LAKELAND FINANCIAL CORP 10-Q

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net income in the first three months of 2022 was $23.6 million, which increased $659,000, or 2.9%, from $23.0 million for the comparable period of 2021 . Diluted income per common share was $0.92 in the first three months of 2022, up 2.2% from $0.90 in the comparable period of 2021 . The increase in net income for 2022 was primarily due to growth in net interest income of $1.2 million and a decrease in provision expense of $1.1 million, offset by a decrease in noninterest income of $1.9 million. Pretax pre-provision earnings in the first three months of 2022 were $28.6 million, a decrease of $892,000, or 3.0%, compared to $29.5 million for the comparable period. Pretax pre-provision earnings is a non-GAAP measure calculated by adding net interest income to noninterest income and subtracting noninterest expense. Annualized return on average total equity was 14.04% in the first three months of 2022 versus 14.27% in the comparable period of 2021 . Annualized return on average total assets was 1.44% in the first three months of 2022 versus 1.58% for the comparable period of 2021 . The Company's average equity to average assets ratio was 10.3% in the first three months of 2022 versus 11.1% in the comparable period of 2021 . The Company’s tangible common equity to tangible assets ratio, which is a non-GAAP financial measure, was 9.22% at March 31, 2022, compared to 10.77% at March 31, 2021 and 10.70% at December 31, 2021. The decline was a result of the yield curve steepening in the first quarter of 2022 and a corresponding decline in the market value of the Company's available-for-sale securities portfolio. This resulted in an unrealized loss in market value of $117.4 million as of March 31, 2022, compared to an unrealized gain in market value of $20.9 million at March 31, 2021, and an unrealized gain in market value of $21.6 million at December 31, 2021. Total assets were $6.572 billion as of March 31, 2022 versus $6.557 billion as of December 31, 2021, an increase of $14.9 million. This increase was primarily due to a $124.0 million increase in securities available-for-sale, a $66.1 million increase in loans, net of the allowance for credit losses, and a $29.2 million increase in deferred taxes, offset by a decrease in cash and cash equivalents of $208.2 million. Balan ce sheet growth was primarily funded through growth in deposits during the first three months of 2022. Deposits increased $85.2 million. Other liabilities increased by $26.0 million primarily to the valuation of swap liabilities of $19.5 million, which resulted from the increase in interest rates during the quarter. Tota l equity decreased by $95.8 million due primarily to a reduction to accumulated other comprehensive income (loss) of $109.8 million, driven by a decrease in the fair value of available-for-sale securities caused by the yield curve steepening in the first quarter of 2022 . The change in total equity was also impacted by net income of $23.6 million and dividends declared and paid of $0.40 per share, totaling $10.2 million. CRITICAL ACCOUNTING POLICIES The Company’s accounting policies are described in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2021. Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for credit losses. See “Note 4 – Allowance for Credit Losses and Credit Quality” for more information on this critical accounting policy. 30 Table of Contents RESULTS OF OPERATIONS Overview Selected income statement information for the three months ended March 31, 2022 and 2021 is presented in the following table: Three Months Ended March 31, (dollars in thousands) 2022 2021 Income Statement Summary: Net interest income $ 44,880 $ 43,679 Provision for credit losses 417 1,477 Noninterest income 10,687 12,557 Noninterest expense 26,969 26,746 Other Data: Efficiency ratio (1) 48.53 % 47.56 % Diluted EPS $ 0.92 $ 0.90 Tangible capital ratio (2) 9.22 % 10.77 % Net charge offs (recoveries) to average loans 0.06 % 0.01 % Net interest margin 2.93 % 3.19 % Net interest margin excluding PPP loans (3) 2.90 % 3.06 % Noninterest income to total revenue 19.23 % 22.33 % Pretax Pre-Provision Earnings (4) $ 28,598 $ 29,490 (1) Noninterest expense/net interest income plus noninterest income. (2) Non-GAAP financial measure. The Company believes that disclosing non-GAAP financial measures provides investors with information useful to understanding the Company’s financial performance. Additionally, these non-GAAP measures are used by management for planning and forecasting purposes, including measures based on “tangible common equity” which is “total equity” excluding intangible assets, net of deferred tax, and “tangible assets” which is “total assets” excluding intangible assets, net of deferred tax. See reconciliation on the next page. (3) Non-GAAP financial measure. Calculated by subtracting the impact PPP loans had on average earnings assets, loan interest income, average interest bearing liabilities, and interest expense. Management believes this is an important measure because it provides for better comparability to prior periods, given the low fixed interest rate of 1.0% applicable to PPP loans, and because the accretion of net loan fee income can be accelerated upon borrower forgiveness and repayment by the SBA. Management is actively monitoring net interest margin on a fully tax equivalent basis with and without PPP loan impact for the duration of this program. See reconciliation on the next page. (4) Non-GAAP financial measure. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Management believes this is an important measure because it may enable investors to identify the trends in the Company's earnings exclusive of the effects of tax and provision expense, which may vary significantly from period to period. See reconciliation on the next page. 31 Table of Contents A reconciliation of non-GAAP measures is provided below (in thousands, except for per share data). Three Months Ended March 31, (dollars in thousands) 2022 2021 Total Equity $ 609,102 $ 651,668 Less: Goodwill (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,176 Tangible Common Equity (A) 605,299 647,874 Total Assets $ 6,572,259 $ 6,016,642 Less: Goodwill (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,176 Tangible Assets (B) 6,568,456 6,012,848 Tangible Capital Ratio (A/B) 9.22 % 10.77 % Net Interest Income $ 44,880 $ 43,679 Noninterest Income 10,687 12,557 Noninterest Expense (26,969) (26,746) Pretax Pre-Provision Earnings $ 28,598 $ 29,490 Impact of Paycheck Protection Program on Net Interest Margin FTE. Three Months Ended March 31, 2022 2021 Total Average Earnings Assets $ 6,392,075 $ 5,638,202 Less: Average Balance of PPP Loans (17,555) (402,730) Total Adjusted Earning Assets 6,374,520 5,235,472 Total Interest Income FTE $ 49,302 $ 48,664 Less: PPP Loan Income (505) (5,166) Total Adjusted Interest Income FTE 48,797 43,498 Adjusted Earning Asset Yield, net of PPP Impact 3.10 % 3.37 % Total Average Interest Bearing Liabilities $ 3,957,547 $ 3,617,491 Less: Average Balance of PPP Loans (17,555) (402,730) Total Adjusted Interest Bearing Liabilities 3,939,992 3,214,761 Total Interest Expense FTE $ 3,154 $ 4,298 Less: PPP Cost of Funds (11) (248) Total Adjusted Interest Expense FTE 3,143 4,050 Adjusted Cost of Funds, net of PPP Impact 0.20 % 0.31 % Net Interest Margin FTE, net of PPP Impact 2.90 % 3.06 % 32 Table of Contents Net Income Net income was $23.6 million in the first three months of 2022 , an increase of $659,000, or 2.9%, versus net income of $23.0 million in the first three months of 2021 . The increase in net income for 2022 was primarily due to growth in net interest income of $1.2 million, or 2.7%, and a decrease in provision expense of $1.1 million, or 71.8%, offset by a decrease in noninterest income of $1.9 million, or 14.9%. Net Interest Income The following table sets forth consolidated information regarding average balances and rates: Three Months Ended March 31, 2022 2021 (fully tax equivalent basis, dollars in thousands) Average Balance Interest Yield (1)/ Rate Average Balance Interest Yield (1)/ Rate Earning Assets Loans: Taxable (2)(3) $ 4,278,894 $ 39,735 3.77 % $ 4,554,183 $ 43,461 3.87 % Tax exempt (1) 22,032 213 3.92 13,043 131 4.07 Investments: Available-for-sale (1) 1,514,024 9,108 2.44 772,247 4,984 2.62 Short-term investments 2,143 1 0.11 2,206 1 0.18 Interest bearing deposits 574,982 245 0.17 296,523 87 0.12 Total earning assets $ 6,392,075 $ 49,302 3.13 % $ 5,638,202 $ 48,664 3.50 % Less: Allowance for credit losses (4) (68,051) (70,956) Nonearning Assets Cash and due from banks 71,905 70,720 Premises and equipment 59,309 59,278 Other nonearning assets 196,705 190,117 Total assets $ 6,651,943 $ 5,887,361 Interest Bearing Liabilities Savings deposits $ 408,314 $ 75 0.07 % $ 330,069 $ 61 0.07 % Interest bearing checking accounts 2,642,003 1,862 0.29 2,182,164 1,495 0.28 Time deposits: In denominations under $100,000 198,257 346 0.71 235,271 648 1.12 In denominations over $100,000 633,947 798 0.51 793,470 2,014 1.03 Miscellaneous short-term borrowings 26 0 0.00 1,517 7 1.87 Long-term borrowings and subordinated debentures 75,000 73 0.40 75,000 73 0.39 Total interest bearing liabilities $ 3,957,547 $ 3,154 0.32 % $ 3,617,491 $ 4,298 0.48 % Noninterest Bearing Liabilities Demand deposits 1,966,117 1,566,045 Other liabilities 45,587 50,496 Stockholders' Equity 682,692 653,329 Total liabilities and stockholders' equity $ 6,651,943 $ 5,887,361 Interest Margin Recap Interest income/average earning assets 49,302 3.13 48,664 3.50 % Interest expense/average earning assets 3,154 0.20 4,298 0.31 % Net interest income and margin $ 46,148 2.93 % $ 44,366 3.19 % (1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $1.27 million, $1.13 million and $687,000 in the three-month periods ended March 31, 2022, December 31, 2021 and March 31, 2021 , respectively. (2) Loan fees are included as taxable loan interest income. Net loan fees attributable to PPP loans were $461,000, $2.02 million and $4.15 million for the three months ended March 31, 2022, December 31, 2021 and March 31 2021 , respectively. All other loan fees were immaterial in relation to total taxable loan interest income for the periods presented. (3) Nonaccrual loans are included in the average balance of taxable loans. 