ISABELLA BANK CORP 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. ISABELLA BANK CORPORATION FINANCIAL REVIEW (Dollars in thousands except per share amounts) The following is management’s discussion and analysis of our financial condition and results of operations. This discussion and analysis is intended to provide a better understanding of the consolidated financial statements and statistical data included elsewhere in this Annual Report on Form 10-K. Executive Summary We reported net income of $22,238 and earnings per common share of $2.95 for the year ended December 31, 2022. Net income and earnings per common share for the same period of 2021 were $19,499 and $2.48, respectively. Net interest income increased $7,780, or 14.76%, during 2022 compared to 2021. While PPP loan fees declined, rising interest rates and growth in core loans and AFS securities led to a $5,685 or 9.46% increase in gross interest income during 2022 compared to 2021. We continued to benefit from the significant reduction in higher-cost borrowings as interest expense on deposits and borrowings decreased $2,095, or 28.26%, for the year ended December 31, 2022 when compared to the same period in 2021. The provision for loan losses during the year ended December 31, 2022 was $483, compared to a net provision reversal of $518 for the same period in 2021. During 2020, increased economic and environmental risk factors, predominantly driven by COVID-19, drove a significant increase in the ALLL and provision expense. Strong credit quality, coupled with improvement in economic factors, such as unemployment rates, resulted in a reduction in the ALLL and a provision reversal during the first quarter of 2021. Credit quality remained strong at December 31, 2022, as evidenced by total past due and nonaccrual loans which were $11,130, or 0.88%, of gross loans. Despite strong credit quality, the ALLL and provision for loan losses increased during 2022 as a result of core loan growth and economic related risk factors. Noninterest income decreased $156 during 2022 compared to the same period in 2021. Gain on sale of mortgages decreased $1,063, as residential mortgage originations sold in the secondary market declined. Offsetting this was an increase in service charges and fees of $1,116, with $619 of the increase attributed to OMSR income. Noninterest expenses increased $3,126 in 2022 when compared to the same period in 2021 and was primarily a result of increased compensation, other losses, donations and community relations related expenses. As of December 31, 2022, total assets and assets under management were $2,030,267 and $2,808,391, respectively. Assets under management include loans sold and serviced of $264,206 and investment and trust assets managed by Isabella Wealth of $513,918, in addition to assets on our consolidated balance sheet. Loans outstanding as of December 31, 2022 totaled $1,264,173. During 2022, gross loans declined $36,864 which was largely the result of a $72,001 reduction in advances to mortgage brokers, which is included within the commercial loan portfolio; however, is not considered a component of our core lending business. During 2022, core loan growth totaled $35,137 and was driven by growth in all loan categories. Total deposits were $1,744,275 as of December 31, 2022, which was an increase of $33,936 since December 31, 2021. A majority of this growth was in the form of demand deposits. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a "well capitalized" institution. Our securities portfolio increased $89,880 since December 31, 2021, predominantly due to $210,869 in purchases, although offset by maturities and an increase in net unrealized losses. The unrealized loss on our AFS securities portfolio resulted from the recent increases in short-term and intermediate-term benchmark interest rates. As a result, this change in unrealized losses has reduced our balance of shareholders' equity and negatively impacted our tangible book value. Management does not anticipate the need to sell securities and incur a loss as a result of the sale. Our net yield on interest earning assets (FTE) was 3.18% for 2022 which increased from 2.87% in 2021. The marked improvement is a result of strategies management began implementing in 2019 and 2020, focused on positioning the Bank to benefit in a rising interest rate environment, including a reduced reliance on higher-cost borrowed funds and brokered deposits. 12 Table of Contents Recent Events and Legislation Impact of COVID-19: Unexpected and unprecedented changes have occurred since early 2020 as the result of COVID-19. The full impact of the pandemic, including the uncertainties surrounding the pandemic, remain in 2022. However, significant progress has been made with vaccinations and medical treatments. Additionally, improved safety guidelines and the easing of restrictions have occurred since the onset of the pandemic. We expect the significance of the pandemic, including the extent of its effect on our financial and operational results, to be dictated by continued developments related to the COVID-19 pandemic. We continue to closely monitor external events and are in continual discussion with our customers to assess, prepare, and respond to conditions as they evolve. Reclassifications Certain amounts reported in management's discussion and analysis of financial condition and results of operations for 2021 and 2020 have been reclassified to conform with the 2022 presentation. Subsequent Events In June 2016, the FASB issued ASU 2016-13 and updated the measurement for credit losses for AFS debt securities and assets measured at amortized cost, which include loans and any other financial assets with the contractual right to receive cash. The new approach requires the use of an expected credit loss model. The new CECL guidance was effective January 1, 2023 and we have fully adopted the new guidance as of that date. Based on portfolio characteristics and economic conditions and expectations as of January 1, 2023, we recorded a combined increase to the ACL and reserve for unfunded commitments on January 1, 2023 of approximately $3,000 upon the adoption of ASU 2016-13. We evaluated subsequent events after December 31, 2022 through the date our condensed consolidated financial statements were issued for potential recognition and disclosure. Outside of the adoption of CECL, no other subsequent events require financial statement recognition or disclosure between December 31, 2022 and the date our condensed consolidated financial statements were issued. Other We have not received, nor are aware of, any notices of regulatory actions as of March 6, 2023. 