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Item 2. Management’s Discussion and Analysis

2022-10-26 compared with 2022-08-03 · 200 added, 177 removed, 388 unchanged (49% of the section changed)

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Net income in the first six months of 2022 was $49.3 million, which increased $2.0 million, or 4.2%, from $47.3 million for the comparable period of 2021 .

Diluted income per common share was $1.92 in the first six months of 2022 , up 3.8% from $1.85 in the comparable period of 2021 .

The increase in net income for 2022 was primarily due to growth in net interest income of $6.2 million, offset by a decrease in noninterest income of $2.7 million and an increase in noninterest expense of $1.5 million .

Pretax pre-provision earnings in the first six months of 2022 were $59.9 million, an increase of $2.0 million, or 3.5%, compared to $57.8 million for the comparable period.

Net income in the first nine months of 2022 was $77.8 million, which increased $6.4 million, or 8.9%, from $71.5 million for the comparable period of 2021 .

Diluted income per common share was $3.03 in the first nine months of 2022 , up 8.6% from $2.79 in the comparable period of 2021 .

The increase in net income for 2022 was primarily due to growth in net interest income of $13.0 million and a decrease to the provision for credit losses of $660,000, offset by a decrease in noninterest income of $3.7 million and an increase in noninterest expense of $3.4 million .

Pretax pre-provision earnings in the first nine months of 2022 were $94.6 million, an increase of $5.9 million, or 6.6%, compared to $88.7 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 15.72% in the first six months of 2022 versus 14.49% in the comparable period of 2021 .

Annualized return on average total assets was 1.52% in the first six months of 2022 versus 1.58% for the comparable period of 2021 .

The Company's average equity to average assets ratio was 9.65% in the first six months of 2022 versus 10.92% in the comparable period of 2021 .

Net income in second quarter of 2022 was $25.7 million, up 5.4% from $24.3 million for the comparable period of 2021.

Diluted earnings per common share was $1.00 in the second quarter of 2022, up 5.3% from $0.95 in the comparable period of 2021.

The increase was driven primarily by growth in net interest income of $5.0 million, offset by a decrease in noninterest income of $848,000 and an increase in noninterest expense of $1.3 million.

Additionally, the Company recorded a reversal to the provision for credit losses of $1.7 million for the second quarter of 2021, compared to no provision for credit losses recorded for the second quarter of 2022.

Pretax pre-provision earnings in the second quarter of 2022 were $31.3 million, an increase of $2.9 million, or 10.2%, compared to $28.4 million for the comparable period of 2021.

Annualized return on average total equity was 17.65% in the second quarter of 2022 versus 14.71% in the comparable period of 2021.

Annualized return on average total assets was 1.59% in the second quarter of 2022 versus 1.58% in the comparable period of 2021.

The average equity to average assets ratio was 9.03% in the second quarter of 2022 versus 10.76% the comparable period of 2021.

The Company’s tangible common equity to tangible assets ratio, which is a non-GAAP financial measure, was 8.92% at June 30, 2022, compared to 10.81% at June 30, 2021 and 10.70% at December 31, 2021.

Tangible equity and tangible assets have been negatively impacted by the decline in market value of the Company's available-for-sale investment securities portfolio.

The market value decline was a result of the yield curve steepening during the first half of 2022.

The increase in market interest rates led to an unrealized loss in market value of $175.6 million as of June 30, 2022, compared to an unrealized gain in market value of $29.9 million at June 30, 2021 and of $21.6 million at December 31, 2021.

When excluding the impact of accumulated other comprehensive income on tangible common equity, the Company's adjusted tangible common equity to adjusted tangible assets ratio was 11.08% at June 30, 2022 compared to 10.49% at June 30, 2021 and 10.47% at December 31, 2021.

The Company elected to transfer $151.4 million in net book value of municipal bonds from the available-for-sale securities portfolio to held-to-maturity designation on April 1, 2022 as a balance sheet management strategy.

Total assets were $6.265 billion as of June 30, 2022 versus $6.557 billion as of December 31, 2021, a decrease of $292.2 million.

Balance sheet contraction was driven primarily through decreases in cash and cash equivalents, deposits and borrowings during the first six months of 2022.

Annualized return on average total equity was 16.89% in the first nine months of 2022 versus 14.29% in the comparable period of 2021 .

Annualized return on average total assets was 1.61% in the first nine months of 2022 versus 1.57% for the comparable period of 2021 .

The Company's average equity to average assets ratio was 9.53% in the first nine months of 2022 versus 11.01% in the comparable period of 2021 .

Equity has been negatively impacted by unrealized losses form the available-for-sale investment securities portfolio.

Net income in the third quarter of 2022 was $28.5 million, which increased $4.4 million, or 18.3%, from $24.1 million for the comparable period of 2021.

Diluted earnings per common share was $1.11 in the third quarter of 2022, up 18.1% from $0.94 in the comparable period of 2021.

The increase was driven primarily by growth in net interest income of $6.8 million and a decrease to the provision for credit losses of $1.3 million, offset by a decrease in noninterest income of $950,000 and an increase in noninterest expense of $1.9 million.

Pretax pre-provision earnings in the third quarter of 2022 were $34.8 million, an increase of $3.9 million, or 12.5%, compared to $30.9 million for the comparable period of 2021.

Annualized return on average total equity was 19.39% in the third quarter of 2022 versus 13.90% in the comparable period of 2021.

