 2,899,939 152,836 5.27 % TOTAL INTEREST EARNING ASSETS 5,015,633 175,332 3.50 % 4,370,809 177,815 4.07 % 3,778,562 179,364 4.75 % Other Assets 397,147 398,102 366,171 Less: Allowance for Credit Losses (43,073) (39,905) (16,198) TOTAL ASSETS $ 5,369,707 $ 4,729,006 $ 4,128,535 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing Demand Deposits $ 1,595,579 $ 1,789 0.11 % $ 1,309,998 $ 4,089 0.31 % $ 1,128,457 $ 8,643 0.77 % Savings Deposits and Money Market Accounts 1,106,692 885 0.08 % 912,183 1,885 0.21 % 733,160 3,406 0.46 % Time Deposits 412,935 2,281 0.55 % 567,932 7,722 1.36 % 670,802 11,756 1.75 % FHLB Advances and Other Borrowings 186,750 4,594 2.46 % 221,832 5,430 2.45 % 279,675 7,444 2.66 % TOTAL INTEREST-BEARING LIABILITIES 3,301,956 9,549 0.29 % 3,011,945 19,126 0.63 % 2,812,094 31,249 1.11 % Demand Deposit Accounts 1,378,647 1,070,284 761,515 Other Liabilities 46,170 51,996 35,916 TOTAL LIABILITIES 4,726,773 4,134,225 3,609,525 Shareholders’ Equity 642,934 594,781 519,010 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 5,369,707 $ 4,729,006 $ 4,128,535 COST OF FUNDS 0.19 % 0.44 % 0.83 % NET INTEREST INCOME $ 165,783 $ 158,689 $ 148,115 NET INTEREST MARGIN 3.31 % 3.63 % 3.92 % (1) Effective tax rates were determined as though interest earned on the Company's investments in municipal bonds and loans was fully taxable. (2) Loans held-for-sale and non-accruing loans have been included in average loans. Interest income on loans includes loan fees of $15,761, $15,003, and $8,397 for 2021, 2020 and 2019, respectively. 35 The following table sets forth for the periods indicated a summary of the changes in interest income and interest expense resulting from changes in volume and changes in rates: Net Interest Income – Rate / Volume Analysis (Tax-Equivalent basis, dollars in thousands) 2021 compared to 2020 Increase / (Decrease) Due to ⁽¹⁾ 2020 compared to 2019 Increase / (Decrease) Due to ⁽¹⁾ Volume Rate Net Volume Rate Net Interest Income: Federal Funds Sold and Other Short-term Investments $ 254 $ (148) $ 106 $ 708 $ (848) $ (140) Taxable Securities 4,426 (1,911) 2,515 244 (3,707) (3,463) Non-taxable Securities 9,764 (2,300) 7,464 4,208 (1,264) 2,944 Loans and Leases (5,290) (7,278) (12,568) 14,325 (15,215) (890) Total Interest Income 9,154 (11,637) (2,483) 19,485 (21,034) (1,549) Interest Expense: Savings and Interest-bearing Demand 1,083 (4,383) (3,300) 1,994 (8,069) (6,075) Time Deposits (1,714) (3,727) (5,441) (1,639) (2,395) (4,034) FHLB Advances and Other Borrowings (863) 27 (836) (1,451) (563) (2,014) Total Interest Expense (1,494) (8,083) (9,577) (1,096) (11,027) (12,123) Net Interest Income $ 10,648 $ (3,554) $ 7,094 $ 20,581 $ (10,007) $ 10,574 (1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. See the Company’s Average Balance Sheet above and the discussions under the headings “USES OF FUNDS,” “SOURCES OF FUNDS,” and “RISK MANAGEMENT – Liquidity and Interest Rate Risk Management” for further information on the Company’s net interest income, net interest margin, and interest rate sensitivity position. PROVISION FOR CREDIT LOSSES The Company provides for credit losses through regular provisions to the allowance for credit losses. The provision is affected by net charge-offs on loans and changes in specific and general allocations of the allowance. During 2021, the Company recorded a negative provision for credit losses of $6,500,000 compared with a provision for credit losses of $17,550,000 during 2020 and a $5,325,000 provision for loan losses during 2019 under the incurred loss model. During 2021, the negative provision for credit losses represented approximately 21 basis points of average loans. The negative provision for credit losses in 2021 was largely due to declines in certain adversely criticized assets and improvement in certain pandemic-related stressed sectors for which the Company had provided significant levels of allowance for credit losses during 2020. The Company realized net charge-offs of $3,342,000 or 11 basis points of average loans during 2021. During 2020, the provision for credit losses represented approximately 55 basis points of average loans. The increased level of provision during 2020 compared with 2019 was primarily due to the developments related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the Company's CECL model. The Company realized net charge-offs of $2,622,000 or 8 basis points of average loans outstanding during 2020. The provision for credit losses made during 2021 was made at a level deemed necessary by management to absorb expected losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for credit losses is completed quarterly by management, the results of which are used to determine provision for credit losses. 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 reasonable and supportable forecasts along with other qualitative and quantitative factors. Refer also to the sections entitled “CRITICAL ACCOUNTING POLICIES AND ESTIMATES” and “RISK MANAGEMENT - Lending and Loan Administration” for further discussion of the provision and allowance for credit losses. 36 NON-INTEREST INCOME During the year ended December 31, 2021, non-interest income increased $4,988,000, or 9%, from the year ended December 31, 2020. During the year ended December 31, 2020, non-interest income increased $8,973,000, or 20%, from the year ended December 31, 2019. Non-interest Income (dollars in thousands) Years Ended December 31, % Change From Prior Year 2021 2020 2019 2020 2019 Trust and Investment Product Fees $ 10,321 $ 8,005 $ 7,278 29 % 10 % Service Charges on Deposit Accounts 7,723 7,334 8,718 5 (16) Insurance Revenues 9,268 8,922 8,940 4 — Company Owned Life Insurance 1,529 2,307 2,005 (34) 15 Interchange Fee Income 13,116 10,529 9,450 25 11 Other Operating Income 6,991 3,388 3,229 106 5 Subtotal 48,948 40,485 39,620 21 2 Net Gains on Sales of Loans 8,267 9,908 4,633 (17) 114 Net Gains on Securities 2,247 4,081 1,248 (45) 227 TOTAL NON-INTEREST INCOME $ 59,462 $ 54,474 $ 45,501 9 20 Trust and investment product fees increased $2,316,000, or 29%, during 2021 compared with 2020. Trust and investment product fees increased $727,000, or 10%, during 2020 compared with 2019. The increase in both years was largely attributable to increased assets under management in the Company's wealth management group. Service charges on deposit accounts increased $389,000, or 5%, during 2021 compared with 2020. Service charges on deposit accounts declined $1,384,000, or 16%, during 2020 compared with 2019. The decline during 2020 compared with 2019 was largely related to the economic impacts of the COVID-19 pandemic and resulting change in deposit customer activity, partially mitigated by the acquisition of Citizens First. Company owned life insurance revenue declined $778,000, or 34%, during 2021 compared with 2020. Company owned life insurance revenue increased $302,000, or 15%, during 2020 compared with 2019. The variance in both periods was largely related to death benefits received from life insurance policies during 2020. Interchange