13 Table of Contents Results of Operations (Dollars in thousands except per share amounts) The following table outlines the results of operations and provides certain key performance measures as of, and for the years ended, December 31: 2022 2021 2020 INCOME STATEMENT DATA Interest income $ 65,798 $ 60,113 $ 64,172 Interest expense 5,317 7,412 13,825 Net interest income 60,481 52,701 50,347 Provision for loan losses 483 ( 518 ) 1,665 Noninterest income 13,666 13,822 14,423 Noninterest expenses 46,820 43,694 51,233 Federal income tax expense 4,606 3,848 987 Net income $ 22,238 $ 19,499 $ 10,885 PER SHARE Basic earnings $ 2.95 $ 2.48 $ 1.37 Diluted earnings $ 2.91 $ 2.45 $ 1.34 Dividends $ 1.09 $ 1.08 $ 1.08 Tangible book value $ 18.25 $ 21.61 $ 21.29 Quoted market value High $ 26.25 $ 29.00 $ 24.50 Low $ 21.00 $ 19.45 $ 15.60 Close (1) $ 23.50 $ 25.50 $ 19.57 Common shares outstanding (1) 7,559,421 7,532,641 7,997,247 PERFORMANCE RATIOS Return on average total assets 1.08 % 0.96 % 0.57 % Return on average shareholders' equity 11.41 % 8.83 % 4.93 % Return on average tangible shareholders' equity 15.17 % 11.31 % 6.34 % Net interest margin yield (FTE) 3.18 % 2.87 % 2.96 % BALANCE SHEET DATA (1) Gross loans $ 1,264,173 $ 1,301,037 $ 1,238,311 AFS securities $ 580,481 $ 490,601 $ 339,228 Total assets $ 2,030,267 $ 2,032,158 $ 1,957,378 Deposits $ 1,744,275 $ 1,710,339 $ 1,566,317 Borrowed funds $ 87,016 $ 99,320 $ 158,747 Shareholders' equity $ 186,210 $ 211,048 $ 218,588 Gross loans to deposits 72.48 % 76.07 % 79.06 % ASSETS UNDER MANAGEMENT (1) Loans sold with servicing retained $ 264,206 $ 278,844 $ 301,377 Assets managed by Isabella Wealth $ 513,918 $ 516,243 $ 443,967 Total assets under management $ 2,808,391 $ 2,827,245 $ 2,702,722 ASSET QUALITY (1) Nonperforming loans to gross loans 0.04 % 0.10 % 0.43 % Nonperforming assets to total assets 0.05 % 0.08 % 0.31 % ALLL to gross loans 0.78 % 0.70 % 0.79 % CAPITAL RATIOS (1) Shareholders' equity to assets 9.17 % 10.39 % 11.17 % Tier 1 leverage 8.61 % 7.97 % 8.37 % Common equity tier 1 capital 12.91 % 12.07 % 12.97 % Tier 1 risk-based capital 12.91 % 12.07 % 12.97 % Total risk-based capital 15.79 % 14.94 % 13.75 % (1) At end of year 14 Table of Contents The following table outlines our interim results of operations and key performance measures as of, and for the unaudited periods ended: Quarter to Date December 31 2022 September 30 2022 June 30 2022 March 31 2022 INCOME STATEMENT DATA Total interest income $ 17,915 $ 17,019 $ 16,102 $ 14,762 Total interest expense 1,643 1,216 1,175 1,283 Net interest income 16,272 15,803 14,927 13,479 Provision for loan losses (57) 18 485 37 Noninterest income 3,272 3,252 3,595 3,547 Noninterest expenses 11,922 11,917 11,661 11,320 Federal income tax expense 1,357 1,233 1,081 935 Net income $ 6,322 $ 5,887 $ 5,295 $ 4,734 PER SHARE Basic earnings $ 0.84 $ 0.78 $ 0.70 $ 0.63 Diluted earnings $ 0.83 $ 0.77 $ 0.69 $ 0.62 Dividends $ 0.28 $ 0.27 $ 0.27 $ 0.27 Quoted market value (1) $ 23.50 $ 21.40 $ 24.80 $ 25.85 Tangible book value $ 18.25 $ 16.96 $ 18.85 $ 19.56 Quarter to Date December 31 2021 September 30 2021 June 30 2021 March 31 2021 INCOME STATEMENT DATA Total interest income $ 15,041 $ 15,142 $ 14,640 $ 15,290 Total interest expense 1,567 1,829 1,927 2,089 Net interest income 13,474 13,313 12,713 13,201 Provision for loan losses 81 (107) 31 (523) Noninterest income 3,608 3,367 3,315 3,532 Noninterest expenses 11,197 11,185 10,495 10,817 Federal income tax expense 1,010 916 881 1,041 Net income $ 4,794 $ 4,686 $ 4,621 $ 5,398 PER SHARE Basic earnings $ 0.63 $ 0.59 $ 0.58 $ 0.68 Diluted earnings $ 0.63 $ 0.58 $ 0.57 $ 0.67 Dividends $ 0.27 $ 0.27 $ 0.27 $ 0.27 Quoted market value (1) $ 25.50 $ 26.03 $ 23.00 $ 21.75 Tangible book value $ 21.61 $ 21.87 $ 21.73 $ 21.35 (1) At end of period 15 Table of Contents CRITICAL ACCOUNTING POLICIES Our significant accounting policies are set forth in “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Of these significant accounting policies, we consider our policies regarding the ALLL, acquisition intangibles and goodwill, and the determination of the fair value and assessment of OTTI of investment securities to be our most critical accounting policies. The ALLL requires our most subjective and complex judgment. Changes in economic conditions and other external factors can have a significant impact on the ALLL and, therefore, the provision for loan losses and results of operations. We have developed policies and procedures for assessing the appropriateness of the ALLL, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, and the discovery of information with respect to borrowers which is not known to us at the time of the issuance of the consolidated financial statements. For additional discussion concerning our ALLL and related matters, see “Allowance for Loan and Lease Losses” and “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. U.S. generally accepted accounting principles require that we determine the fair value of the assets and liabilities of an acquired entity, and record the fair value on the date of acquisition. We employ a variety of measures in the determination of the fair value, including the use of discounted cash flow analysis, market appraisals, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculations of the value. In other cases, where the value is not easily determined, we consult with independent experts to determine the fair value of the identified asset or liability. Once valuations have been determined, the net difference between the price paid for the acquired entity and the net value of assets acquired on our balance sheet, including identifiable intangibles, is recorded as goodwill. Acquisition intangibles and goodwill are qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired on at least an annual basis. AFS securities are carried at fair value with changes in the fair value included as a component of other comprehensive income. Declines in the fair value of AFS securities below their cost that are other-than-temporary are reflected as realized losses in the consolidated statements of income. We evaluate AFS securities for indications of losses that are considered other-than-temporary, if any, on a regular basis. The market values for most AFS investment securities are typically obtained from outside sources and applied to individual securities within the portfolio. Municipal securities for which no readily determinable market values are available are priced using fair value curves which most closely match the securities' characteristics. 16 Table of Contents Average Balances, Interest Rates, and Net Interest Income The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing liabilities, and noninterest bearing liabilities for the last three years. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a federal income tax rate of 21%. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in other interest earning assets. Year Ended December 31 2022 2021 2020 Average Balance Tax Equivalent Interest Average Yield / Rate Average Balance Tax Equivalent Interest Average Yield / Rate Average Balance Tax Equivalent Interest Average Yield / Rate INTEREST EARNING ASSETS Loans (1) $ 1,249,634 $ 53,283 4.26 % $ 1,208,141 $ 51,410 4.26 % $ 1,236,169 $ 54,102 4.38 % Taxable investment securities 477,159 8,294 1.74 % 297,357 4,920 1.65 % 229,468 5,214 2.27 % Nontaxable investment securities 107,158 3,933 3.67 % 117,997 4,235 3.59 % 140,665 5,189 3.69 % Fed funds sold 10 — 2.42 % 5 — 0.02 % 4 — 0.06 % Other 99,301 1,344 1.35 % 255,246 706 0.28 % 142,717 1,026 0.72 % Total earning assets 1,933,262 66,854 3.46 % 1,878,746 61,271 3.26 % 1,749,023 65,531 3.75 % NONEARNING ASSETS Allowance for loan losses (9,477) (9,396) (8,837) Cash and demand deposits due from banks 24,708 29,139 24,987 Premises and equipment 24,648 24,760 25,846 Accrued income and other assets 81,823 109,625 118,195 Total assets $ 2,054,964 $ 2,032,874 $ 1,909,214 INTEREST BEARING LIABILITIES Interest bearing demand deposits $ 374,623 274 0.07 % $ 345,015 216 0.06 % $ 262,188 357 0.14 % Savings deposits 630,574 1,135 0.18 % 558,102 616 0.11 % 456,088 1,212 0.27 % Time deposits 270,296 2,612 0.97 % 336,094 4,610 1.37 % 387,881 7,315 1.89 % Federal funds purchased and repurchase agreements 49,974 79 0.16 % 57,453 53 0.09 % 35,518 36 0.10 % FHLB advances 7,863 152 1.93 % 69,342 1,302 1.88 % 210,451 4,905 2.33 % Subordinated debt, net of unamortized issuance costs 29,200 1,065 3.65 % 17,000 615 3.62 % — — 0.00 % Total interest bearing liabilities 1,362,530 5,317 0.39 % 1,383,006 7,412 0.54 % 1,352,126 13,825 1.02 % NONINTEREST BEARING LIABILITIES Demand deposits 482,781 416,247 320,820 Other 14,695 12,858 15,613 Shareholders’ equity 194,958 220,763 220,655 Total liabilities and shareholders’ equity $ 2,054,964 $ 2,032,874 $ 1,909,214 Net interest income (FTE) $ 61,537 $ 53,859 $ 51,706 Net yield on interest earning assets (FTE) 3.18 % 2.87 % 2.96 % (1) Includes loans and mortgage loans AFS 17 Table of Contents Net interest income is the amount by which interest income on earning assets exceeds the interest expense on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities, as well as market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful. The FTE adjustment is based on a federal income tax rate of 21%. Volume and Rate Variance Analysis The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows: Volume—change in volume multiplied by the previous period's FTE rate. Rate—change in the FTE rate multiplied by the previous period's volume. All interest income presented in the table below is reported on a FTE basis using a federal income tax rate of 21%. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. 2022 Compared to 2021 Increase (Decrease) Due to 2021 Compared to 2020 Increase (Decrease) Due to Volume Rate Net Volume Rate Net Changes in interest income Loans $ 1,769 $ 104 $ 1,873 $ (1,211) $ (1,481) $ (2,692) Taxable investment securities 3,114 260 3,374 1,324 (1,618) (294) Nontaxable investment securities (396) 94 (302) (817) (137) (954) Fed Funds Sold — — — — — — Other (659) 1,297 638 529 (849) (320) Total changes in interest income 3,828 1,755 5,583 (175) (4,085) (4,260) Changes in interest expense Interest bearing demand deposits 20 38 58 90 (231) (141) Savings deposits 89 430 519 227 (823) (596) Time deposits (796) (1,202) (1,998) (889) (1,816) (2,705) Federal funds purchased and repurchase agreements (8) 34 26 20 (3) 17 FHLB advances (1,187) 37 (1,150) (2,793) (810) (3,603) Subordinated debt, net of unamortized issuance costs 445 5 450 615 — 615 Total changes in interest expense (1,437) (658) (2,095) (2,730) (3,683) (6,413) Net change in interest margin (FTE) $ 5,265 $ 2,413 $ 7,678 $ 2,555 $ (402) $ 2,153 The interest rate increases during 2022 alleviated much of the pressure placed on our net interest margin. Additionally, SBA PPP fee income has supported our yield on total earning assets over the past two years. The recent rate increases, and future rate increases expected during 2023, should lead to continued improvement in our net yield on interest earning assets. Average Yield / Rate for the Three-Month Periods Ended: December 31 2022 September 30 2022 June 30 2022 March 31 2022 December 31 2021 Total earning assets 3.77 % 3.53 % 3.41 % 3.13 % 3.19 % Total interest bearing liabilities 0.49 % 0.35 % 0.34 % 0.37 % 0.45 % Net yield on interest earning assets (FTE) 3.43 % 3.28 % 3.16 % 2.86 % 2.86 % 18 Table of Contents Quarter to Date Net Interest Income (FTE) December 31 2022 September 30 2022 June 30 2022 March 31 2022 December 31 2021 Total interest income (FTE) $ 18,183 $ 17,276 $ 16,373 $ 15,022 $ 15,246 Total interest expense 1,643 1,216 1,175 1,283 1,567 Net interest income (FTE) $ 16,540 $ 16,060 $ 15,198 $ 13,739 $ 13,679 Allowance for Loan and Lease Losses The viability of any financial institution is ultimately determined by its management of credit risk. Loans represent our single largest concentration of risk. The ALLL is our estimation of incurred losses within the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated within each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a representation of other qualitative risks that reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The following table summarizes our charge-offs, recoveries, provision for loan losses, and ALLL balances as of, and for the unaudited three month periods ended: December 31 2022 September 30 2022 June 30 2022 March 31 2022 December 31 2021 Total charge-offs $ 249 $ 173 $ 106 $ 91 $ 149 Total recoveries 479 132 117 155 78 Net loan charge-offs (recoveries) (230) 41 (11) (64) 71 Net loan charge-offs (recoveries) to average loans outstanding (0.02) % 0.00 % 0.00 % (0.01) % 0.01 % Provision for loan losses $ (57) $ 18 $ 485 $ 37 $ 81 Provision for loan losses to average loans outstanding 0.00 % 0.00 % 0.04 % 0.00 % 0.01 % ALLL $ 9,850 $ 9,677 $ 9,700 $ 9,204 $ 9,103 ALLL as a % of loans at end of period 0.78 % 0.78 % 0.76 % 0.76 % 0.70 % The following table summarizes charge-off and recovery activity by loan segment for the year ended December 31, 2022: Commercial Agricultural Residential Real Estate Consumer Total Charge-offs $ 77 $ — $ — $ 542 $ 619 Recoveries 442 9 150 282 883 Net loan charge-offs (recoveries) $ (365) $ (9) $ (150) $ 260 $ (264) Average loans outstanding $ 748,833 $ 93,621 $ 332,276 $ 74,338 $ 1,249,068 Net loan charge-offs (recoveries) to average loans outstanding (0.05) % (0.01) % (0.05) % 0.35 % (0.02) % The following table summarizes charge-offs, recoveries, and provision for loan loss activity for the years ended December 31: 2022 2021 2020 2019 2018 ALLL at beginning of period $ 9,103 $ 9,744 $ 7,939 $ 8,375 $ 7,700 Charge-offs 619 607 381 948 1,101 Recoveries 883 484 521 482 798 Provision for loan losses 483 (518) 1,665 30 978 ALLL at end of period $ 9,850 $ 9,103 $ 9,744 $ 7,939 $ 8,375 Net loan charge-offs (recoveries) $ (264) $ 123 $ (140) $ 466 $ 303 Net loan charge-offs (recoveries) to average loans outstanding (0.02) % 0.01 % (0.01) % 0.04 % 0.03 % ALLL as a % of loans at end of period 0.78 % 0.70 % 0.79 % 0.67 % 0.74 % ALLL as a % of nonaccrual loans 2155.36 % 731.16 % 183.40 % 121.48 % 115.36 % 19 Table of Contents During 2020, we increased the ALLL as a result of increased economic and environmental related risk factors, primarily driven by COVID-19. While these risk factors