Annualized return on average total assets was 1.80% in the third quarter of 2022 versus 1.56% in the comparable period of 2021.

The average equity to average assets ratio was 9.27% in the third quarter of 2022 versus 11.19% the comparable period of 2021.

The Company’s tangible common equity to tangible assets ratio, which is a non-GAAP financial measure, was 8.20% at September 30, 2022, compared to 10.92% at September 30, 2021 and 10.70% at December 31, 2021.

Tangible equity and tangible assets have declined due to unrealized losses of the Company's available-for-sale investment securities portfolio.

The market value decline was a result of the yield curve steepening caused by inflation and the tightening of monetary policy by the Federal Reserve Board beginning in March of 2022 and throughout the past six months.

Unrealized losses from available-for-sale investment securities were $256.1 million as of September 30, 2022, compared to unrealized gains of $15.5 million at September 30, 2021 and unrealized gains of of $21.6 million at December 31, 2021.

When excluding the impact of accumulated other comprehensive income on tangible common equity and tangible assets, the Company's adjusted tangible common equity to adjusted tangible assets ratio, which is a non-GAAP financial measure, was 11.22% at September 30, 2022 compared to 10.75% at September 30, 2021 and 10.47% at December 31, 2021.

Total assets were $6.288 billion as of September 30, 2022 versus $6.557 billion as of December 31, 2021, a decrease of $268.9 million.

Balance sheet contraction was driven primarily by decreases in cash and cash equivalents, deposits and borrowings during the first nine months of 2022.

Cash and cash equivalents decreased $478.4 million, deposits decreased $71.3 million and borrowings decreased $75.0 million.

Offsetting these decreases were increases to loans, net of the allowance for credit losses, of $137.1 million, other assets of $58.4 million and total investment securities of $29.4 million.

Tota l equity decreased by $142.8 million due primarily to a reduction to accumulated other comprehensive income (loss) of $174.6 million.

The reduction in accumulated other comprehensive income was caused by a decrease in the fair value of available-for-sale securities due to the steepening of the yield curve during the first six months of 2022 .

The change in total equity was also impacted by net income of $49.3 million and dividends declared and paid of $0.80 per share, totaling $20.4 million.

Offsetting these decreases were increases to loans, net of the allowance for credit losses, of $202.5 million and other assets of $88.5 million.

Tota l equity decreased by $185.7 million due primarily to a reduction to accumulated other comprehensive income of $237.8 million.

The reduction in accumulated other comprehensive income was caused by a decrease in the fair value of available-for-sale securities due to the steepening of the yield curve during 2022 .

The change in total equity was also impacted by net income inflows of $77.8 million and dividends declared and paid of $1.20 per share, totaling $30.6 million.

CRITICAL ACCOUNTING POLICIES

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RESULTS OF OPERATIONS

Selected income statement information for the three and six months ended June 30, 2022 and 2021 is presented in the following table:

Three Months Ended June 30, Six Months Ended June 30,

Selected income statement information for the three and nine months ended September 30, 2022 and 2021 is presented in the following table:

Three Months Ended September 30, Nine Months Ended September 30,

(dollars in thousands) 2022 2021 2022 2021

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Diluted EPS $ 1.11 $ 0.94 $ 3.03 $ 2.79

Average Equity/Average Assets 9.27 % 11.19 % 9.53 % 11.01 %

Tangible capital ratio (2) 8.20 % 10.92 % 8.20 % 10.92 %

9 unchanged sentences

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.

The tangible capital ratio is calculated by excluding the balance of goodwill, net of deferred taxes.

See reconciliation on the next page.

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(4) 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.

Calculated by subtracting the impact PPP loans had on average earning 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.

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A reconciliation of non-GAAP measures is provided below (in thousands, except for per share data).

Three Months Ended June 30, Six Months Ended June 30,

As of and for the As of and for the

Three Months Ended September 30, Nine Months Ended September 30,

(dollars in thousands) 2022 2021 2022 2021

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Impact of Paycheck Protection Program on Net Interest Margin FTE.

Three Months Ended June 30, Six Months Ended June 30,

As of and for the As of and for the

Three Months Ended September 30, Nine Months Ended September 30,

2022 2021 2022 2021

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Net Interest Margin Excluding PPP Loans FTE 3.57 % 2.95 % 3.24 % 2.98 %

Net income was $49.3 million in the first six months of 2022 , an increase of $2.0 million, or 4.2%, versus net income of $47.3 million in the first six months of 2021 .

The increase in net income for 2022 was primarily due to growth in net interest income of $6.2 million, or 7.1%, offset by a a decrease to noninterest income of $2.7 million, or 11.4% and an increase to noninterest expense of $1.5 million, or 2.8%.

Additionally, the change in provision for credit losses recorded during the period impacted net income, as $417,000 provision for credit losses was recorded during the first six months of 2022 , compared to a reversal for provision expense of $223,000 during the first six months of 2021 .

Net income was $25.7 million for the three months ended June 30, 2022, an increase of $1.3 million, or 5.4%, versus net income of $24.3 million for the three months ended June 30, 2021.

The increase was primarily due to growth in net interest income which increased $5.0 million, or 11.5%, offset by a decrease to noninterest income of $848,000, or 7.5%, and an increase to noninterest expense of $1.3 million, or 4.7%.

Additionally, the provision for credit losses recorded during the period impacted net income as no provision for credit losses was recorded during the three months ended June 30, 2022, compared to a reversal for credit losses of $1.7 million during the three months ended June 30, 2021.