fees increased $2,587,000, or 25%, during 2021 compared to 2020. The increased level of fees during 2021 compared with 2020 was due to increased economic activity and increased card utilization by customers. Interchange fees increased $1,079,000, or 11%, during 2020 compared to 2019. The increase during 2020 compared with 2019 was largely attributable to the acquisition of Citizens First and increased card utilization by customers. Other operating income increased $3,603,000, or 106%, during 2021 compared with 2020. The increase during 2021 was largely attributable to the net gain of approximately $1.4 million related to the sale of the two branch office locations in Lexington, Kentucky and approximately $863,000 of fair value adjustments and higher transaction fees associated with interest rate swap transactions with loan customers. Also contributing to the increase in 2021, was the donation of a building and accompanying real estate to a local municipality in one of the Company’s market areas. The estimated fair value of the property was approximately $575,000 greater than the book value which increased other operating income. A corresponding contribution expense of $800,000 was recognized in advertising and promotion expense of the Company’s income statement related to the donation of the building and real estate. Net gains on sales of loans declined $1,641,000, or 17%, during 2021 compared with the 2020. The decline in 2021 compared with 2020 was generally attributable to a lower level of fair value adjustments on commitments to sell loans and a modestly lower level of loans sold, which were partially offset by higher pricing levels on loans sold. Net gains on sales of loans increased $5,275,000, or 114%, during 2020 compared with 2019. The increase in the net gains on sales of loans during 2020 compared with 2019 was generally attributable to a higher sales volume and higher pricing levels on loans sold. Loan sales totaled $266.0 million during 2021, $316.4 million during 2020 and $185.4 million during 2019. The Company realized $2,247,000 in gains on sales of securities during 2021 compared with $4,081,000 during 2020 and $1,248,000 during 2019. The sales of securities in all periods were done as part of shifts in the allocations within the securities portfolio. 37 NON-INTEREST EXPENSE During 2021, non-interest expense totaled $124,007,000, an increase of $6,884,000, or 6%, compared with 2020. The year ended December 31, 2021 included non-recurring expenses totaling $4,100,000 related to the Company’s previously discussed operating optimization plan, $3,050,000 related to a previously disclosed litigation reserve, and $735,000 of transaction-related expenses for the acquisition of Citizens Union Bancorp of Shelbyville, Inc., which was completed on January 1, 2022. During 2020, non-interest expense totaled $117,123,000, an increase of $2,961,000, or 3%, compared with 2019. Non-interest Expense (dollars in thousands) Years Ended December 31, % Change From Prior Year 2021 2020 2019 2020 2019 Salaries and Employee Benefits $ 68,570 $ 68,112 $ 63,885 1 % 7 % Occupancy, Furniture and Equipment Expense 14,831 14,024 13,776 6 2 FDIC Premiums 1,419 740 533 92 39 Data Processing Fees 7,611 6,889 7,927 10 (13) Professional Fees 5,009 3,998 4,674 25 (14) Advertising and Promotion 4,197 3,589 4,230 17 (15) Intangible Amortization 2,731 3,539 3,721 (23) (5) Other Operating Expenses 19,639 16,232 15,416 21 5 TOTAL NON-INTEREST EXPENSE $ 124,007 $ 117,123 $ 114,162 6 3 Salaries and benefits were relatively stable during 2021 compared with 2020 increasing by $458,000, or less than 1%. Salaries and benefits increased $4,227,000, or 7%, during 2020 compared with 2019. The increase in salaries and benefits during 2020 compared with 2019 was largely attributable to an increased number of full-time equivalent employees during 2020. Occupancy, furniture and equipment expense increased $807,000, or 6%, during 2021 compared with 2020. The increase during 2021 was due to lease termination costs associated with the Company’s operating optimization plan that totaled approximately $1,411,000 during 2021. Occupancy, furniture and equipment expense increased $248,000, or 2%, during 2020 compared with 2019. FDIC premiums increased $679,000, or 92%, during 2021 compared with 2020 and increased $207,000, or 39%, during 2020 compared with 2019. The increase during 2021 compared with 2020 was related to credits received from the FDIC during 2020. There were no credits received during 2021 and a lower level of credits in 2020 compared with 2019. The credits received in 2020 and prior years were due to the reserve ratio of the deposit insurance fund exceeding the FDIC targeted levels. Data processing fees increased $722,000, or 10%, during 2021 compared with 2020. The increase was related to various software costs including expenses related to the PPP loan program as well as increased data processing fees for the branch sales during 2021. Data processing fees declined $1,038,000, or 13%, during 2020 compared with 2019. The decline in data processing fees during 2020 compared with 2019 was largely due to acquisition related costs during 2019. Professional fees increased $1,011,000, or 25%, during 2021 compared with 2020. The increase during 2021 compared with 2020 was largely attributable to professional fees associated with the acquisition of CUB and an increase in legal fees related to non-acquisition related legal matters. Professional fees declined $676,000, or 14%, during 2020 compared with 2019. The decline in professional fees during 2020 compared with 2019 was largely related to higher levels of merger and acquisition related professional fees in 2019. Advertising and promotion expense increased $608,000, or 17%, during 2021 compared with 2020. The increase during 2021 was attributable to the donation of a building and accompanying real estate to a local municipality in one of the Company’s market areas. The estimated fair value of the property was approximately $800,000 which resulted in the increase in the contribution expense during 2021. Advertising and promotion expense declined $641,000, or 15%, during 2020 compared with 2019. The decline during 2020 was largely attributable to lesser marketing and sponsorship expenditures impacted by the COVID-19 pandemic. Other operating expenses increased $3,407,000, or 21%, during 2021 compared with 2020 and increased $816,000, or 5% during 2020 compared with 2019. The increase during 2021 was primarily attributable to the establishment of a settlement reserve for a lawsuit challenging the Company’s checking account practices associated with its assessment of overdraft fees for 38 certain debit card transactions. Like many other financial institutions, the Company has been the subject of an overdraft fee related putative class action lawsuit since the third quarter of 2020. This type of litigation is often time consuming and expensive to defend. In order to avoid further costs associated with this type of litigation, the Company determined it was in its