remain, improvement in credit quality indicators resulted in a reduction to the ALLL during 2021. Despite strong credit quality, the ALLL increased during 2022 as a result of core loan growth during the year and increased economic related risk factors. The following table illustrates the two main components of the ALLL as of: December 31 2022 September 30 2022 June 30 2022 March 31 2022 December 31 2021 ALLL Individually evaluated for impairment $ 451 $ 474 $ 515 $ 573 $ 578 Collectively evaluated for impairment 9,399 9,203 9,185 8,631 8,525 Total $ 9,850 $ 9,677 $ 9,700 $ 9,204 $ 9,103 ALLL to gross loans Individually evaluated for impairment 0.04 % 0.04 % 0.04 % 0.05 % 0.04 % Collectively evaluated for impairment 0.74 % 0.74 % 0.72 % 0.71 % 0.66 % Total 0.78 % 0.78 % 0.76 % 0.76 % 0.70 % The following table illustrates the amounts of the ALLL allocated to each loan segment and the percentage of these loan segments to gross loans as of December 31: 2022 2021 2020 2019 2018 ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans Commercial $ 1,321 58.61 $ 1,740 62.07 $ 2,162 61.10 $ 1,914 59.08 $ 2,563 58.43 Agricultural 577 8.25 289 7.22 311 8.11 634 9.85 775 11.27 Residential real estate 617 26.97 747 25.08 1,363 24.84 2,047 25.16 1,992 24.39 Consumer 961 6.17 908 5.63 798 5.95 922 5.91 857 5.91 Total Allocated 3,476 100.00 3,684 100.00 4,634 100.00 5,517 100.00 6,187 100.00 Unallocated 6,374 — 5,419 — 5,110 — 2,422 — 2,188 — Total $ 9,850 100.00 $ 9,103 100.00 $ 9,744 100.00 $ 7,939 100.00 $ 8,375 100.00 While we utilize our best judgment and information available, the ultimate adequacy of the ALLL is dependent upon a variety of factors beyond our control, including the performance of our borrowers, the economy, and changes in interest rates. We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at an appropriate level. For further discussion of the allocation of the ALLL, see “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. 20 Table of Contents Loans Past Due and Loans in Nonaccrual Status Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans for indications of additional deterioration. Total Past Due and Nonaccrual Loans as of December 31 2022 2021 2020 2019 2018 Commercial $ 7,504 $ 561 $ 2,148 $ 2,477 $ 2,722 Agricultural 234 987 3,786 4,285 5,377 Residential real estate 3,333 2,287 3,580 4,572 3,208 Consumer 59 196 96 71 105 Total $ 11,130 $ 4,031 $ 9,610 $ 11,405 $ 11,412 Total past due and nonaccrual loans to gross loans 0.88 % 0.31 % 0.78 % 0.96 % 1.01 % Past due and nonaccrual status loans, as a percentage of gross loans, has improved in recent years with the exception of 2022. During the fourth quarter, past due loans increased as a result of one commercial relationship. Therefore, we do not believe the recent increase is an indicator of credit deterioration. A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Troubled Debt Restructurings We have taken a proactive approach to modifying loans to assist borrowers who are willing to work with us, thus making them less likely to default, and to avoid foreclosure. This approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure. Modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status. We restructure debt with borrowers who due to financial difficulties are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow temporary interest-only payment structures, forgive principal, forgive interest, or grant a combination of these modifications. Typically, the modifications are for a period of three years or less. There were no TDRs that were government sponsored as of December 31, 2022 or December 31, 2021. Losses associated with TDRs, if any, are included in the estimation of the ALLL during the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period thereafter to ensure its continued appropriateness. 21 Table of Contents The following table provides a roll-forward of TDRs for the years ended December 31, 2021 and 2022: Accruing Interest Nonaccrual Total Number of Loans Balance Number of Loans Balance Number of Loans Balance January 1, 2021 108 $ 22,200 7 $ 2,730 115 $ 24,930 New modifications 11 8,473 — — 11 8,473 Principal advances (payments) — (1,697) — (242) — (1,939) Loans paid off (22) (5,739) — — (22) (5,739) Transfers to accrual status 3 2,127 (3) (2,127) — — Transfers to nonaccrual status (2) (88) 2 88 — — December 31, 2021 98 25,276 6 449 104 25,725 New modifications 4 2,969 — — 4 2,969 Principal advances (payments) — (2,188) — (105) — (2,293) Loans paid off (24) (4,988) — — (24) (4,988) Balances charged-off — — (1) (74) (1) (74) December 31, 2022 78 $ 21,069 5 $ 270 83 $ 21,339 The following table summarizes our TDRs as of December 31: 2022 2021 2020 Accruing Interest Nonaccrual Total Accruing Interest Nonaccrual Total Accruing Interest Nonaccrual Total Current $ 20,844 $ 256 $ 21,100 $ 25,236 $ 294 $ 25,530 $ 22,017 $ 2,421 $ 24,438 Past due 30-59 days 225 — 225 40 85 125 183 — 183 Past due 60-89 days — — — — — — — — — Past due 90 days or more — 14 14 — 70 70 — 309 309 Total $ 21,069 $ 270 $ 21,339 $ 25,276 $ 449 $ 25,725 $ 22,200 $ 2,730 $ 24,930 2019 2018 Accruing Interest Nonaccrual Total Accruing Interest Nonaccrual Total Current $ 20,847 $ 507 $ 21,354 $ 21,794 $ 2,673 $ 24,467 Past due 30-59 days 346 — 346 899 — 899 Past due 60-89 days 1 — 1 707 — 707 Past due 90 days or more — 3,036 3,036 — 878 878 Total $ 21,194 $ 3,543 $ 24,737 $ 23,400 $ 3,551 $ 26,951 Additional disclosures about TDRs are included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. 22 Table of Contents Impaired Loans The following is a summary of information pertaining to impaired loans as of December 31: 2022 2021 Recorded Balance Unpaid Principal Balance Valuation Allowance Recorded Balance Unpaid Principal Balance Valuation Allowance TDRs Commercial real estate $ 5,388 $ 5,643 $ 12 $ 5,707 $ 5,961 $ 9 Commercial other 2,793 2,793 — 3,246 3,246 4 Agricultural real estate 8,522 8,522 — 9,182 9,181 — Agricultural other 2,413 2,413 — 4,543 4,543 — Residential real estate senior liens 2,223 2,293 356 3,047 3,203 504 Total TDRs 21,339 21,664 368 25,725 26,134 517 Other impaired loans Commercial real estate 161 223 — 314 377 — Agricultural real estate — — — 356 357 — Agricultural other — — — 108 108 — Residential real estate senior liens 518 708 83 370 485 61 Home equity lines of credit — — — 37 37 — Total other impaired loans 679 931 83 1,185 1,364 61 Total impaired loans $ 22,018 $ 22,595 $ 451 $ 26,910 $ 27,498 $ 578 We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. Additional disclosures related to impaired loans are included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. 