Net income was $77.8 million in the first nine months of 2022 , an increase of $6.4 million, or 8.9%, versus net income of $71.5 million in the first nine months of 2021 .

The increase in net income for 2022 was primarily due to growth in net interest income of $13.0 million, or 9.7%, and a decrease to the provision for credit losses of $660,000, offset by a decrease to noninterest income of $3.7 million, or 10.5%, and an increase to noninterest expense of $3.4 million, or 4.3%.

Net income was $28.5 million for the three months ended September 30, 2022, an increase of $4.4 million, or 18.3%, versus net income of $24.1 million for the three months ended September 30, 2021.

The increase was primarily due to growth in net interest income which increased $6.8 million, or 14.8%, and a decrease to the provision for credit losses of $1.3 million, offset by a decrease to noninterest income of $950,000, or 8.5%, and an increase to noninterest expense of $1.9 million, or 7.4%.

Net Interest Income

The following table sets forth consolidated information regarding average balances and rates:

Six Months Ended June 30,

Nine Months Ended September 30,

(fully tax equivalent basis, dollars in thousands) Average Balance Interest Yield (1)/

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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 $2.7 million and $1.5 million in the six-month periods ended June 30, 2022 and June 30, 2021 , respectively.

Taxable equivalent basis adjustments were $4.1 million and $2.5 million in the nine-month periods ended September 30, 2022 and September 30, 2021, respectively.

(2) Loan fees are included as taxable loan interest income.

Net loan fees attributable to PPP loans were $641,000 and $6.9 million for the six months ended June 30, 2022 and June 30, 2021 , respectively.

Net loan fees attributable to PPP loans were $690,000 and $10.5 million for the nine months ended September 30, 2022 and September 30, 2021, respectively.

All other loan fees were immaterial in relation to total taxable loan interest income for the periods presented.

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The following table sets forth consolidated information regarding average balances and rates:

Three Months Ended June 30,

Three Months Ended September 30,

(fully tax equivalent basis, dollars in thousands) Average Balance Interest Yield (1)/

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Taxable equivalent basis adjustments were $1.4 million and $791,000 in the three-month periods ended June 30, 2022 and June 30, 2021 , respectively.

Taxable equivalent basis adjustments were $1.45 million and $976,000 in the three-month periods ended September 30, 2022 and September 30, 2021, respectively.

(2) Loan fees are included as taxable loan interest income.

Net loan fees attributable to PPP loans were $180,000 and $2.8 million for the three-months ended June 30, 2022 and June 30, 2021 , respectively.

Net loan fees attributable to PPP loans were $50,000 and $3.57 million for the three months ended September 30, 2022 and September 30, 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.

Net interest income increased $6.2 million, or 7.1%, to $93.6 million for the six months ended June 30, 2022, compared with $87.3 million for the first six months of 2021 .

Net interest income increased $13.0 million, or 9.7%, to $146.1 million for the nine months ended September 30, 2022, compared with $133.1 million for the first nine months of 2021 .

Growth in core loans and investment security balances coupled with rising interest rates positively impacted investment security and loan income and offset the decline in PPP loan income of $12.0 million during the period.

In addition, interest expense declined by $164,000, further benefiting the increase in net interest income.

Interest expense increased by $6.3 million, partially offsetting the positive impact of increased loan and securities interest income.

Average earning assets increased by $353.5 million, due primarily to growth in investment securities of $494.8 million.

Average loans outstanding decreased $163.6 million to $4.364 billion during the six months ended June 30, 2022, compared to $4.527 billion during the same period of 2021.

Average PPP loans decreased by $361.6 million to $13.6 million for the first six months of 2022 compared to $375.2 million for the first six months of 2021 .

Excluding PPP loans, average core loans increased $198.1 million to $4.350 billion during the six months ended June 30, 2022, compared to $4.152 billion during the

same period of 2021.

Average loans outstanding decreased $87.6 million to $4.381 billion during the nine months ended September 30, 2022, compared to $4.469 billion during the same period of 2021.

Average PPP loans decreased by $286.8 million to $10.1 million for the first nine months of 2022 compared to $296.9 million for the first nine months of 2021 .

Excluding PPP loans, average core loans increased $199.2 million to $4.371 billion during the nine months ended

September 30, 2022, compared to $4.172 billion during the same period of 2021 .

The earning asset growth was funded through an increase in deposits.

Average deposits increased $552.4 million to $5.800 billion during the six months ended June 30, 2022, compared to $5.248 billion for the same period of 2021 .

The tax equivalent net interest margin was 3.09 % for the six months ended June 30, 2022 compared to 3.10% during the first six months of 2021 .

The yield on earning assets totaled 3.35% during the six months ended June 30, 2022 compared to 3.39% in the same period of 2021 .

Cost of funds (expressed as a percentage of average earning assets) totaled 0.26% during the first six months of 2022, compared to 0.29% in the same period of 2021 .

The lower margin was caused by reduced levels of PPP income recognition and changes in the earning asset mix during 2021 and 2022 to reflect increased investment securities and interest bearing deposits, which are lower yielding assets.

Net interest margin excluding PPP loans was 3.08% for the six months ended June 30, 2022 compared to 3.00% for the same period of 2021 .

Net interest income increased by $5.0 million, or 11.5%, for the three months ended June 30, 2022 as compared to the three months ended June 30, 2021.

The increased level of net interest income during the second quarter of 2022 was largely driven by an increase in average earning assets of $232.3 million, due primarily to growth in securities of $520.9 million.