33 Table of Contents Net interest income increased $1.2 million, or 2.7%, to $44.9 million for the three months ended March 31, 2022, compared with $43.7 million for the first three months of 2021 . Growth in core loans and investment security balances coupled with the steepening yield curve positively impacted investment security and loan income and offset the decline in PPP income of $4.7 million during the quarter. In addition, interest expense declined by $1.1 million, further benefiting the increase in net interest income. Average earning assets increased by $753.9 million, due primarily to growth in investment securities of $741.8 million and growth in interest bearing deposits of $278.5 million. Average loans outstanding decreased $266.3 million to $4.301 billion during the three months ended March 31, 2022, compared to $4.567 billion during the same period of 2021. PPP loans declined by $385.2 million to $17.6 million for the first three months of 2022 compared to $402.7 million for the first three months of 2021 . Excluding PPP loans, average core loans increased $118.9 million to $4.283 billion during the three months ended March 31, 2022, compared to $4.164 billion during the same period of 2021. The earning asset growth was funded through an increase in deposits. Average deposits increased $741.6 million to $5.849 billion during the three months ended March 31, 2022, compared to $5.107 billion for the same period of 2021 . The tax equivalent net interest margin was 2.93% for the three months ended March 31, 2022 compared to 3.19% during the first three months of 2021 . The yield on earning assets totaled 3.13% during the three months ended March 31, 2022 compared to 3.50% in the same period of 2021 . Cost of funds (expressed as a percentage of average earning assets) totaled 0.20% during the first three months of 2022, and represented a historical low, compared to 0.31% in the same period of 2021 . The lower margin was due to lower yields on loans and securities and excess liquidity on the Company's balance sheet, partially offset by a lower cost of funds. The earning asset mix has changed during 2021 and 2022 to reflect increased investment securities balances and interest bearing deposits, which are lower yielding assets. Net interest margin excluding PPP loans was 2.90% for the three months ended March 31, 2022 compared to 3.06% for the same period of 2021 . On a linked quarter basis net interest margin, excluding PPP, expanded by three basis points to 2.90% compared to 2.87% for the three months ended December 31, 2022. Earning assets yields benefited from the steepening of the yield curve and the Federal Reserve increase to the target Federal Funds Rate in March 2022 of 25 basis points. Further tightening by the Federal Reserve Bank in 2022 is expected to benefit net interest margin due primarily to the repricing of variable rate loans to higher interest rates. Variable rate loans represent 68% of total loans as of March 31, 2022. The benefit of rising rates on the loan portfolio will be offset by excess liquidity that remains on the balance sheet. During the first quarter of 2022, the Bank deployed additional excess liquidity of $250 million to the investment security portfolio. Investment security portfolio and interest-bearing deposit yields are lower than traditional commercial loan yields and continue to negatively impact net interest margin. The Bank expects the excess liquidity position to moderate over time with declines in deposits and increased loan demand. The Bank expects to deploy future cash flows from the investment portfolio to fund loan demand and balance sheet liquidity needs. Provision for Credit Losses The Company recorded a provision for credit losses expense of $417,000 for the three months ended March 31, 2022 compared to a provision expense of $1.5 million during the comparable period of 2021 , a decrease of $1.1 million. Net charge offs were $664,000 during the three month period ended March 31, 2022 compared to net charge offs of $91,000 during the comparable period of 2021 . Additional factors considered by management included key loan quality metrics, including reserve coverage of nonperforming loans and economic conditions in the Company’s markets, and changes in the facts and circumstances of watch list credits, which includes the security position of the borrower. Management’s overall view on current credit quality was also a factor in the determination of the provision for credit losses. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans. 34 Table of Contents Noninterest Income Noninterest income categories for the three-month period ended March 31, 2022 and 2021 are shown in the following table: Three Months Ended March 31, (dollars in thousands) 2022 2021 Dollar Change Percent Change Wealth advisory fees $ 2,287 $ 2,178 $ 109 5.0 % Investment brokerage fees 519 464 55 11.9 Service charges on deposit accounts 2,809 2,491 318 12.8 Loan and service fees 2,889 2,776 113 4.1 Merchant card fee income 815 622 193 31.0 Bank owned life insurance income (loss) (83) 756 (839) (111.0) Interest rate swap fee income 50 249 (199) (79.9) Mortgage banking income 509 1,373 (864) (62.9) Net securities gains 0 753 (753) (100.0) Other income 892 895 (3) (0.3) Total noninterest income $ 10,687 $ 12,557 $ (1,870) (14.9) % Noninterest income to total revenue 19.2 % 22.3 % The Company's noninterest income decreased $1.9 million, or 14.9%, to $10.7 million for the three months ended March 31, 2022 compared to $12.6 million in the prior year period. Noninterest income was positively impacted by elevated service charges on deposit accounts