23 Table of Contents Nonperforming Assets The following table summarizes our nonperforming assets as of December 31: 2022 2021 2020 2019 2018 Nonaccrual status loans $ 457 $ 1,245 $ 5,313 $ 6,535 $ 7,260 Accruing loans past due 90 days or more — 97 — — 113 Total nonperforming loans 457 1,342 5,313 6,535 7,373 Foreclosed assets 439 211 527 456 355 Debt securities 77 131 230 230 230 Total nonperforming assets $ 973 $ 1,684 $ 6,070 $ 7,221 $ 7,958 Nonperforming loans as a % of total loans 0.04 % 0.10 % 0.43 % 0.55 % 0.65 % Nonperforming assets as a % of total assets 0.05 % 0.08 % 0.31 % 0.40 % 0.42 % The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status. The level of nonperforming loans continued to improve and remains low in comparison to peer banks. The following table summarizes nonaccrual loans as of December 31: 2022 2021 2020 2019 2018 Commercial $ 96 $ 341 $ 1,329 $ 1,621 $ 1,757 Agricultural 234 774 3,785 4,285 4,949 Residential real estate 127 130 199 629 554 Total $ 457 $ 1,245 $ 5,313 $ 6,535 $ 7,260 Nonaccrual loans as a % of loans at end of period 0.04 % 0.10 % 0.43 % 0.55 % 0.64 % Included in the nonaccrual loan balances above were loans also classified as TDR as of December 31: 2022 2021 2020 2019 2018 Commercial $ 36 $ 139 $ 129 $ 390 $ 160 Agricultural 234 310 2,559 3,048 3,391 Residential real estate — — 42 105 — Total $ 270 $ 449 $ 2,730 $ 3,543 $ 3,551 Additional disclosures about nonaccrual status loans are included in “Note 4 – Loans and ALLL”of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. 24 Table of Contents Noninterest Income and Noninterest Expenses Significant noninterest income balances are highlighted in the following table for the years ended December 31: Change Change 2022 2021 $ % 2020 $ % Service charges and fees ATM and debit card fees $ 4,774 $ 4,600 $ 174 3.78 % $ 3,723 $ 877 23.56 % Service charges and fees on deposit accounts 2,566 2,139 427 19.96 % 1,847 292 15.81 % Freddie Mac servicing fee 669 747 (78) (10.44) % 625 122 19.52 % Net OMSR income (loss) 435 (184) 619 336.41 % 44 (228) (518.18) % Other fees for customer services 286 312 (26) (8.33) % 305 7 2.30 % Total service charges and fees 8,730 7,614 1,116 14.66 % 6,544 1,070 16.35 % Wealth management fees 3,005 3,071 (66) (2.15) % 2,578 493 19.12 % Earnings on corporate owned life insurance policies 884 800 84 10.50 % 755 45 5.96 % Net gain on sale of mortgage loans 631 1,694 (1,063) (62.75) % 2,716 (1,022) (37.63) % Gains from redemption of corporate owned life insurance policies 57 271 (214) (78.97) % 891 (620) (69.58) % Net income (loss) on joint venture investment — — — 0.00 % 577 (577) (100.00) % Other 359 372 (13) (3.49) % 362 10 2.76 % Total noninterest income $ 13,666 $ 13,822 $ (156) (1.13) % $ 14,423 $ (601) (4.17) % Service charges and fees on deposit accounts declined in 2020 as a result of waived fees. In response to the COVID-19 pandemic, which led to an increase in the need for electronic services and products, we elected to remove select deposit account related charges and fees and temporarily waived some charges and fees to ease the financial stress of our customers. Despite some fees being removed or waived, fee income increased during 2021, but did not reach pre-pandemic levels. During 2022, we experienced an increase in fees mainly due to an increase in the number of deposit accounts. Although we expect a continuation in deposit account growth in 2023, fee levels may not exceed 2022 due to continued regulatory discussions around the practice of service charges and fees. OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. During 2021, the volume of loans serviced decreased, while prepayment speeds continued to increase. Both of these factors contributed to the recognition of a loss during 2021. During 2022, prepayment speeds declined as a result of an increase in interest rates, resulting in income recognized during 2022. OMSR income during 2023 is not expected to exceed 2022 levels as a result of an anticipated decline in the volume of loans serviced. In 2020 wealth management fees decreased mainly due to the decline in market values of assets under management. During 2021, we experienced an increase in wealth management fees driven by a combination of the growth in the stock market and increased new business activity. During 2022, there was strong growth in the portfolio, however the decline in the market offset the increase in fees related to growth. We expect wealth management fees to exceed 2022 levels in 2023, as a result of new business activity. The amount of loans sold is driven by customer demand and balance sheet management strategies. We experienced a significant increase in loan demand in early 2021 which led to an increase in the number and dollar amount of loans sold; as such, net gain on sale of mortgage loans increased significantly. In mid-2021, we decided to retain more loan originations on the balance sheet, due to our liquidity position, thereby decreasing the number of mortgage loans sold, which had an impact on the net gain on loans sold. As a result of this change in strategy, coupled with a decline in loan demand, net gain on sale of mortgage loans declined in the second half of 2021 and during 2022. As demand is expected to remain at reduced levels in 2023, due to the rise in interest rates, net gain on sale of mortgage loans is not expected to exceed 2022 levels during 2023. We recognized gains from the redemption of corporate owned life insurance policies in connection with the passing of retired bank employees. 25 Table of Contents We sold our membership interest in our joint venture investment in Corporate Settlement Solutions, LLC during the fourth quarter of 2020. The fluctuations in all other income are spread throughout various categories, none of which are individually significant. Significant noninterest expense balances are highlighted in the following table for the years ended December 31: Change Change 2022 2021 $ % 2020 $ % Compensation and benefits $ 24,887 $ 23,749 $ 1,138 4.79 % $ 23,772 $ (23) (0.10) % Furniture and equipment 6,006 5,462 544 9.96 % 5,787 (325) (5.62) % Occupancy 3,691 3,661 30 0.82 % 3,557 104 2.92 % Losses on extinguishment of debt — — — 0.00 % 7,643 (7,643) (100.00) % Other Audit, consulting, and legal fees 2,358 2,066 292 14.13 % 1,836 230 12.53 % ATM and debit card fees 1,909 1,810 99 5.47 % 1,441 369 25.61 % Marketing costs 1,056 939 117 12.46 % 877 62 7.07 % Loan underwriting fees 1,004 849 155 18.26 % 825 24 2.91 % Donations and community relations 923 705 218 30.92 % 723 (18) (2.49) % Memberships and subscriptions 876 877 (1) (0.11) % 740 137 18.51 % Director fees 790 703 87 12.38 % 695 8 1.15 % FDIC insurance premiums 537 690 (153) (22.17) % 612 78 12.75 % All other 2,783 2,183 600 27.49 % 2,725 (542) (19.89) % Total other 12,236 10,822 1,414 13.07 % 10,474 348 3.32 % Total noninterest expenses $ 46,820 $ 43,694 $ 3,126 7.15 % $ 51,233 $ (7,539) (14.72) % During the fourth quarter of 2020, we incurred expense of $7,643 as a result of the extinguishment of $100,000 of FHLB advances. Donations and community relations increased during 2022 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve, which includes an expanded footprint. While government restrictions and temporary business closures related to COVID-19 impacted our ability to maintain the level of support in early 2021, we have since increased the level of community support. We intend to increase our community support in 2023, as a result expenses in 2023 are expected to exceed 2022 levels. FDIC insurance premiums decreased in 2022 as a result of increased earnings and improved credit quality metrics. While we anticipate these trends to continue, FDIC insurance premiums are expected to increase in 2023 as a result of the recently approved increase in the base deposit insurance rate. The fluctuations in all other noninterest expenses are spread throughout various categories, none of which are individually significant. 