This earning asset growth was funded through an increase in deposits.

Average deposits increased $365.3 million to $5.753 billion for the second quarter of 2022, compared to $5.387 billion for the comparable period of 2021.

During this same period, average core deposits increased $365.4 million.

The Company defines "core deposits" as total deposits (including all deposits by municipalities and other government agencies), excluding brokered deposits.

Long-term borrowings have decreased by $20.6 million during these comparable periods due to repayment of a putable $75.0 million advance with the FHLB during the three months ended June 30, 2022.

The company’s net interest margin increased 25 basis points to 3.26% for the second quarter of 2022 compared to 3.01% for the second quarter of 2021.

The increased margin in the second quarter of 2022 compared to the prior year period was due to higher yields on loans, partially offset by a higher cost of funds.

The higher yields were driven by three Federal Reserve Bank increases to the target Federal Funds rate in March, May, and June of 2022.

The overall effect of these rate increases raised the Federal Funds rate by a cumulative 150 basis points and increased the target Federal Funds rate range from a zero-bound range of 0.00% - 0.25% prior to the first rate increase in March of 2022 to a range of 1.50 - 1.75% at June 30, 2022.

Total PPP loan income recognized for the second quarter of 2022 was $204,000 compared to $3.7 million for the second quarter of 2021, a decrease of 94%.

PPP interest and fees had a nominal impact on the second quarter 2022 net interest margin compared to net interest margin compression of 6 basis points for the second quarter 2021.

Despite the decrease in PPP loan fee income, earning asset yields increased 30 basis points from 3.28% for the second quarter of 2021 to 3.58% for the second quarter of 2022.

Average deposits increased $465.4 million to $5.746 billion during the nine months ended September 30, 2022, compared to $5.280 billion for the same period of 2021 .

The tax equivalent net interest margin was 3.25 % for the nine months ended September 30, 2022, compared to 3.11% during the first nine months of 2021 .

The increased margin was caused by increased yields on loans and securities, and partially offset by increased rates on interest bearing liabilities.

Also contributing to the increased margin was an increase to earning assets of $353.5 million, or 6.1%, which was funded by an increase in average deposits.

The higher yields and increased cost of funds were driven by a series of rate increases beginning in March of 2022 to the target Federal Funds rate by the Federal Reserve Board.

The cumulative effect of these rate increases raised the target Federal Funds rate 300 basis points since March 2022, increasing the target Federal Funds rate range from a zero-bound range of 0.00% - 0.25% prior to the first rate increase to a range of 3.00% - 3.25% at September 30, 2022.

Total PPP loan income recognized for the nine months ended September 30, 2022 was $767,000 compared to $12.8 million for the comparable period in 2021 .

PPP interest and fees provided a benefit of 1 basis point on the net interest margin for the nine months ended September 30, 2022, compared to a benefit of 13 basis points for the same period in 2021 .

Net interest margin, excluding PPP, was 3.24% for the nine months ended September 30, 2022, compared to 2.98% for the same period in 2021.

Despite the decrease in PPP loan fee income, earning asset yields increased 26 basis points, from 3.38% for the nine months ended September 30, 2021, to 3.64% for the nine months ended September 30, 2022 due primarily to the repricing of variable rate loans.

Offsetting the increased yield on earning assets was an increase to the Company's cost of funds of 12 basis points as interest expense as a percentage of earning assets increased from 0.27% for the nine months ended September 30, 2021 to 0.39% for the nine months ended September 30, 2022.

Net interest income increased by $6.8 million, or 14.8%, for the three months ended September 30, 2022 as compared to the three months ended September 30, 2021.

The increase in net interest income during the third quarter of 2022 was driven by the increase in loan interest income due primarily to the rising interest rate environment and an increase in average earning assets of $81.8 million.

This earning asset growth was funded through an increase in average deposits of $294.2 million during the three months ended September 30, 2022.

Offsetting this growth in average deposits was a decrease in long-term borrowings of $75.0 million due to repayment of a putable $75.0 million advance with the FHLB during the second quarter of 2022.

The Company’s net interest margin increased 44 basis points to 3.57% for the third quarter of 2022 compared to 3.13% for the third quarter of 2021.

The increased margin in the third quarter of 2022 compared to the prior year period was primarily due to higher yields on loans and securities and partially offset by a higher cost of funds.

The higher yields were driven by the rising rate environment in 2022 and redeployment of excess liquidity from interest bearing deposits, that was used to fund loan growth during the period also benefited net interest margin.

The Company expects deposit betas to increase in the fourth quarter of 2022 as the Federal Reserve Bank is expected to continue tightening.

Total PPP loan income recognized for the third quarter of 2022 was $58,000 compared to $3.9 million for the third quarter of 2021.

PPP interest and fees had a nominal impact on the third quarter 2022 net interest margin compared to an expansionary benefit to net interest margin of 18 basis points for the third quarter 2021.

Net interest margin, excluding PPP, was 3.57% for the three months ended September 30, 2022, compared to 2.95% for the same period in 2021.

Despite the decrease in PPP loan fee income, earning asset yields increased 87 basis points from 3.37% for the third quarter of 2021 to 4.24% for the third quarter of 2022.

Offsetting the increased yield on earning assets was an increase to the Company's cost of funds of 43 basis points.

Interest expense as a percentage of earning assets increased to 0.32% for the three-month period ended June 30, 2022, from 0.27% for the three-month period ended June 30, 2021.