best interest to pursue a settlement of this lawsuit during the third quarter of 2021 and therefore accrued a $3,050,000 settlement reserve. On October 21, 2021, the Company executed a settlement agreement for payment of that amount in connection with this lawsuit which remains subject to court approval. In addition, the Company recognized $1,276,000 of charges related to various fixed asset write-downs as a part of the Company’s operating optimization plans announced in March 2021. PROVISION FOR INCOME TAXES The Company records a provision for current income taxes payable, along with a provision for deferred taxes payable in the future. Deferred taxes arise from temporary differences, which are items recorded for financial statement purposes in a different period than for income tax returns. The Company’s effective tax rate was 18.1%, 17.1%, and 16.9%, respectively, in 2021, 2020, and 2019. The effective tax rate in all periods is lower than the blended statutory rate. The lower effective rate in all periods primarily resulted from the Company’s tax-exempt investment income on securities, loans, and company owned life insurance, income tax credits generated by investments in affordable housing projects, and income generated by subsidiaries domiciled in a state with no state or local income tax. See Note 10 to the Company’s consolidated financial statements included in Item 8 of this Report for additional details relative to the Company’s income tax provision. CAPITAL RESOURCES As of December 31, 2021, shareholders’ equity increased by $43.8 million to $668.5 million compared with $624.7 million at year-end 2020. The increase in shareholders' equity was attributable to increased retained earnings of $61.9 million due to net income of $84.1 million during 2021 which was partially offset by the payment of $22.2 million in shareholder dividends. Partially mitigating the increase in retained earnings was a decline in accumulated other comprehensive income of $19.9 million related to the decrease in value of the Company's available-for-sale securities portfolio. Shareholders’ equity represented 11.9% of total assets at December 31, 2021 and 12.6% of total assets at December 31, 2020. Shareholders’ equity included $127.6 million of goodwill and other intangible assets at December 31, 2021 compared to $130.9 million of goodwill and other intangible assets at December 31, 2020. On January 25, 2021, the Company's Board of Directors approved a stock repurchase program for up to 1.0 million of its outstanding common shares. The Company did not repurchase any shares of common stock under the repurchase plan during 2021. On January 31, 2022, the Company’s Board of Directors terminated the 2021 repurchase program and approved a new plan to repurchase up to 1.0 million shares of the Company’s outstanding common stock. On a share basis, the amount of common stock subject to the new repurchase plan represented approximately 3% of the Company’s outstanding shares on the date it was approved, which was inclusive of the approximately 2.9 million shares issued in conjunction with the CUB acquisition. The Company is not obligated to purchase any shares under the plan, and the plan may be discontinued at any time. The actual timing, number and share price of shares purchased under the repurchase plan will be determined by the Company at its discretion and will depend upon such factors as the market price of the stock, general market and economic conditions and applicable legal requirements. The Company has not repurchased any shares of common stock under the 2022 repurchase plan. Federal banking regulations provide guidelines for determining the capital adequacy of bank holding companies and banks. These guidelines provide for a more narrow definition of core capital and assign a measure of risk to the various categories of assets. The Company is required to maintain minimum levels of capital in proportion to total risk-weighted assets and off-balance sheet exposures. The current risk-based capital rules, as adopted by federal banking regulators, are based upon guidelines developed by the Basel Committee on Banking Supervision and reflect various requirements of the Dodd-Frank Act (the “Basel III Rules”). The Basel III Rules require banking organizations to, among other things, maintain a minimum ratio of Total Capital to risk-weighted assets, a minimum ratio of Tier 1 Capital to risk-weighted assets, a minimum ratio of “Common Equity Tier 1 Capital” to risk-weighted assets, and a minimum leverage ratio (calculated as the ratio of Tier 1 Capital to adjusted average consolidated assets). In addition, under the Basel III Rules, in order to avoid limitations on capital distributions, including dividend payments, the Company is required to maintain a 2.5% capital conservation buffer above the adequately capitalized regulatory capital ratios. 39 At December 31, 2021, the capital levels for the Company and its subsidiary bank remained well in excess of the minimum amounts needed for capital adequacy purposes and the Bank’s capital levels met the necessary requirements to be considered well-capitalized. The table below presents the Company’s consolidated and the subsidiary bank's capital ratios under regulatory guidelines: 12/31/2021 Ratio 12/31/2020 Ratio Minimum for Capital Adequacy Purposes ⁽¹⁾ Well-Capitalized Guidelines Total Capital (to Risk Weighted Assets) Consolidated 16.20 % 15.86 % 8.00 % N/A Bank 13.36 14.00 8.00 10.00 % Tier 1 (Core) Capital (to Risk Weighted Assets) Consolidated 14.61 % 13.93 % 6.00 % N/A Bank 12.83 13.21 6.00 8.00 % Common Tier 1 (CET 1) Capital Ratio (to Risk Weighted Assets) Consolidated 14.18 % 13.48 % 4.50 % N/A Bank 12.83 13.21 4.50 6.50 % Tier 1 Capital (to Average Assets) Consolidated 10.10 % 10.07 % 4.00 % N/A Bank 8.88 9.56 4.00 5.00 % (1) Excludes capital conservation buffer. In December 2018, the 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, which was finalized effective September 30, 2020, 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 elected to adopt the five-year transition option and, as a result, began the required three-year phase-in by reflecting 25% of the previously deferred estimated capital impact of CECL in its regulatory capital effective January 1, 2022. An additional 25% is to be phased in at the beginning of each subsequent year until fully phased in by January 1, 2025. Under the five-year transition option, the amount of adjustments to regulatory capital that could be deferred until the phase-in period began included both the initial impact of our adoption of CECL at January 1, 2020 and 25% of subsequent changes in our allowance for credit losses during each quarter of the two-year period ended December 31, 2021. On April 9, 2020, federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program. Specifically, the agencies have clarified that banking organizations, including the Company and the Bank, are permitted to assign a zero percent risk weight to PPP loans for purposes of determining risk-weighted assets and risk-based capital ratios. USES OF FUNDS LOANS December 31, 2021 total loans declined $84.1 million, or 3%, compared with December 31, 2020. The decline in total loans at December 31, 2021 compared to year-end 2020 was primarily due to a decrease in PPP loans. PPP loans, net of deferred fees, totaled $19.5 million ($20.3 million principal balance and $0.8 million of remaining net deferred fees) at December 31, 2021 compared with $182.0 million at December 31, 2020. Excluding PPP loans, total loans increased $86.8 million, or 3%, at December 31, 2021 compared with year-end 2020. Commercial and industrial loans increased approximately $18.5 million, or 4%, during 2021 compared with year-end 2020, commercial real estate loans increased $69.5 million, or 5%, and agricultural loans declined $17.9 million, or 5% (excluding PPP loans). At December 31, 2021, as compared with year-end 2020, retail loans increased $16.7 million, or 3%. 