26 Table of Contents Analysis of Changes in Financial Condition The following table shows the composition and changes in our balance sheet as of December 31: Change 2022 2021 $ % ASSETS Cash and cash equivalents $ 38,924 $ 105,330 $ (66,406) (63.05) % AFS securities Amortized cost of AFS securities 625,605 485,710 139,895 28.80 % Unrealized gains (losses) on AFS securities (45,124) 4,891 (50,015) N/M AFS securities 580,481 490,601 89,880 18.32 % Mortgage loans AFS 379 1,735 (1,356) (78.16) % Loans Gross loans 1,264,173 1,301,037 (36,864) (2.83) % Less allowance for loan and lease losses 9,850 9,103 747 8.21 % Net loans 1,254,323 1,291,934 (37,611) (2.91) % Premises and equipment 25,553 24,419 1,134 4.64 % Corporate owned life insurance policies 32,988 32,472 516 1.59 % Equity securities without readily determinable fair values 15,746 17,383 (1,637) (9.42) % Goodwill and other intangible assets 48,287 48,302 (15) (0.03) % Accrued interest receivable and other assets 33,586 19,982 13,604 68.08 % TOTAL ASSETS $ 2,030,267 $ 2,032,158 $ (1,891) (0.09) % LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities Deposits $ 1,744,275 $ 1,710,339 $ 33,936 1.98 % Borrowed funds 87,016 99,320 (12,304) (12.39) % Accrued interest payable and other liabilities 12,766 11,451 1,315 11.48 % Total liabilities 1,844,057 1,821,110 22,947 1.26 % Shareholders’ equity 186,210 211,048 (24,838) (11.77) % TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 2,030,267 $ 2,032,158 $ (1,891) (0.09) % A discussion of changes in balance sheet amounts by major categories follows: Cash and cash equivalents Included in cash and cash equivalents are funds held with the FRB which fluctuate from period to period. Cash levels decreased significantly during 2022 as a result of the purchase of AFS securities. These purchases were funded through deposit growth and a decline in loans during 2022. 27 Table of Contents AFS securities The primary objective of our investing activities is to manage our overall exposure to changes in interest rates. Secondary considerations include ensuring ample access to liquidity, generating returns, and providing current income. Over the last two years, the flat yield curve encouraged the use of excess funds to reduce higher-cost borrowings as opposed to investing in AFS securities. However, based on balance sheet strategies, excess funds above what is required to retire future maturities of higher-cost funding sources was prudently deployed to purchase AFS securities in future periods. The following is a schedule of the carrying value of AFS securities as of December 31: 2022 2021 2020 U.S. Treasury $ 208,701 $ 209,703 $ — States and political subdivisions 117,512 121,205 143,656 Auction rate money market preferred 2,342 3,242 3,237 Mortgage-backed securities 39,070 56,148 88,652 Collateralized mortgage obligations 205,728 92,301 101,983 Corporate 7,128 8,002 1,700 Total $ 580,481 $ 490,601 $ 339,228 Excluding those holdings in government sponsored enterprises and municipalities within the State of Michigan, there were no investments in securities of any one issuer that exceeded 10% of shareholders’ equity during 2022, 2021, and 2020. We have a policy prohibiting investments in securities that we deem unsuitable due to their inherent credit or market risks. Prohibited investments include stripped mortgage-backed securities, zero coupon bonds, nongovernment agency asset-backed securities, and structured notes. Our holdings in mortgage-backed securities and collateralized mortgage obligations include only government agencies and government sponsored agencies as we hold no investments in private label mortgage-backed securities or collateralized mortgage obligations. The following is a schedule of maturities of AFS securities and their weighted average yields as of December 31, 2022. Weighted average yields have been computed on an FTE basis using a tax rate of 21%. Our auction rate money market preferred investments are long-term floating rate instruments. The issuers of auction rate securities generally have the right to redeem or refinance the debt. Because of their lack of contractual maturities, auction rate money market preferred stocks are not reported by a specific maturity group. Mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group due to their variable monthly payments. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Maturing Within One Year After One Year But Within Five Years After Five Years But Within Ten Years After Ten Years Securities with Variable Monthly Payments or Noncontractual Maturities Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) U.S. Treasury $ — — $ 208,701 0.98 $ — — $ — — $ — — States and political subdivisions 19,666 3.47 42,778 2.69 20,575 3.19 34,493 3.57 — — Mortgage-backed securities — — — — — — — — 39,070 2.34 Collateralized mortgage obligations — — — — — — — — 205,728 2.87 Auction rate money market preferred — — — — — — — — 2,342 2.79 Corporate — — — — 7,128 3.78 — — — — Total $ 19,666 3.47 $ 251,479 0.31 $ 27,703 3.34 $ 34,493 3.57 $ 247,140 2.79 28 Table of Contents Loans Loans are the largest component of earning assets. The proper management of credit and market risk inherent in the loan portfolio is critical to our financial stability. To control these risks, we have adopted strict underwriting standards, lending limits to a single borrower, loan to collateral value limits, and a defined market area. We also monitor and limit loan concentrations to specific industries. We have no foreign loans and there were no concentrations greater than 10% of total loans that are not disclosed as a separate category in the following table. The following table presents the composition of the loan portfolio for the years ended December 31: 2022 2021 2020 2019 2018 Commercial $ 740,920 $ 807,439 $ 756,686 $ 700,941 $ 659,529 Agricultural 104,314 93,955 100,461 116,920 127,161 Residential real estate 340,885 326,361 307,543 298,569 275,343 Consumer 78,054 73,282 73,621 70,140 66,674 Total $ 1,264,173 $ 1,301,037 $ 1,238,311 $ 1,186,570 $ 1,128,707 The following table presents the change in the loan portfolio categories for the years ended December 31: 2022 2021 2020 $ Change % Change $ Change % Change $ Change % Change Commercial $ (66,519) (8.24) % $ 50,753 6.71 % $ 55,745 7.95 % Agricultural 10,359 11.03 % (6,506) (6.48) % (16,459) (14.08) % Residential real estate 14,524 4.45 % 18,818 6.12 % 8,974 3.01 % Consumer 4,772 6.51 % (339) (0.46) % 3,481 4.96 % Total $ (36,864) (2.83) % $ 62,726 5.07 % $ 51,741 4.36 % Advances to mortgage brokers, within the commercial loan portfolio, which is not considered a component of our core lending business, was the primary driver behind the fluctuations experienced since December 31, 2021, as participation in this mortgage purchase program paused during most of 2021 and again in 2022. We've recently experienced an increase in commercial loan demand, despite changes in advances to mortgage brokers and continued forgiveness of the remaining SBA PPP loans. As demand is expected to continue, we anticipate growth in the commercial loan portfolio in 2023. While Agricultural loans have increased in 2022 and are expected to continue in 2023, we do not anticipate the same level of growth experienced in 2022 as the result of the competitive lending environment. Residential mortgage lending activities have slowed during the year as a result of rising interest rates. As interest rates are expected to continue to increase in 2023, growth in residential and consumer loans is anticipated to continue but at a slower pace. Accrued interest receivable and other assets Other assets consist primarily of prepaid expenses, OMSR, and net deferred tax assets. The increase in accrued interest receivable and other assets during 2022 was due primarily to the change in the net deferred tax assets related to AFS securities. For more information related to estimates and deferred taxes, refer to “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” and “Note 15 – Federal Income Taxes” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. 29 Table of Contents Deposits Deposits are our primary source of funding. The following table presents the composition of the deposit portfolio as of December 31: 2022 2021 2020 Noninterest bearing demand deposits $ 494,346 $ 448,352 $ 375,395 Interest bearing demand deposits 372,155 364,563 302,444 Savings deposits 625,734 596,662 505,497 Certificates of deposit 251,541 297,696 358,165 Brokered certificates of deposit — — 14,029 Internet certificates of deposit 499 3,066 10,787 Total $ 1,744,275 $ 1,710,339 $ 1,566,317 The following table presents the change in the deposit categories for the years ended December 31: 2022 2021 $ Change % Change $ Change % Change Noninterest bearing demand deposits $ 45,994 10.26 % $ 72,957 19.43 % Interest bearing demand deposits 7,592 2.08 % 62,119 20.54 % Savings deposits 29,072 4.87 % 91,165 18.03 % Certificates of deposit (46,155) (15.50) % (60,469) (16.88) % Brokered certificates of deposit — 0.00 % (14,029) (100.00) % Internet certificates of deposit (2,567) (83.72) % (7,721) (71.58) % Total $ 33,936 1.98 % $ 144,022 9.19 % Total deposits have increased over the past 12 months with significant growth in non-contractual deposits, such as demand and savings deposits. While we experienced a decline in certificates of deposit over the past year, the decline has slowed as a result of the recent increase in the interest rate environment. We expect interest rates to continue to rise in 2023 and anticipate a shift of customers moving back to certificates of deposit products. Over the last few years, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit. The following table presents estimated balances of uninsured deposits as of December 31: 2022 2021 2020 2019 2018 Uninsured deposits $ 585,901 $ 548,213 $ 461,859 $ 336,399 $ 292,017 Uninsured deposits are the portion of deposit accounts in U.S. offices that exceed the FDIC insurance limits. The balance provided above are estimates and reflect the methodologies and assumptions used for regulatory reporting of uninsured deposits. The remaining maturity of estimated uninsured certificates of deposit, by account, as of December 31, 2022 is presented in the table below. Estimated uninsured certificates of deposit is based on individual accounts and does not reflect uninsured balances by account owner. Maturity Within 3 months $ 12,568 Within 3 to 6 months 2,320 Within 6 to 12 months 13,194 Over 12 months 9,050 Total $ 37,132 30 Table of Contents Borrowed Funds Borrowed funds include FHLB advances, securities sold under agreements to repurchase, subordinated debt, and federal funds purchased. The balance of borrowed funds fluctuates from period to period based on our funding needs that arise from changes in loans, investments, and deposits. To provide balance sheet growth, we may utilize borrowings and brokered deposits to fund earning assets. The following table presents borrowed funds balances as of December 31: 2022 2021 2020 Securities sold under agreements to repurchase without stated maturity dates $ 57,771 $ 50,162 $ 68,747 FHLB advances — 20,000 90,000 Subordinated debt, net of unamortized issuance costs 29,245 29,158 — Total $ 87,016 $ 99,320 $ 158,747 Over the last few years, we used excess funds to reduce and payoff FHLB advances. On June 2, 2021, we completed a private placement of $30,000 in aggregate principal amount of 3.25% Fixed-to-Floating Rate Subordinated Notes due 2031 (the "Notes"). The Notes will initially bear a fixed interest rate of 3.25% until June 15, 2026, after which time until maturity on June 15, 2031, the interest rate will reset quarterly to an annual floating rate equal to the then-current 3-month SOFR plus 256 basis points. The Notes are redeemable by us at our option, in whole or in part, on or after June 15, 2026. The Notes are not subject to redemption at the option of the holders. For additional disclosure related to borrowed funds, see “Note 8 – Borrowed Funds” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Accrued interest payable and other liabilities Included in accrued interest payable and other liabilities are obligations related to our defined benefit pension plan and other employee benefits. For more information on the defined benefit pension plan and other employee benefits, see “Note 12 – Benefit Plans” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Contractual Obligations and Loan Commitments We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily indicate our future cash requirements. For additional disclosure related to Contractual Obligations and Loan Commitments, see “Note 9 – Off-Balance-Sheet Activities, Commitments and Other Matters” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. 