Interest expense as a percentage of earning assets increased to 0.67% for the three months ended September 30, 2022, from 0.24% for the three months ended September 30, 2021.

Provision for Credit Losses

The Company recorded no provision for credit losses expense for the three months ended June 30, 2022 compared to a reversal for provision expense of $1.7 million during the comparable period of 2021 .

Net charge offs were $3,000 during the three month period ended June 30, 2022 compared to net recoveries of $1.6 million during the comparable period of 2021 .

The Company recorded provision for credit losses expense of $417,000 for the six months ended June 30, 2022 compared to a reversal for provision expense of $223,000 during the comparable period of 2021.

Net charge-offs were $667,000 during the six month period ended June 30, 2022 compared to net recoveries of $1.5 million during the comparable period of 2021.

The Company recorded provision for credit losses expense of $417,000 for the nine months ended September 30, 2022 compared to provision expense of $1.1 million during the comparable period of 2021 .

Net charge-offs were $951,000 during the nine month period ended September 30, 2022 compared to net recoveries of $1.5 million during the comparable period of 2021 .

The Company recorded no provision for credit losses expense for the three months ended September 30, 2022 compared to provision expense of $1.3 million during the comparable period of 2021 .

Net charge offs were $284,000 during the three month period ended September 30, 2022 compared to net recoveries of $35,000 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.

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.

Noninterest Income

Noninterest income categories for the six-month and three-month periods ended June 30, 2022 and 2021 are shown in the following table:

Six Months Ended

Noninterest income categories for the nine-month and three-month periods ended September 30, 2022 and 2021 are shown in the following table:

Nine Months Ended

September 30,

(dollars in thousands) 2022 2021 Dollar Change Percent Change

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Three Months Ended

September 30,

(dollars in thousands) 2022 2021 Dollar Change Percent Change

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Merchant card fee income 941 838 103 12.3

Bank owned life insurance income (loss) (183) 705 (888) (126.0)

Bank owned life insurance income 54 640 (586) (91.6)

Interest rate swap fee income 88 180 (92) (51.1)

Mortgage banking income 351 415 (64) (15.4)

Net securities gains 0 44 (44) (100.0)

Mortgage banking income (loss) (89) (32) (57) 178.1

Other income 423 1,029 (606) (58.9)

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Noninterest income to total revenue 16.2 % 19.5 %

The Company's noninterest income decreased $2.7 million, or 11.4%, to $21.2 million for the six months ended June 30, 2022 compared to $23.9 million in the prior year period.

Notably, the fee-based businesses of wealth advisory fees improved by 5.5%, service charges on deposit accounts improved by 13.5%, loan and service fees improved by 4.6% and merchant card fee income improved by 23.8%.

The decrease in noninterest income resulted primarily from reduced bank owned life insurance income of $1.7 million due to decline in the equity markets as well as $928,000 decline in mortgage banking income due to the impact of rising interest rates on reduced mortgage loan origination volumes.

The Company's noninterest income decreased by $848,000, or 7.5%, to $10.5 million for the second quarter of 2022, compared to $11.3 million for the second quarter of 2021.

Noninterest income was positively impacted by elevated service charges on deposit accounts which increased by $361,000, or 14.3%, as a result of increased economic activity in the Company's operating footprint.

In addition, loan and service fee income increased by $153,000, or 5.0%, merchant card fee income increased by $138,000, or 18.0% and wealth advisory fees increased by $126,000, or 6.1%.

Driving the decrease was a reduction of $888,000 in bank owned life insurance income related to the company's variable life insurance policies.

These policies are tied to the equity markets and can be subject to volatility based on market performance.

In addition, other income decreased $445,000 which was caused by a reduction in income recognized during the quarter related to various limited partnership investment holdings and other non-recurring items.

The Company's noninterest income decreased $3.7 million, or 10.5%, to $31.3 million for the nine months ended September 30, 2022 compared to $35.0 million in the prior year period.

Notably, the Company's fee-based businesses of wealth advisory fees improved by 1.8%, investment brokerage fees improved by 9.7%, service charges on deposit accounts improved by 11.8%, loan and service fees improved by 3.5% and merchant card fee income improved by 19.5%.

Market value declines impacted the overall decrease in noninterest income.

Bank owned life insurance income decreased by $2.3 million primarily due to declines in market value of variable life insurance policies of $1.1 million during the nine months ended September 30, 2022, compared to market value gains of $1.1 million for the comparable period of 2021.

In addition, other income decreased by $1.1 million, mortgage banking income decreased by $985,000, net securities gains decreased by $797,000 and interest rate swap income decreased $442,000.

Other income declined due to income declines in various limited partnership investment holdings and other non-recurring items.

The decline in mortgage banking income was caused by a decrease in volume due to a slowdown in mortgage demand because of the higher interest rate environment.

Excluding the impact of the variable life insurance policies market value changes, noninterest income was $32.5 million for the nine months ended September 30, 2022, compared to $34.0 million for the nine months ended September 30, 2021, a decline of $1.5 million, or 4.4%.

The valuation changes to the variable life insurance policies are offset by similar changes to the deferred compensation expense that is recognized in salaries and employee benefits.

The Company's noninterest income decreased by $950,000, or 8.5%, to $10.2 million for the third quarter of 2022, compared to $11.1 million for the third quarter of 2021.

Noninterest income was positively impacted by increases in fee-based lines of business due to fee generating volume for the respective service lines.