which increased $318,000, or 12.8% for these comparable periods. In addition, merchant card fee income increased $193,000, or 31.0%, and loan and loan and service fees were up $113,000, or 4.1%. These increases were due to an increase in economic activity within the Company's operating footprint. Offsetting these increases were decreases of $864,000, or 62.9%, in mortgage banking income as mortgage banking has seen a decrease in loan originations during the first quarter of 2022 compared to the first quarter of 2021, due to the rise in interest rates. In addition, bank owned life insurance income decreased by $839,000, or 111.0%, and net securities gains decreased $753,000, as there were no investment security sales in the first quarter of 2022. The decrease in bank owned life insurance income was caused by market fluctuations in the Company's variable life insurance policies during the first quarter of 2022, which are tied to equity market returns. Noninterest Expense Noninterest expense categories for the three-month period ended March 31, 2022 and 2021 are shown in the following tables: Three Months Ended March 31, (dollars in thousands) 2022 2021 Dollar Change Percent Change Salaries and employee benefits $ 14,392 $ 14,385 $ 7 0.0 % Net occupancy expense 1,629 1,503 126 8.4 Equipment costs 1,411 1,445 (34) (2.4) Data processing fees and supplies 3,081 3,319 (238) (7.2) Corporate and business development 1,219 1,509 (290) (19.2) FDIC insurance and other regulatory fees 439 464 (25) (5.4) Professional fees 1,559 1,877 (318) (16.9) Other expense 3,239 2,244 995 44.3 Total noninterest expense $ 26,969 $ 26,746 $ 223 0.8 % Efficiency ratio 48.5 % 47.6 % 35 Table of Contents The Company’s noninterest expense increased by $223,000, or 0.8%, to $27.0 million in the first three months of 2022 compared to $26.7 million in the corresponding prior year period. Other expense increased $995,000, or 44.3%, driven by accruals for ongoing legal matters and an increase in director share-based compensation expense, due to the appreciation of the Company's stock price. Professional fees decreased $318,000, or 16.9%, due to reduced legal fees and a reduction in other professional fees related to the Lake City Bank Digital conversion that were incurred in 2021 and were not recurring in 2022. Corporate and business development expense decreased $290,000, or 19.2%, and data processing fees and supplies decreased $238,000 or 7.2%. Corporate and business development expenses were lower in the first quarter of 2022 compared to the prior year first quarter of 2021 due to lower contributions and advertising expense. Data processing fees were lower in the first quarter of 2022 compared to the prior year first quarter of 2021 due primarily to lower processing costs associated with PPP forgiveness applications in the first quarter of 2022. The Company's efficiency ratio was 48.5% for the three months ended March 31, 2022 compared to 47.6% for the first quarter of 2021 and 45.6% for the linked fourth quarter of 2021. As previously disclosed, in the third quarter of 2019, t he Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks. The former client subsequently filed several related bankruptcy cases, captioned In re Interlogic Outsourcing, Inc., et al ., which are pending in the United States Bankruptcy Court for the Western District of Michigan. On April 27, 2021, the bankruptcy court entered an order approving an amended plan of liquidation, which was filed by the former client, other debtors and bankruptcy plan proponents, and approving the consolidation of the assets in the aforementioned cases under the Khan IOI Consolidated Estate Trust. On August 9, 2021, the liquidating trustee for the bankruptcy estates filed a complaint against the Bank and the Company, and has agreed to stay prosecution of the action through May 31, 2022. The action is focused on a series of business transactions among the client, related entities, and the Bank, which the liquidating trustee alleges are voidable under applicable federal bankruptcy and state law. The complaint also addresses treatment of the Bank’s claims filed in the bankruptcy cases. Based on current information, we have determined that a material loss is neither probable nor estimable at this time, and the Bank and the Company intend to vigorously defend themselves against all allegations asserted in the complaint. The Company's income tax expense decreased $491,000, or 9.8%, in the three-month period ended March 31, 2022 compared to the same period in 2021. The effective tax rate was 16.1% in the three-month period ended March 31, 2022, compared to 18.0% for the comparable period of 2021. The year-to-date effective tax rate for 2022 decreased as compared to the prior year primarily due to a higher percentage of income being derived from tax-advantaged sources as well as a larger tax benefit from stock-based compensation payments. FINANCIAL CONDITION Overview Total assets of the Company were $6.572 billion as of March 31, 2022, an increase of $14.9 million, when compared to $6.557 billion as of December 31, 2021. This increase was primarily due to a $124.0 million increase in securities available-for-sale, a $66.1 million increase in net loans, and an increase of $29.2 million in deferred taxes offset by a decrease in cash and cash equivalents of $208.2 million. The outstanding balance of Paycheck Protection Program (PPP) loans at March 31, 2022, was $12.5 million versus $26.2 million at December 31, 2021. Loans excluding PPP loans increased by $79.5 million, or 1.9%, from $4.262 billion at December 31, 2021 to $4.341 billion at March 31, 2022. Total deposits increased $85.2 million, or 1.5%. The increase in deposits was primarily driven by growth in core deposits of $85.0 million, or 1.5%. Core deposits were $5.810 billion as of March 31, 2022 compared to $5.725 billion as of December 31, 2021. Uses of Funds Total Cash and Cash Equivalents Total cash and cash equivalents decreased by $208.2 million, or 30.5% to $475.0 million at March 31, 2022, from $683.2 million at December 31, 2021. Cash and cash equivalents at March 31, 2022 reflect an additional deployment of $250 million in funds to the available-for-sale investment securities portfolio during the first quarter of 2022. Cash and cash equivalents include short-term investments. Short-term investments include cash on deposit that earns interest such as excess liquidity maintained at the Federal Reserve Bank. Cash and cash equivalents balances will vary depending on the cyclical nature of the bank’s liquidity position. 36 Table of Contents Investment Portfolio The amortized cost and the fair value of securities as of March 31, 2022 and December 31, 2021 were as follows: March 31, 2022 December 31, 2021 (dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value U.S Treasury securities $ 2,250 $ 2,246 $ 900 $ 900 U.S government sponsored agencies 164,514 152,892 145,858 143,452 Mortgage-backed securities: residential 634,654 596,321 487,157 486,676 Mortgage-backed securities: commercial 96 96 522 523 State and municipal securities 838,427 770,980 742,532 767,007 Total $ 1,639,941 $ 1,522,535 $ 1,376,969 $ 1,398,558 At March 31, 2022 and December 31, 2021, there were no holdings of securities of any one issuer, other than the U.S. government agencies and government sponsored entities, in an amount greater than 10% of stockholders’ equity. Management is aware that, as interest rates rise, any unrealized loss in the investment portfolio will increase, and as interest rates fall the unrealized gain in the investment portfolio will rise. Since the majority of the bonds in the investment portfolio are fixed-rate, with only a few adjustable-rate bonds, we would expect our investment portfolio to follow this market value pattern. This is taken into consideration when evaluating the gain or loss of investment securities in the portfolio and the potential for an allowance for credit losses. Purchases of securities available-for-sale totaled $292.1 million in the first three months of 2022. The purchases consisted of U.S. Treasury securities, securities issued by government sponsored entities, mortgage-backed securities issued by government sponsored entities and state and municipal securities. The investment security purchases reflect the deployment of excess liquidity to the available-for-sale investment securities portfolio. Investment securities represented 23.2% of total assets on March 31, 2022 compared to 21.3% of total assets on December 31, 2021. Management expects the investment portfolio as a percent of total assets to normalize once core loan growth demand increases and investment security repayments are deployed into loan growth. Paydowns from prepayments and scheduled payments of $26.5 million were received in the first three months of 2022, and the amortization of premiums, net of the accretion of discounts, was $1.7 million. Maturities and calls of securities totaled $3.1 million in the first three months of 2022. There were no sales of investment securities in the first three months of 2022. No allowance for credit losses was recognized in the first three months of 2022. The fair value of the investment securities portfolio as of March 31, 2022 included an unrealized losses of $177.4 million compared to unrealized gains of $21.6 million as of December 31, 2021. Unrealized losses in the investment securities portfolio resulted from the steepening of the yield curve during the first quarter of 2022. The investment portfolio is managed by a third-party firm to provide for an appropriate balance between liquidity, credit risk, interest rate risk management and investment return and to limit the Company’s exposure to credit risk in the investment securities portfolio to an acceptable level. The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds under what is commonly referred to as the “Volcker Rule” of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Real Estate Mortgage Loans Held-for-Sale Real estate mortgage loans held-for-sale decreased by $5.2 million, or 70.1%, to $2.2 million at March 31, 2022, from $7.5 million at December 31, 2021. The balance of this asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market. The Company generally sells conforming qualifying mortgage loans it originates on the secondary market. Proceeds from sales of residential mortgages totaled $18.1 million in the first three months of 2022 compared to $25.7 million in the first three months of 2021. Management expects the volume of loans originated for sale in the secondary market to decline as compared to volumes originated in 2021 due to the rise in interest rates that have occurred in the first quarter of 2022. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans were $381.5 million and $375.4 million as of March 31, 2022 and December 31, 2021, respectively. 37 Table of Contents Loan Portfolio The loan portfolio by portfolio segment as of March 31, 2022 and December 31, 2021 is summarized as follows: (dollars in thousands) March 31, 2022 December 31, 2021 Current Period Change Commercial and industrial loans $ 1,463,457 33.6 % $ 1,389,469 32.4 % $ 73,988 Commercial real estate and multi-family residential loans 1,957,372 44.9 1,954,846 45.6 2,526 Agri-business and agricultural loans 423,669 9.8 445,825 10.4 (22,156) Other commercial loans 78,412 1.8 73,490 1.7 4,922 Consumer 1-4 family mortgage loans 350,166 8.0 344,720 8.0 5,446 Other consumer loans 83,395 1.9 82,755 1.9 640 Subtotal, gross loans 4,356,471 100.0 % 4,291,105 100.0 % 65,366 Less: Allowance for credit losses (67,526) (67,773) 247 Net deferred loan fees (2,757) (3,264) 507 Loans, net $ 4,286,188 $ 4,220,068 $ 66,120 Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, increased by $65.4 million to $4.356 billion at March 31, 2022 from $4.291 billion at December 31, 2021. The increase was primarily driven by originations of loans concentrated in the commercial and industrial categories and was offset by seasonal paydowns in the agri-business and agricultural loans segments and forgiveness of outstanding PPP loans. Total loans excluding PPP loans increased by $79.5 million, as of March 31, 2022 as compared to December 31, 2021. The following table summarizes the Company’s non-performing assets as of March 31, 2022 and December 31, 2021: (dollars in thousands) March 31, 2022 December 31, 2021 Nonaccrual loans including nonaccrual troubled debt restructured loans $ 13,900 $ 14,973 Loans past due over 90 days and still accruing 18 117 Total nonperforming loans 13,918 15,090 Other real estate owned 196 196 Repossessions 17 0 Total nonperforming assets $ 14,131 $ 15,286 Individually analyzed loans including troubled debt restructurings $ 24,554 $ 25,581 Nonperforming loans to total loans 0.32 % 0.35 % Nonperforming assets to total assets 0.22 % 0.23 % Performing troubled debt restructured loans $ 4,976 $ 5,121 Nonperforming troubled debt restructured loans (included in nonaccrual loans) 6,443 6,218 Total troubled debt restructured loans $ 11,419 $ 11,339 Total nonperforming assets decreased by $1.2 million, or 7.6%, to $14.1 million during the three month period ended March 31, 2022. The ratio of nonperforming assets to total assets at March 31, 2022 decreased from 0.23% at December 31, 2021 to 0.22% at March 31, 2022. A loan is individually analyzed when full payment under the original loan terms is not expected. The analysis for smaller loans that are similar in nature and which are not in nonaccrual or troubled debt restructured status, such as residential mortgage, consumer, and credit card loans, is determined based on the class of loans. If a loan is individually analyzed, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows or at the fair value of collateral if repayment is expected solely from the collateral. Total individually analyzed loans decreased by $1.0 million to $24.6 million at March 31, 2022 from $25.6 million at December 31, 2021. 38 Table of Contents Loans are charged against the allowance for credit losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb current expected credit losses relating to specifically identified loans based on an evaluation of the loans by management, as well as other current expected losses in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. General allowance is determined after considering the following factors: application of loss percentages using a probability of default/loss given default approach subject to a floor, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans: Substandard, Doubtful and Loss. The regulations also contain a Special Mention category. Special Mention applies to loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as Substandard, Doubtful or Loss but do possess credit deficiencies or potential weaknesses deserving management’s close attention. The Company’s policy is to establish a specific allowance for credit losses for any assets where management has identified conditions or circumstances that indicate an asset is nonperforming. If an asset or portion thereof is classified as a loss, the Company’s policy is to either establish specified allowances for credit losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount. At March 31, 2022, the allowance for credit losses was 1.55% of total loans outstanding, versus 1.58% of total loans outstanding at December 31, 2021. At March 31, 2022, management believed the allowance for credit losses was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions deteriorate, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for credit losses. The process of identifying credit losses is a subjective process. The Company has a relatively high percentage of commercial and commercial real estate loans, which are extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing conservative credit structures, by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and market area. As of March 31, 2022, based on management’s review of the loan