40 December 31, 2020 total loans increased $10.0 million, or less than 1%, compared with December 31, 2019. The increase in loans during 2020 compared with year-end 2019 was primarily the result in the Company’s participation in the PPP. Excluding the $182.0 million in PPP loans at December 31, 2020, total loans declined by $172.0 million, or 6%, during 2020 compared with year-end 2019. The decline in total loans, excluding the PPP loans, was impacted by elevated pay-offs within the commercial real estate loan portfolio, reduced line utilization within the commercial loan portfolio partially attributable to the PPP loan originations during 2020, and continued pay-downs in the Company's residential and home equity loan portfolios related to a low interest rate environment. The composition of the loan portfolio has remained relatively stable and diversified over the past several years, including 2021. The portfolio is most heavily concentrated in commercial real estate loans at 51% of the portfolio and commercial and industrial loans at 18% of the portfolio, and agricultural loans at 12% of the portfolio. The Company’s commercial lending is extended to various industries, including multi-family housing and lodging, agribusiness and manufacturing, as well as health care, wholesale, and retail services. Loan Portfolio December 31, (dollars in thousands) 2021 2020 2019 2018 2017 Commercial and Industrial Loans and Leases $ 548,350 $ 694,437 $ 589,758 $ 543,761 $ 486,668 Commercial Real Estate Loans 1,530,677 1,467,397 1,495,862 1,208,646 926,729 Agricultural Loans 358,150 376,186 384,526 365,208 333,227 Home Equity and Consumer Loans 307,184 297,702 306,972 285,534 219,662 Residential Mortgage Loans 263,565 256,276 304,855 328,592 178,733 Total Loans 3,007,926 3,091,998 3,081,973 2,731,741 2,145,019 Less: Unearned Income (3,662) (3,926) (4,882) (3,682) (3,381) Subtotal 3,004,264 3,088,072 3,077,091 2,728,059 2,141,638 Less: Allowance for Loan Losses (37,017) (46,859) (16,278) (15,823) (15,694) Loans, Net $ 2,967,247 $ 3,041,213 $ 3,060,813 $ 2,712,236 $ 2,125,944 Ratio of Loans to Total Loans Commercial and Industrial Loans and Leases 18 % 23 % 19 % 20 % 23 % Commercial Real Estate Loans 51 % 47 % 49 % 44 % 43 % Agricultural Loans 12 % 12 % 12 % 13 % 16 % Home Equity and Consumer Loans 10 % 10 % 10 % 11 % 10 % Residential Mortgage Loans 9 % 8 % 10 % 12 % 8 % Total Loans 100 % 100 % 100 % 100 % 100 % The Company’s policy is generally to extend credit to consumer and commercial borrowers in its primary geographic market area in southern Indiana and central and western Kentucky. Commercial extensions of credit outside this market area are generally concentrated in real estate loans within a reasonable proximity of the Company’s primary market and are granted on a selective basis. The following table indicates the amounts of loans (excluding residential mortgages on 1-4 family residences and consumer loans) outstanding as of December 31, 2021, which, based on remaining scheduled repayments of principal, are due in the periods indicated (dollars in thousands). Within One Year One to Five Years After Five Years Total Commercial and Agricultural $ 860,098 $ 1,243,604 $ 315,567 $ 2,419,269 Interest Sensitivity Fixed Rate Variable Rate Loans Maturing After One Year $ 412,426 $ 1,146,745 41 INVESTMENTS The investment portfolio is a principal source for funding the Company’s loan growth and other liquidity needs of its subsidiaries. The Company’s securities portfolio primarily consists of money market securities, collateralized and uncollateralized federal agency securities, municipal obligations of state and political subdivisions, and mortgage-backed securities and collateralized mortgage obligations (MBS/CMO - Residential) issued by U.S. government agencies. Money market securities include federal funds sold, interest-bearing balances with banks, and other short-term investments. The composition of the year-end balances in the investment portfolio is presented in Note 2 (Securities) of the Notes to the Consolidated Financial Statements included in Item 8 of this Report and in the table below: Investment Portfolio, at Amortized Cost December 31, (dollars in thousands) 2021 % 2020 % 2019 % Federal Funds Sold and Other Short-term Investments $ 349,717 16 % $ 287,776 20 % $ 43,913 5 % Obligations of State and Political Subdivisions 896,048 40 548,273 37 307,943 35 MBS/CMO - Residential 797,693 36 535,526 37 526,907 60 US Gov't Sponsored Entities & Agencies 175,457 8 88,376 6 — n/m ⁽¹⁾ Equity Securities 353 n/m ⁽¹⁾ 353 n/m ⁽¹⁾ 353 n/m ⁽¹⁾ Total Securities Portfolio $ 2,219,268 100 % $ 1,460,304 100 % $ 879,116 100 % (1) n/m = not meaningful The amortized cost of investment securities, including federal funds sold and short-term investments, increased $759.0 million, or 52%, at year-end 2021 compared with year-end 2020 and increased $581.2 million, or 66%, at year-end 2020 compared with year-end 2019. The increase over the past two years was largely attributable to increased levels of deposits during both 2021 and 2020 in addition to PPP loan forgiveness and repayment activity over those same periods. The investment portfolio continues to be relatively balanced with agency issued mortgage related securities and collateralized and uncollateralized federal agency securities, totaling $973.2 million, or 44% of the total securities portfolio at December 31, 2021. The Company’s level of obligations of state and political subdivisions increased to $896.0 million or 40% of the portfolio at December 31, 2021. Investment Securities, at Carrying Value (dollars in thousands) December 31, Securities Available-for-Sale 2021 2020 2019 Obligations of State and Political Subdivisions $ 925,706 $ 581,247 $ 324,300 MBS/CMO - Residential 791,950 548,307 530,525 US Gov't Sponsored Entities & Agencies 171,961 88,298 — Total Securities $ 1,889,617 $ 1,217,852 $ 854,825 The Company’s $1.890 billion available-for-sale investment portfolio provides an additional funding source for the liquidity needs of the Company’s subsidiaries and for asset/liability management requirements. Although management has the ability to sell these securities if the need arises, their designation as available-for-sale should not necessarily be interpreted as an indication that management anticipates such sales. 