In particular, service charges on deposit accounts increased $234,000, or 8.5%, investment brokerage fees increased $130,000, or 25.0%, and merchant card fee income increased $103,000, or 12.3%.

Wealth advisory fees declined by $118,000, or 5.4%, and were negatively impacted by market value declines of 15% in trust assets during 2022.

Other income declined by $606,000 due to income declines in various limited partnership holdings and other non-recurring items.

In addition, bank owned life insurance income decreased by $586,000.

This decrease was primarily caused by market value declines of the Company's variable life insurance policies which are tied to the equity markets and declined in value by $234,000 during the third quarter of 2022, compared to an increase of $284,000 during the third quarter of 2021.

Noninterest Expense

Noninterest expense categories for the six-month and three-month periods ended June 30, 2022 and 2021 are shown in the following tables:

Six Months Ended

June 30, 2022

Noninterest expense categories for the nine-month and three-month periods ended September 30, 2022 and 2021 are shown in the following tables:

Nine Months Ended

September 30, 2022

(dollars in thousands) 2022 2021 Dollar Change Percent Change

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Three Months Ended

June 30, 2022

September 30, 2022

(dollars in thousands) 2022 2021 Dollar Change Percent Change

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Efficiency ratio 44.5 % 45.7 %

The Company's noninterest expense increased $1.5 million, or 2.8%, to $54.9 million for the six months ended June 30, 2022, from $53.4 million for the six months ended June 30, 2021.

The increase was due primarily due to an increase in other expense of $2.4 million, or 57.6%, driven by accruals for ongoing legal matters, offset by decreases in salaries and benefits of $957,000 and reduced professional fees of $743,000, or 20.0%.

The Company's noninterest expense increased by $1.3 million, or 4.7%, to $27.9 million in the second quarter of 2022, compared to $26.6 million in the second quarter of 2021.

Other expense increased $1.4 million driven by accruals for ongoing legal matters.

In addition, corporate and business development expenses increased $734,000, or 105.0%, and net occupancy expense increased $261,000, or 18.3%.

The increase in corporate and business development expenses was primarily a result of increased sponsorships and contributions, including $150,000 given in $10,000 increments to the fifteen community foundations in our market footprint in recognition of Lake City Bank's 150th anniversary.

In addition, corporate and business development expense reflects higher advertising costs and increased client development expense.

The increase to net occupancy

expense was caused by budgeted repairs to company facilities.

Salaries and employee benefits decreased by $964,000, or 6.1%, and professional fees decreased $425,000, or 23.1%.

The decrease to salary and benefits was driven by reduced deferred compensation expense, which is tied to equity market performance of the underlying funds which are directed by the plan participants, and the reduction in professional fees was a result of reduced legal expenses during the second quarter of 2022.

The Company's efficiency ratio was 47.8% for the six months ended June 30, 2022 compared to 48.0% for the first six months of 2021.

The Company's efficiency ratio was 47.2% for the second quarter of 2022 and 48.5% for the second 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 Company's noninterest expense increased by $3.4 million, or 4.3%, to $82.8 million for the nine months ended September 30, 2022, from $79.4 million for the nine months ended September 30, 2021.

The increase was due primarily due to an increase in other expense of $3.4 million, or 50.0%, driven by accruals for ongoing legal matters, Corporate and business development expense increased $870,000, or 27.1%, caused by increased advertising, charitable contributions, including contributions associated with the company's sesquicentennial celebration, and other corporate development activities.

Net occupancy expense increased $450,000, or 10.4%, driven by budgeted repairs, ongoing upgrades to existing facilities and the opening of a new branch in Elkhart.

Offsetting these increases are decreases in salaries and employee benefits of $537,000, or 1.2%, and professional fees of $531,000, or 10.5%, due to a decrease in legal expense.

The decline in salaries and benefits was impacted by a decline in deferred compensation of $2.4 million, offset by increases in salaries and wages of $758,000, increased performance-based compensation of $499,000 and increased health insurance expense of $329,000.

Deferred compensation expense was $1.2 million for the nine months ended September 30, 2021.

Operating expenses excluding the

effects of legal settlement accruals of $3.0 million and market value declines from the deferred compensation program of $1.2 million, were $81.0 million for the nine months ended September 30, 2022, compared to $78.2 million for the comparable period in 2021, an increase of $2.8 million, or 3.6%.

The Company's noninterest expense increased by $1.9 million, or 7.4%, to $27.9 million in the third quarter of 2022 , compared to $26.0 million in the third quarter of 2021 .

Other expense increased $1.0 million, or 38.2%, driven by accruals for ongoing legal matters.

In addition, corporate and business development expenses increased $426,000, or 42.6%, and salaries and employee benefits increased $420,000, or 3.0%.

The increase in corporate and business development expenses was primarily a result of increased client development activities, advertising costs and increased contributions to our communities.

The increase to salaries and employee benefits was driven primarily by increased salaries and wages of $415,000, increases to performance-based compensation expense of $367,000 and increased employee health insurance expense of $113,000, offset by declines in deferred compensation expense of $519,000.

Deferred compensation expense was $279,000 for the three months ended September 30, 2021.

Operating expenses, excluding the effects of one-time legal settlement accruals of $1.1 million and market value volatility declines of $240,000 from the deferred compensation program, were $27.0 million for the three months ended September 30, 2022, compared to $25.7 million for the comparable period during 2021, an increase of $1.3 million, or 5.1%.