31 Table of Contents Capital Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 74,445 shares or $1,762 of common stock during 2022, and 67,436 shares or $1,593 of common stock in 2021. We offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $463 and $433 during 2022 and 2021, respectively. We also grant restricted stock awards pursuant to the RSP, effective June 24, 2020. Pursuant to this plan, we increased shareholders’ equity by $147 and $86 during 2022 and 2021. We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 47,665 shares or $1,124 of common stock during 2022 and 135,465 shares or $3,050 during 2021. As of December 31, 2022, we were authorized to repurchase up to an additional 419,826 shares of common stock. In the fourth quarter of 2021, we completed a “modified Dutch Auction” tender offer which resulted in the purchase of 396,576.78534 shares at a price of $27.00 per share for a total amount of approximately $10,708. The FRB has established minimum risk-based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of December 31: 2022 2021 Actual Minimum Required - BASEL III Required to be Considered Well Capitalized Actual Minimum Required - BASEL III Required to be Considered Well Capitalized Common equity tier 1 capital 12.91 % 7.00 % 6.50 % 12.07 % 7.00 % 6.50 % Tier 1 capital 12.91 % 8.50 % 8.00 % 12.07 % 8.50 % 8.00 % Total capital 15.79 % 10.50 % 10.00 % 14.94 % 10.50 % 10.00 % Tier 1 leverage 8.61 % 4.00 % 5.00 % 7.97 % 4.00 % 5.00 % There are no significant regulatory constraints placed on our capital. At December 31, 2022, the Bank exceeded minimum capital requirements. For further information regarding the Bank’s capital requirements, see “Note 10 – Minimum Regulatory Capital Requirements” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. 32 Table of Contents Fair Value We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, impaired loans, goodwill, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write downs of individual assets. For further information regarding fair value measurements, see “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” and “Note 17 – Fair Value” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Liquidity Liquidity is monitored regularly by our ALCO, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources. Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $488,981 or 24.08% of assets as of December 31, 2022, compared to $495,259 or 24.37% as of December 31, 2021. The decline in the amount and percentage of primary liquidity is a result of investment purchases, with an offset in increased deposits. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Based on these same factors, daily liquidity could vary significantly. Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. In recent periods, we have elected to use excess funds to reduce borrowings and other higher-cost funding sources. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of December 31, 2022, we had available lines of credit of $344,393. The frequency and complexity of our liquidity stress testing has increased since early 2020 and continues to evolve due to economic uncertainly as a result of COVID-19 and changes within the interest rate and economic environment. Our liquidity position remained strong at the end of 2022, which is illustrated in the following table: December 31 2022 Total cash and cash equivalents $ 38,924 Available lines of credit Fed funds lines with correspondent banks 93,000 FHLB borrowings 237,407 FRB Discount Window 8,986 Other lines of credit 5,000 Total available lines of credit 344,393 Unencumbered lendable value of FRB collateral, estimated 1 410,000 Total cash and liquidity $ 793,317 (1) Includes estimated unencumbered lendable value of FHLB collateral of $350,000 The following table summarizes our sources and uses of cash for the years ended December 31: 2022 2021 $ Variance Net cash provided by (used in) operating activities $ 26,937 $ 25,501 $ 1,436 Net cash provided by (used in) investing activities (106,255) (229,635) 123,380 Net cash provided by (used in) financing activities 12,912 62,824 (49,912) Increase (decrease) in cash and cash equivalents (66,406) (141,310) 74,904 Cash and cash equivalents January 1 105,330 246,640 (141,310) Cash and cash equivalents December 31 $ 38,924 $ 105,330 $ (66,406) 33 Table of Contents Market Risk Our primary market risks are interest rate risk and liquidity risk. IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. Managing IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital. The FRB has adopted a policy requiring banks to effectively manage the various risks that can have a material impact on safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our ALCO policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long-term assets, limiting the mismatch in repricing opportunities of assets and liabilities, and the frequency of measuring and reporting to our Board of Directors. The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic rate environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits. Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals. We do not believe there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. We do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term, and we do not expect to make material changes to our market risk methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques. Gap analysis is also utilized as a method to measure interest rate sensitivity. Interest rate sensitivity is determined by the amount of earning assets and interest bearing liabilities repricing within a specific time period, and their relative sensitivity to a change in interest rates. We strive to achieve reasonable stability in the net interest margin through periods of changing interest rates. One specific focus of interest rate sensitivity is the loan portfolio, primarily with commercial and agricultural loans. 34 Table of Contents The following table shows the maturity of loans outstanding at December 31, 2022 based on contractual terms. Also provided are the amounts classified according to the sensitivity to changes in interest rates. 1 Year or Less 1 to 5 Years 5 to 15 Years Over 15 Years Total Commercial $ 81,025 $ 179,439 $ 180,130 $ 300,326 $ 740,920 Agricultural 16,386 24,245 26,495 37,188 104,314 Residential real estate 9,507 20,530 126,438 184,410 340,885 Consumer 1,789 33,163 43,102 — 78,054 Total $ 108,707 $ 257,377 $ 376,165 $ 521,924 $ 1,264,173 Fixed interest rates Commercial $ 43,950 $ 132,293 $ 35,368 $ 3,356 $ 214,967 Agricultural 5,314 12,089 4,233 1,157 22,793 Residential real estate 6,070 11,278 95,053 23,063 135,464 Consumer 1,510 32,814 43,066 — 77,390 Total $ 56,844 $ 188,474 $ 177,720 $ 27,576 $ 450,614 Variable interest rates Commercial $ 37,075 $ 47,146 $ 144,762 $ 296,970 $ 525,953 Agricultural 11,072 12,156 22,262 36,031 81,521 Residential real estate 3,437 9,252 31,385 161,347 205,421 Consumer 279 349 36 — 664 Total $ 51,863 $ 68,903 $ 198,445 $ 494,348 $ 813,559 Our primary market risk exposures related to the COVID-19 pandemic remain uncertain. A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis. Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment. Customer deposit levels may experience unusual fluctuations due to COVID-related government support programs ending, customer and business needs, and a potential decline in money supply as the Federal Reserve shrinks its balance sheet. We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of the crisis continues to reveal itself. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The information presented in the section captioned “Market Risk” in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference. 35 Table of Contents