42 The amortized cost of available-for-sale debt securities at December 31, 2021 is shown in the following table by contractual maturity. MBS/CMO - Residential securities are based on estimated average lives. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations. Maturities and Average Yields of Securities at December 31, 2021 (dollars in thousands) Within One Year After One But Within Five Years After Five But Within Ten Years After Ten Years Amount Yield Amount Yield Amount Yield Amount Yield Obligations of State and Political Subdivisions $ 2,806 4.32 % $ 18,670 4.19 % $ 70,964 3.86 % $ 803,608 2.97 % MBS/CMO - Residential — — 785 3.00 % 25,587 2.05 % 771,321 1.59 % US Gov't Sponsored Entities & Agencies — — — — % 7,496 1.01 % 167,961 1.49 % Total Securities $ 2,806 4.32 % $ 19,455 4.14 % $ 104,047 3.21 % $ 1,742,890 2.22 % A tax-equivalent adjustment using a tax rate of 21 percent was used in the above table. CONTRACTUAL OBLIGATIONS In addition to the other uses of funds discussed previously, the Company has certain contractual obligations to make cash payments. These contractual obligations primarily consist of borrowings from the Federal Home Loan Bank (“FHLB”), junior subordinated debentures, deposits, repurchase agreements, and lease commitments for certain office facilities. A summary of these payment obligations is set forth below. Contractual and Other Obligations Payments Due In (dollars in thousands) One Year or Less Over One Year Total Deposits without Stated Maturities $ 4,397,217 $ — $ 4,397,217 Time Deposits 347,099 — 347,099 Federal Home Loan Bank Advances — 25,000 25,000 Other Borrowings (Subordinated Notes and Debentures) — 55,804 55,804 Securities Sold under Repurchase Agreements 68,328 — 68,328 Lease Obligations 1,735 10,314 12,049 Total Contractual and Other Obligations $ 4,814,379 $ 91,118 $ 4,905,497 In the normal course of business, the Company makes commitments to extend credit and commitments to sell loans, which are not reflected in its consolidated financial statements. For further information about such commitments, see Note 14 (Commitments and Off-balance Sheet Items) in Notes to the Consolidated Financial Statements included in Item 8 of this Report. SOURCES OF FUNDS The Company’s primary source of funding is its base of core customer deposits. Core deposits consist of demand deposits, savings, interest-bearing checking, money market accounts, and certificates of deposit of less than $100,000. Other sources of funds are certificates of deposit of $100,000 or more, brokered deposits, overnight borrowings from other financial institutions and securities sold under agreement to repurchase. The membership of the Company’s affiliate bank in the Federal Home Loan Bank System provides a significant additional source for both long and short-term collateralized borrowings. In addition, the Company, as a separate and distinct corporation from its bank and other subsidiaries, also has the ability to borrow funds from other financial institutions and to raise debt or equity capital from the capital markets and other sources. The following pages contain a discussion of changes in these areas. 43 The table below illustrates changes between years in the average balances of all funding sources: Funding Sources - Average Balances (dollars in thousands) December 31, % Change From Prior Year 2021 2020 2019 2021 2020 Demand Deposits Non-interest-bearing $ 1,378,647 $ 1,070,284 $ 761,515 29 % 41 % Interest-bearing 1,595,579 1,309,998 1,128,457 22 16 Savings Deposits 460,945 358,389 293,044 29 22 Money Market Accounts 645,747 553,794 440,116 17 26 Other Time Deposits 226,419 288,762 285,208 (22) 1 Total Core Deposits 4,307,337 3,581,227 2,908,340 20 23 Certificates of Deposits of $100,000 or more and Brokered Deposits 186,516 279,170 385,594 (33) (28) FHLB Advances and Other Borrowings 186,750 221,832 279,675 (16) (21) Total Funding Sources $ 4,680,603 $ 4,082,229 $ 3,573,609 15 14 Maturities of certificates of deposit of $100,000 or more and brokered deposits are summarized as follows: (dollars in thousands) 3 Months Or Less 3 - 6 Months 6 - 12 Months Over 12 Months Total December 31, 2021 $ 47,577 $ 34,927 $ 39,941 $ 22,971 $ 145,416 CORE DEPOSITS The Company’s overall level of average core deposits increased approximately $726.1 million, or 20%, during 2021 compared with 2020. During 2021, average demand deposits (non-interest bearing and interest bearing) increased $593.9 million, average savings deposits increased $102.6 million, average money market demand deposits increased $92.0 million and average time deposits under $100,000 declined $62.3 million. The Company’s overall level of average core deposits increased approximately $672.9 million, or 23%, during 2020 compared with 2019. The increase in total average core deposits during 2021 following the increase in 2020 was largely impacted by general inflows of customers deposits generally related to the COVID-19 pandemic, participation in the PPP, stimulus payments provided by the federal government, and an increase in public funds. The Company’s ability to attract core deposits continues to be influenced by competition and the interest rate environment, as well as the availability of alternative investment products. Core deposits continue to represent a significant funding source for the Company’s operations and represented 92% of average total funding sources during 2021 compared with 88% during 2020 and 81% during 2019. Demand, savings, and money market deposits have provided a growing source of funding for the Company in each of the periods reported. Average demand, savings, and money market deposits increased 24% during 2021 following 26% growth during 2020. Average demand, savings, and money market deposits totaled $4.080 billion or 95% of core deposits (87% of total funding sources) in 2021 compared with $3.292 billion or 92% of core deposits (81% of total funding sources) in 2020 and $2.623 billion or 90% of core deposits (73% of total funding sources) in 2019. Other time deposits consist of certificates of deposits in denominations of less than $100,000. These average deposits declined by 22% during 2021 following an increase of 1% during 2020. Other time deposits comprised 5% of core deposits in 2021, 8% in 2020 and 10% in 2019. OTHER FUNDING SOURCES Certificates of deposits in denominations of $100,000 or more and brokered deposits are an additional source of other funding for the Company’s bank subsidiary. Large denomination certificates and brokered deposits declined $92.7 million, or 33%, during 2021 following a decline of $106.4 million, or 28% during 2020. Large certificates and brokered deposits comprised approximately 4% of average total funding sources in 2021 compared with 7% in 2020 and 11% in 2019. This type of funding is used as both long-term and short-term funding sources. Federal Home Loan Bank