portfolio, the Company had 79 credit relationships totaling $218.8 million on the classified loan list versus 81 credit relationships totaling $234.5 million on December 31, 2021. The decrease in classified loans for the first three months of 2022 resulted primarily from paydowns to previously classified loans on the non-individually analyzed portion of the watchlist. As of March 31, 2022, the Company had $170.3 million of assets classified as Special Mention, $48.4 million classified as Substandard, $0 classified as Doubtful and $0 classified as Loss as compared to $176.6 million, $57.9 million, $0 and $0, respectively, at December 31, 2021. Allowance estimates are developed by management after taking into account actual loss experience adjusted for current economic conditions and a reasonably supportable forecast period. The Company has regular discussions regarding this methodology with regulatory authorities. Allowance estimates are considered a prudent measurement of the risk in the Company’s loan portfolio based upon loan segment. In accordance with CECL accounting guidance, the allowance is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. For a more thorough discussion of the allowance for credit losses methodology see the Critical Accounting Policies section of this Item 2. The allowance for credit losses decreased $247,000, from $67.8 million at December 31, 2021 to $67.5 million at March 31, 2022. Most of the Company’s recent loan growth has been concentrated in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits. Management has historically considered growth and portfolio composition when determining credit loss allocations. The Paycheck Protection Program During the three months ended March 31, 2022, the Company has continued processing forgiveness applications for PPP made during the first and second rounds of the PPP program. As of March 31, 2022, the Company had $12.5 million in PPP loans outstanding, net of deferred fees, consisting of $3.1 million from PPP round one and $9.4 million from PPP round two. There were seven PPP round one loans and 21 round two loans that had not yet been through the SBA's forgiveness process. The balance of deferred fees not yet recognized into income was $246,000 as of March 31, 2022. 39 Table of Contents Sources of Funds The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the three months ended March 31, 2022 and 2021 are summarized in the following table: Three months ended March 31, 2022 2021 (dollars in thousands) Balance Rate Balance Rate Noninterest bearing demand deposits $ 1,966,117 0.00 % $ 1,566,045 0.00 % Savings and transaction accounts: Savings deposits 408,314 0.07 330,069 0.07 Interest bearing demand deposits 2,642,003 0.29 2,182,164 0.28 Time deposits: . Deposits of $100,000 or more 633,947 0.51 793,470 1.03 Other time deposits 198,257 0.71 235,271 1.12 Total deposits $ 5,848,638 0.21 % $ 5,107,019 0.33 % FHLB advances and other borrowings 75,026 0.40 76,517 0.42 Total funding sources $ 5,923,664 0.32 % $ 5,183,536 0.34 % Deposits and Borrowings As of March 31, 2022, total deposits increased by $85.2 million, or 1.5%, from December 31, 2021. Core deposits increased by $85.0 million to $5.810 billion as of March 31, 2022 from $5.725 billion as of December 31, 2021. Total brokered deposits were $10.2 million at March 31, 2022 compared to $10.0 million at December 31, 2021 reflecting a $241,000 increase during the first three months of 2022. Since December 31, 2021, the change in core deposits was comprised of increases in public funds deposits of $55.9 million, commercial deposits of $19.9 million, and retail deposits of $9.2 million. Total public funds deposits, including public funds transaction accounts, were $1.341 billion at March 31, 2022 and $1.285 billion at December 31, 2021. The following table summarizes deposit composition at March 31, 2022 and December 31, 2021: (dollars in thousands) March 31, 2022 December 31, 2021 Current Period Change Retail $ 2,187,733 $ 2,178,534 $ 9,199 Commercial 2,282,081 2,262,229 19,852 Public funds 1,340,565 1,284,641 55,924 Core deposits $ 5,810,379 $ 5,725,404 $ 84,975 Brokered deposits 10,244 10,003 241 Total deposits $ 5,820,623 $ 5,735,407 $ 85,216 There was no change in borrowings from December 31, 2021. The Company utilizes wholesale funding, including brokered deposits and Federal Home Loan Bank advances, to supplement funding of assets, which is primarily used for loan and investment securities growth. Capital As of March 31, 2022, total stockholders’ equity was $609.1 million, a decrease of $95.8 million, or 13.6%, from $704.9 million at December 31, 2021. Net income of $23.6 million increased equity. Offsetting the increase to stockholders’ equity was a decrease of $109.8 million in accumulated other comprehensive income (loss), which was primarily driven by a net decrease in the fair value of available-for-sale securities as a result of the yield curve steepening in the first quarter of 2022. Dividends declared and paid of $0.40 per share, or $10.2 million, also contributed the decrease to total stockholders equity. 