The Company's efficiency ratio was 46.7% for the nine months ended September 30, 2022 compared to 47.2% for the first nine months of 2021.

The Company's efficiency ratio was 44.5% for the third quarter of 2022 and 45.7% for the third quarter of 2021.

As previously disclosed, in the third quarter of 2019, the 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 August 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 $612,000, or 5.7%, in the six months ended June 30, 2022 compared to the same period in 2021.

The effective tax rate was 17.0% in the six months ended June 30, 2022, compared to 18.5% 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.

On August 9, 2021, the liquidating trustee for the bankruptcy estates filed a complaint against the Bank and the Company, and agreed to stay prosecution of the action through August 31, 2022.

The original complaint focused on a series of business transactions among the client, related entities, and the Bank, which the liquidating trustee alleged are voidable under applicable federal bankruptcy and state law.

The complaint also addressed treatment of the Bank’s claims filed in the bankruptcy cases.

On August 31, 2022, the trustee filed his amended complaint against the former client, the Bank, the Company, four officers of the Bank and one independent director of the Bank.

The amended complaint alleges that the former client engaged in a check kiting scheme involving multiple banks.

The amended complaint alleges that a series of business transactions among the client, his related entities and the Bank are voidable under applicable bankruptcy and state laws.

The amended complaint also alleges that the Bank, the Company and the five individual bank representatives who are named as defendants violated various federal and state laws in assisting the former client in his check kiting scheme.

Based on current information, we have determined that a material loss is neither probable nor estimable at this time, and the Bank, the Company and the five individual Bank representatives who are named as defendants intend to vigorously defend themselves against all allegations asserted in the amended complaint.

The Company's income tax expense increased $156,000, or 1.0%, in the nine months ended September 30, 2022 compared to the same period in 2021.

The effective tax rate was 17.4% in the nine months ended September 30, 2022, compared to 18.5% for the comparable period of 2021.

The year-to-date effective tax rate is reduced by income from tax-advantaged sources such as f ederally tax exempt municipal bond interest income as w ell as a tax benefit from stock-based compensation vesting of shares for plan participants.

FINANCIAL CONDITION

Total assets of the Company were $6.265 billion as of June 30, 2022, a decrease of $292.2 million, when compared to $6.557 billion as of December 31, 2021.

This decrease was primarily due to a $513.7 million decrease in cash and cash equivalents, offset by increases in loans net of the allowance for credit losses of $137.1 million, other assets of $58.4 million and secruities of $29.4 million.

Loans excluding PPP loans increased by $157.8 million, or 3.7%, from $4.262 billion at December 31, 2021 to $4.419 billion at June 30, 2022.

Total assets of the Company were $6.288 billion as of September 30, 2022, a decrease of $268.9 million, when compared to $6.557 billion as of December 31, 2021.

This decrease was primarily due to a $478.4 million decrease in cash and cash equivalents, offset by increases in loans, net of the allowance for credit losses, of $202.5 million and in other assets of $88.5 million.

Loans excluding PPP loans increased by $226.5 million, or 5.3%, from $4.262 billion at December 31, 2021 to $4.488 billion at September 30, 2022.

Total deposits decreased $71.3 million, or 1.2%.

1 unchanged sentence

Public funds deposits increased by $196.5 million since year end.

Core deposits were $5.612 billion as of June 30, 2022 compared to $5.725 billion as of December 31, 2021 .

Core deposits were $5.654 billion as of September 30, 2022, a decrease of $71.3 million, 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 $513.7 million, or 75.2%, to $169.5 million at June 30, 2022, from $683.2 million at December 31, 2021.

The decrease in cash and cash equivalents at June 30, 2022 reflects an additional deployment of $250 million in funds to the available-for-sale investment securities portfolio, funding of loan growth of $157.8 million, and repayment of an FHLB advance of $75.0 million.

Total cash and cash equivalents decreased by $478.4 million, or 70.0%, to $204.8 million at September 30, 2022, from $683.2 million at December 31, 2021.

The decrease in cash and cash equivalents at September 30, 2022 reflects an additional deployment of $250 million in funds to the available-for-sale investment securities portfolio in the first quarter of 2022, funding of core loan growth of $226.5 million, and repayment of an FHLB advance of $75.0 million, offset by a reduction in deposits of $71.3 million.

Cash and cash equivalents include short-term investments.

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Investment Portfolio

The Company elected to transfer $151.4 million in net book value of municipal bonds from the available-for-sale securities portfolio to held-to-maturity on April 1, 2022 as an overall balance sheet management strategy.

The fair value of securities transferred was $127.0 million.

The amortized cost and the fair value of securities as of June 30, 2022 and December 31, 2021 were as follows:

June 30, 2022 December 31, 2021

The amortized cost and the fair value of securities as of September 30, 2022 and December 31, 2021 were as follows:

September 30, 2022 December 31, 2021

(dollars in thousands) Amortized

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Total Investment Portfolio $ 1,576,143 $ 1,295,512 $ 1,376,969 $ 1,398,558

At June 30, 2022 and December 31, 2021, there were no holdings of securities of any one issuer, other than the U.S.

The Company elected to transfer $151.4 million in net book value of municipal bonds from the available-for-sale securities portfolio to held-to-maturity on April 1, 2022 as part of an overall balance sheet management strategy.

The fair value of securities transferred was $127.0 million.

At September 30, 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.

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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 $313.9 million in the first six months of 2022.

Purchases of securities available-for-sale totaled $313.9 million in the first nine months of 2022.