advances and other borrowings represent an important source of other funding for the Company. Average borrowed funds declined $35.1 million, or 16%, during 2021 following a decline of $57.8 million, or 21%, during 44 2020. Borrowings comprised approximately 4% of average total funding sources during 2021 compared with 5% in 2020 and 8% in 2019. The bank subsidiary of the Company also utilizes short-term funding sources from time to time. These sources consist of overnight federal funds purchased from other financial institutions, secured repurchase agreements that generally mature within one day of the transaction date, and secured overnight variable rate borrowings from the FHLB. These borrowings represent an important source of short-term liquidity for the Company’s bank subsidiary. Long-term debt at the Company’s bank subsidiary is in the form of FHLB advances, which are secured by the pledge of certain investment securities, residential and housing-related mortgage loans, and certain other commercial real estate loans. See Note 7 (FHLB Advances and Other Borrowings) of the Notes to the Consolidated Financial Statements included in Item 8 of this Report for further information regarding borrowed funds. PARENT COMPANY FUNDING SOURCES The parent company is a corporation separate and distinct from its bank and other subsidiaries. For information regarding the financial condition, result of operations, and cash flows of the Company, presented on a parent-company-only basis, see Note 17 (Parent Company Financial Statements) of the Notes to the Consolidated Financial Statements included in Item 8 of this Report. The Company uses funds at the parent company level to pay dividends to its shareholders, to acquire or make other investments in other businesses or their securities or assets, to repurchase its stock from time to time, and for other general corporate purposes. The parent company does not have access to the deposits and certain other sources of funds that are available to its bank subsidiary to support its operations. Instead, the parent company has historically derived most of its revenues from dividends paid to the parent company by its bank subsidiary. The Company’s banking subsidiary is subject to statutory restrictions on its ability to pay dividends to the parent company. See Note 8 (Shareholders’ Equity) of the Notes to the Consolidated Financial Statements included in Item 8 of this Report, which is incorporated herein by reference. The parent company has in recent years supplemented the dividends received from its subsidiaries with borrowings, which are discussed in detail below. On June 25, 2019, the Company sold and issued $40.0 million in aggregate principal amount of its 4.50% Fixed-to-Floating Rate Subordinated Notes due 2029 (the “Notes”). The Company used the proceeds from the offering to pay $15.0 million of the approximately $15.5 million of cash consideration upon closing of the Citizens First Corporation merger and the remaining balance to repay the Company’s $25.0 million term loan from U.S. Bank National Association dated October 11, 2018. The Notes have a ten-year term, from and including the date of issuance to but excluding June 30, 2024, and will bear interest at a fixed annual rate of 4.50%, payable semi-annually in arrears. From and including June 30, 2024 to but excluding the maturity date or early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then-current three-month LIBOR (provided, however, that in the event three-month LIBOR is less than zero, three-month LIBOR shall be deemed to be zero) plus 268 basis points, payable quarterly in arrears. The Notes are redeemable, in whole or in part, on June 30, 2024, on any scheduled interest payment date thereafter and at any time upon the occurrence of certain events. The Purchase Agreement contains certain customary representations, warranties and covenants made by the Company, on the one hand, and the Purchasers, severally and not jointly, on the other hand. The Notes were issued under an Indenture, dated June 25, 2019, by and between the Company and U.S. Bank National Association, as trustee. The Notes are not subject to any sinking fund and are not convertible into or exchangeable for any other securities or assets of the Company or any of its subsidiaries. The Notes are not subject to redemption at the option of the holder. The Notes are unsecured, subordinated obligations of the Company only and are not obligations of, and are not guaranteed by, any subsidiary of the Company. The Notes rank junior in right to payment to the Company’s current and future senior indebtedness. The Notes are intended to qualify as Tier 2 capital for regulatory capital purposes for the Company. At year-end 2021, the Company had available to it a $15 million revolving line of credit facility that will mature on September 26, 2022. Borrowings are available for general working capital purposes. Interest is payable quarterly at a floating rate based upon one-month LIBOR plus a margin payable in respect of any principal amounts advanced under the revolving line of credit. There was no outstanding balance as of December 31, 2021. Effective January 1, 2011, and as a result of the acquisition of American Community Bancorp, Inc., the Company assumed long-term debt obligations of American Community in the form of two junior subordinated debentures issued by American Community in the aggregate unpaid principal amount of approximately $8.3 million. Effective March 1, 2016, and as a result of the acquisition of River Valley Bancorp, the Company assumed long-term debt obligations of River Valley in the form of a junior subordinated debenture issued by River Valley in the aggregate unpaid principal amount of approximately $7.2 million. 45 Effective July 1, 2019, and as a result of the acquisition of Citizens First Bancorp, the Company assumed long-term debt obligations of Citizens First in the form of a junior subordinated debenture issued by Citizens First in the aggregate unpaid principal amount of approximately $5.2 million. The junior subordinated debentures were issued to certain statutory trusts established by River Valley, American Community, and Citizens First (in support of related issuances of trust preferred securities issued by those trusts) and mature in installments of principal payable in 2033, 2035 and 2037, respectively, and bear interest payable on a quarterly basis at a floating rate, adjustable quarterly based on the three-month LIBOR plus a specified percentage. These debentures are of a type that are eligible (under current regulatory capital requirements) to qualify as Tier 1 capital (with certain limitations) for regulatory purposes and as of December 31, 2021 approximately $16.1 million of the junior subordinated debentures were treated as Tier 1 capital for regulatory capital purposes. See Note 17 (Parent Company Financial Statements) of the Notes to the Consolidated Financial Statements included in Item 8 of this Report for further information regarding the parent company borrowed funds and other