40 Table of Contents The impact on equity for other comprehensive income (loss) is not included in regulatory capital. The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1, or core capital, as a percentage of average assets, to measure the soundness of a financial institution. In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations. As of March 31, 2022, the Company's capital levels remained characterized as “well-capitalized”. The actual capital amounts and ratios of the Company and the Bank as of March 31, 2022 and December 31, 2021, are presented in the table below. Capital ratios for March 31, 2022 are preliminary until the Call Report and FR Y-9C are filed. Actual Minimum Required For Capital Adequacy Purposes For Capital Adequacy Purposes Plus Capital Conservation Buffer Minimum Required to Be Well Capitalized Under Prompt Corrective Action Regulations (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio As of March 31, 2022: Total Capital (to Risk Weighted Assets) Consolidated $ 760,631 15.15 % $ 401,620 8.00 % $ 527,126 N/A N/A N/A Bank $ 740,811 14.80 % $ 400,489 8.00 % $ 525,641 10.50 % $ 500,611 10.00 % Tier I Capital (to Risk Weighted Assets) Consolidated $ 697,729 13.90 % $ 301,215 6.00 % $ 426,721 N/A N/A N/A Bank $ 678,084 13.55 % $ 300,366 6.00 % $ 425,519 8.50 % $ 400,489 8.00 % Common Equity Tier 1 (CET1) Consolidated $ 697,729 13.90 % $ 225,911 4.50 % $ 351,417 N/A N/A N/A Bank $ 678,084 13.55 % $ 225,275 4.50 % $ 350,428 7.00 % $ 325,397 6.50 % Tier I Capital (to Average Assets) Consolidated $ 697,729 10.47 % $ 266,473 4.00 % $ 266,473 N/A N/A N/A Bank $ 678,084 10.20 % $ 265,822 4.00 % $ 265,822 4.00 % $ 332,277 5.00 % As of December 31, 2021: Total Capital (to Risk Weighted Assets) Consolidated $ 744,421 15.35 % $ 388,020 8.00 % $ 509,276 N/A N/A N/A Bank $ 726,091 15.01 % $ 387,118 8.00 % $ 508,093 10.50 % $ 483,898 10.00 % Tier I Capital (to Risk Weighted Assets) Consolidated $ 683,754 14.10 % $ 291,015 6.00 % $ 412,271 N/A N/A N/A Bank $ 665,424 13.75 % $ 290,339 6.00 % $ 411,313 8.50 % $ 387,118 8.00 % Common Equity Tier 1 (CET1) Consolidated $ 683,754 14.10 % $ 218,261 4.50 % $ 339,518 N/A N/A N/A Bank $ 665,424 13.75 % $ 217,754 4.50 % $ 338,729 7.00 % $ 314,534 6.50 % Tier I Capital (to Average Assets) Consolidated $ 683,754 10.73 % $ 254,898 4.00 % $ 254,898 N/A N/A N/A Bank $ 665,424 10.46 % $ 254,425 4.00 % $ 254,425 4.00 % $ 318,030 5.00 % 41 Table of Contents FORWARD-LOOKING STATEMENTS This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the federal securities law. Forward-looking statements are not historical facts and are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “project,” “possible,” “continue,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain and, accordingly, the reader is cautioned not to place undue reliance on any forward-looking statement made by the Company. Actual results could differ materially from those addressed in the forward-looking statements as a result of numerous factors, including, without limitation: • the effects of future economic, business and market conditions and changes, including in connection with the COVID-19 pandemic, both domestic and foreign; • governmental monetary and fiscal policies and the impact the current economic environment will have on these; • the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities and other interest sensitive assets and liabilities; • changes in borrowers’ credit risks and payment behaviors; • the failure of assumptions and estimates used in our reviews of our loan portfolio, underlying the establishment of reserves for possible credit losses, our analysis of our capital position and other estimates; • changes in the prices, values and sales volumes of residential and commercial real estate; • the effects of disruption and volatility in capital markets on the value of our investment portfolio; • the risk of labor availability, trade policy and tariffs, as well as supply chain constraints could impact loan demand from the manufacturing sector; • changes in the scope and cost of FDIC insurance, the state of Indiana’s Public Deposit Insurance Fund and other coverages; • changes in the availability and cost of credit and capital in the financial markets; • the anticipated phase out of most LIBOR tenors by mid-2023 and establishment of a new reference rate or rates; • the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services; • the timing and scope of any legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators; • risk of cyber-security attacks that could result in damage to the Company's or third-party service providers' networks or data of the Company; • changes in technology or products that may be more difficult or costly, or less effective than anticipated; • the effects of any employee or customer fraud; • the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions; • changes in accounting policies, rules and practices; • the effects of war or other conflicts, acts of terrorism or other catastrophic events, including storms, droughts, tornados and flooding, that may affect general economic conditions, including agricultural production and demand and prices for agricultural goods and land used for agricultural purposes, generally and in our markets; and 42 Table of Contents • the risks noted in the Risk Factors discussed under Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2021, as well as other risks and uncertainties set forth from time to time in the Company’s other filings with the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.