indebtedness. RISK MANAGEMENT The Company is exposed to various types of business risk on an on-going basis. These risks include credit risk, liquidity risk and interest rate risk. Various procedures are employed at the Company’s subsidiary bank to monitor and mitigate risk in the loan and investment portfolios, as well as risks associated with changes in interest rates. Following is a discussion of the Company’s philosophies and procedures to address these risks. LENDING AND LOAN ADMINISTRATION Primary responsibility and accountability for day-to-day lending activities rests with the Company’s subsidiary bank. Loan personnel at the subsidiary bank have the authority to extend credit under guidelines approved by the Bank’s board of directors. The executive loan committee serves as a vehicle for communication and for the pooling of knowledge, judgment and experience of its members. The committee provides valuable input to lending personnel, acts as an approval body, and monitors the overall quality of the Bank’s loan portfolio. The Corporate Credit Risk Management Committee comprised of members of the Company’s and its subsidiary Bank’s executive officers and board of directors, strives to ensure a consistent application of the Company’s lending policies. The Company also maintains a comprehensive risk-grading and loan review program, which includes quarterly reviews of problem loans, delinquencies and charge-offs. The purpose of this program is to evaluate loan administration, credit quality, loan documentation and the adequacy of the allowance for credit losses. In response to requests from borrowers who had experienced pandemic-related business or personal cash flow interruptions, and in accordance with regulatory guidance, the Company began making short-term loan modifications involving both partial and full payment deferrals in April 2020. As of December 31, 2021, the Company has just one commercial real estate loan, in the principal amount of $3.5 million, with a payment modification that is still in effect, with such credit relationship making full interest payments. The Company tracks lending exposure by industry classification to determine potential risk associated with industry concentrations, if any, that could lead to additional credit loss exposure. As a result of the COVID-19 pandemic, the Company identified certain loan segments that represented higher levels of credit risk, as many of the customers in these segments were expected to incur significant negative impacts to their businesses as a result of governmental stay-at-home orders and travel restrictions, limited attendance, social distancing and face mask requirements, and work-from-home and hybrid work models being used by employers. At December 31, 2021, the Company had the following exposure to these COVID-19-impacted loan segments: Industry Segment (dollars in thousands) Number of Loans Outstanding Balance % of Total Loans (excludes PPP Loans) % of Industry Segment Under Deferral Lodging / Hotels 32 $ 113,381 3.8 % 3.1 % Retail Shopping / Strip Centers 58 89,002 3.0 % — % Restaurants 161 62,163 2.1 % — % The Company maintains an allowance for credit losses to cover management's estimate of all expected credit losses over the expected contractual life of the loan portfolio. Management estimates the required level of allowance for credit losses using past loan loss experience, information about specific borrower situations and estimated collateral values, along with reasonable 46 and supportable forecasts, judgmentally adjusted for economic, external and internal quantitative and qualitative factors and portfolio trends. Economic factors include evaluating changes in international, national, regional and local economic and business conditions that affect the collectability of the loan portfolio. Internal factors include evaluating changes in lending policies and procedures; changes in the nature and volume of the loan portfolio; and changes in experience, ability and depth of lending management and staff. 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. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. The allowance for credit losses is comprised of: (a) specific reserves on individual credits; (b) general reserves for certain loan categories and industries, and overall historical loss experience; and (c) unallocated reserves based on performance trends in the loan portfolios, current economic conditions, and other factors that influence the level of estimated credit losses. The need for specific reserves are considered for credits when: (a) the customer’s cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or, (d) other reasons where the ultimate collectability of the loan is in question, or the loan characteristics require special monitoring. Allowance for Credit Losses (dollars in thousands) Years Ended December 31, 2021 2020 2019 2018 2017 Balance of Allowance for Possible Losses at Beginning of Period $ 46,859 $ 16,278 $ 15,823 $ 15,694 $ 14,808 Impact of adopting ASC 326 — 8,767 — — — Impact of adopting ASC 326 - PCD loans — 6,886 — — — Loans Charged-off: Commercial and Industrial Loans and Leases 2,777 2,119 3,810 1,500 151 Commercial Real Estate Loans 10 36 320 49 220 Agricultural Loans — — — — 49 Home Equity and Consumer Loans 1,003 942 1,155 922 765 Residential Mortgage Loans 45 39 117 75 93 Total Loans Charged-off 3,835 3,136 5,402 2,546 1,278 Recoveries of Previously Charged-off Loans: Commercial and Industrial Loans and Leases 61 23 56 141 14 Commercial Real Estate Loans 40 129 29 20 48 Agricultural Loans — — — 20 9 Home Equity and Consumer Loans 359 358 440 387 280 Residential Mortgage Loans 33 4 7 37 63 Total Recoveries 493 514 532 605 414 Net Loans Recovered (Charged-off) (3,342) (2,622) (4,870) (1,941) (864) Additions to Allowance Charged to Expense (6,500) 17,550 5,325 2,070 1,750 Balance at End of Period $ 37,017 $ 46,859 $ 16,278 $ 15,823 $ 15,694 Net Charge-offs (Recoveries) to Average Loans Outstanding 0.11 % 0.08 % 0.17 % 0.08 % 0.04 % Provision for Credit Losses to Average Loans Outstanding (0.21) % 0.55 % 0.18 % 0.09 % 0.09 % Allowance for Credit Losses to Total Loans at Year-end 1.23 % 1.52 % 0.53 % 0.58 % 0.73 % The following table indicates the breakdown of the allowance for credit losses for the periods indicated (dollars in thousands): Years Ended December 31, 2021 2020 2019 2018 2017 Commercial and Industrial Loans and Leases $ 9,754 $ 6,645 $ 4,799 $ 2,953 $ 4,735 Commercial Real Estate Loans 19,245 29,878 4,692 5,291 4,591 Agricultural Loans 4,505 6,756 5,315 5,776 4,894 Home Equity and Consumer Loans 1,808 1,636 634 649 628 Residential Mortgage Loans 1,705 1,944 333 472 343 Unallocated — — 505 682 503 Total Allowance for Credit Losses $ 37,017 $ 46,859 $ 16,278 $ 15,823 $ 15,694 47 The Company’s allowance for credit losses totaled $37.0 million at December 31, 2021 compared to $46.9 million at December 31, 2020. The allowance for credit losses represented 1.23% of period-end loans at December 31, 2021 compared with 1.52% of period-end loans at year-end 2020. Under the CECL model, which was adopted by the Company on January 1, 2020, certain acquired loans continue to carry a fair value discount as well as an allowance for credit losses. As of December 31, 2021, the Company held net discounts on acquired loans of $4.9 million. The allowance for credit losses declined during 2021 as a result of the Company recording a negative $6.5 million provision for credit losses while recording modest net charge-offs. During 2020, the allowance for credit losses increased through elevated provision for credit losses primarily due to the developments during 2020 related to the COVID-19 pandemic and the resulting impact on the economic assumptions used in the CECL model. The Company realized net charge-offs of $3,342,000, or 0.11% of average loans outstanding during 2021 compared with net charge-offs of $2,622,000, or 0.08% of average loans outstanding during 2020 and $4,870,000, or 0.17% of average loans during 2019. Please see “RESULTS OF OPERATIONS - Provision for Credit Losses” and “CRITICAL ACCOUNTING POLICIES AND ESTIMATES - Allowance for Credit Losses” for additional information regarding the allowance. NON-PERFORMING ASSETS Non-performing assets consist of: (a) non-accrual loans; (b) loans which have been renegotiated to provide for a reduction or deferral of interest or principal because of deterioration in the financial condition of the borrower; (c) loans past due 90 days or more as to principal or interest; and, (d) other real estate owned. Loans are 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 is reversed against income at the time a loan is placed on non-accrual. 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 an analysis of the Company’s non-performing assets. Non-performing Assets December 31, (dollars in thousands) 2021 2020 2019 2018 2017 Non-accrual Loans $ 14,602 $ 21,507 $ 13,802 $ 12,579 $ 11,091 Past Due Loans (90 days or more and accruing) 156 — 190 633 719 Total Non-performing Loans 14,758 21,507 13,992 13,212 11,810 Other Real Estate — 325 425 286 54 Total Non-performing Assets $ 14,758 $ 21,832 $ 14,417 $ 13,498 $ 11,864 Restructured Loans $ 104 $ 111 $ 116 $ 121 $ 149 Non-performing Loans to Total Loans 0.49 % 0.70 % 0.45 % 0.48 % 0.55 % Allowance for Credit Losses to Non-performing Loans 250.83 % 217.88 % 116.34 % 119.76 % 132.89 % Non-performing assets totaled $14.8 million, or 0.26% of total assets at December 31, 2021 compared to $21.8 million, or 0.44% of total assets at December 31, 2020 and compared to $14.4 million, or 0.33% of total assets at December 31, 2019. Non-performing loans totaled $14.8 million, or 0.49% of total loans at December 31, 2021 compared with $21.5 million, or 0.70% of total loans at December 31, 2020 and $14.0 million, or 0.45% of total loans at December 31, 2019. The decline in the level of commercial real estate non-performing loans during 2021 was largely attributable to the payoff of a commercial real estate credit in the lodging industry that was placed in non-accrual status during the third quarter of 2020. The increase in the level of non-performing assets and non-performing loans at December 31, 2020 compared with year-end 2019 was largely attributable to the gross-up of purchased credit deteriorated loans upon the adoption of the CECL standard during 2020 and a commercial real estate credit in the lodging industry that was moved to non-performing status in the third quarter of 2020. 48 The following tables present an analysis of the Company’s non-accrual loans and loans past due 90 days or more and still accruing. Non-Accrual Loans December 31, (dollars in thousands) 2021 2020 2019 2018 2017 Commercial and Industrial Loans and Leases $ 10,530 $ 8,133 $ 4,940 $ 2,430 $ 4,753 Commercial Real Estate Loans 2,243 10,188 3,433 6,833 4,618 Agricultural Loans 1,136 1,915 2,739 1,449 748 Home Equity Loans 24 271 79 88 199 Consumer Loans 82 170 115 162 286 Residential Mortgage Loans 587 830 2,496 1,617 487 Total $ 14,602 $ 21,507 $ 13,802 $ 12,579 $ 11,091 Loans Past Due 90 Days or More & Still Accruing December 31, (dollars in thousands) 2021 2020 2019 2018 2017 Commercial and Industrial Loans and Leases $ — $ — $ 190 $ — $ — Commercial Real Estate Loans 156 — — 364 471 Agricultural Loans — — — 269 248 Home Equity Loans — — — — — Consumer Loans — — — — — Residential Mortgage Loans — — — — — Total $ 156 $ — $ 190 $ 633 $ 719 For additional detail on individually analyzed loans, see Note 4 in the Notes to the Consolidated Financial Statements included in Item 8 of this Report. Interest income recognized on non-performing loans for 2021 was $630,000. The gross interest income that would have been recognized in 2021 on non-performing loans if the loans had been current in accordance with their original terms was $891,000. Loans are typically placed on non-accrual status when scheduled principal or interest payments are past due for 90 days or more, unless the loan is well secured and in the process of collection. LIQUIDITY AND INTEREST RATE RISK MANAGEMENT Liquidity is a measure of the ability of the Company’s subsidiary bank to fund new loan demand, existing loan commitments and deposit withdrawals. The purpose of liquidity management is to match sources of funds with anticipated customer borrowings and withdrawals and other obligations to ensure a dependable funding base, without unduly penalizing earnings. Failure to properly manage liquidity requirements can result in the need to satisfy customer withdrawals and other obligations on less than desirable terms. The liquidity of the parent company is dependent upon the receipt of dividends from its bank subsidiary, which are subject to certain regulatory limitations explained in Note 8 (Shareholders’ Equity) of the Notes to the Consolidated Financial Statements included in Item 8 of this Report. The subsidiary bank’s source of funding is predominately core deposits, time deposits in excess of $100,000 and brokered certificates of deposit, maturities of securities, repayments of loan principal and interest, federal funds purchased, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank and Federal Reserve Bank. Interest rate risk is the exposure of the Company’s financial condition to adverse changes in market interest rates. In an effort to estimate the impact of sustained interest rate movements to the Company’s earnings, the Company monitors interest rate risk through computer-assisted simulation modeling of its net interest income. The Company’s simulation modeling monitors the potential impact to net interest income under various interest rate scenarios. The Company’s objective is to actively manage its asset/liability position within a one-year interval and to limit the risk in any of the interest rate scenarios to a reasonable level of tax-equivalent net interest income within that interval. The Company’s Asset/Liability Committee monitors compliance within established guidelines of the Funds Management Policy. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk section for further discussion regarding interest rate risk. 49