The purchases consisted of U.S.

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The investment security purchases reflect the deployment of excess liquidity to the available-for-sale investment securities portfolio.

Investment securities represented 22.8% of total assets on June 30, 2022 compared to 21.3% of total assets on December 31, 2021.

The Company paused additions to the investment securities portfolio at the end of the second quarter as excess liquidity on the balance sheet was reduced by loan growth and deposit outflows during the quarter.

Management expects to use cash flows from the investment securities portfolio to help fund loan growth and for the investment securities portfolio to represent a lower percent of total assets over time.

Paydowns from prepayments and scheduled payments of $53.9 million were received in the first six months of 2022, and the amortization of premiums, net of the accretion of discounts, was $3.2 million.

Maturities and calls of securities totaled $5.7 million in the first six months of 2022.

There were no sales of available-for-sale investment securities in the first six months of 2022.

No allowance for credit losses was recognized for available-for-sale or held-to-maturity securites in the first six months of 2022.

The fair value of the investment securities portfolio as of June 30, 2022 included an unrealized losses of $175.6 million compared to unrealized gains of $21.6 million as of December 31, 2021.

Unrealized losses in the investment securities portfolio resulted from rising interest rates during the first six months 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 a minimal level.

Investment securities represented 21.0% of total assets on September 30, 2022, compared to 21.3% of total assets on December 31, 2021.

The Company deployed $35.0 million of cash flows from the investment securities portfolio to fund loan growth during 2022 and expects the investment securities portfolio to represent a lower percentage of total assets over time, towards historical levels of 14% of total assets.

Paydowns from prepayments and scheduled payments of $77.5 million were received in the first nine months of 2022, and the amortization of premiums, net of the accretion of discounts, was $4.8 million.

Maturities and calls of securities totaled $8.5 million in the first nine months of 2022.

There were no sales of available-for-sale investment securities in the first nine months of 2022.

No allowance for credit losses was recognized for available-for-sale or held-to-maturity securities in the first nine months of 2022.

The fair value of the available-for-sale investment securities portfolio as of September 30, 2022 included unrealized losses of $256.1 million compared to unrealized gains of $21.6 million as of December 31, 2021.

Unrealized losses in the available-for-sale investment securities portfolio resulted from the rising interest rate environment during the first nine months of 2022.

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 $4.8 million, or 64.6%, to $2.6 million at June 30, 2022, from $7.5 million at December 31, 2021.

Real estate mortgage loans held-for-sale decreased by $6.4 million, or 85.3%, to $1.1 million at September 30, 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 $28.4 million in the first six months of 2022 compared to $71.0 million in the first six 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 mortgage interest rates that have occurred during the first half of 2022.

Proceeds from sales of residential mortgages totaled $34.3 million in the first nine months of 2022 compared to $98.7 million in the first nine months of 2021.

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets.

The unpaid principal balances of these loans were $379.8 million and $375.4 million as of June 30, 2022 and December 31, 2021, respectively.

The unpaid principal balances of loans serviced for others were $372.3 million and $375.4 million as of September 30, 2022 and December 31, 2021, respectively.

Loan Portfolio

The loan portfolio by portfolio segment as of June 30, 2022 and December 31, 2021 is summarized as follows:

(dollars in thousands) June 30,

The loan portfolio by portfolio segment as of September 30, 2022 and December 31, 2021 is summarized as follows:

(dollars in thousands) September 30,

2022 December 31,

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Loans, net $ 4,422,596 $ 4,220,068 $ 202,528

Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, increased by $136.1 million to $4.427 billion at June 30, 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 $157.8 million, as of June 30, 2022 as compared to December 31, 2021.

The following table summarizes the Company’s non-performing assets as of June 30, 2022 and December 31, 2021:

(dollars in thousands) June 30,

Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, increased by $201.2 million to $4.492 billion at September 30, 2022 from $4.291 billion at December 31, 2021.

The increase was primarily driven by originations of loans concentrated in the commercial and industrial and commercial real estate and multi-famly residential categories and was offset by seasonal paydowns in the agri-business and agricultural loans segments.

Total loans, excluding PPP loans, increased by $226.5 million, as of September 30, 2022 as compared to December 31, 2021.

The following table summarizes the Company’s non-performing assets as of September 30, 2022 and December 31, 2021:

(dollars in thousands) September 30,

2022 December 31,

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Adoption of this standard was retrospective to January 1, 2022.

Total nonperforming assets decreased by $2.5 million, or 16.3%, to $12.8 million during the six month period ended June 30, 2022.

The ratio of nonperforming assets to total assets at June 30, 2022 decreased from 0.23% at December 31, 2021 to 0.20% at June 30, 2022.

Total nonperforming assets decreased by $5.2 million, or 33.8%, to $10.1 million during the nine month period ended September 30, 2022.

The ratio of nonperforming assets to total assets decreased from 0.23% at December 31, 2021 to 0.16% at September 30, 2022.

A loan is individually analyzed when full payment under the original loan terms is not expected.

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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 $5.6 million to $20.0 million at June 30, 2022 from $25.6 million at December 31, 2021.

Total individually analyzed loans decreased by $8.3 million to $17.3 million at September 30, 2022 from $25.6 million at December 31, 2021.

Loans are charged against the allowance for credit losses when management believes that the principal is uncollectible.

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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 June 30, 2022, the allowance for credit losses was 1.53% of total loans outstanding, versus 1.58% of total loans outstanding at December 31, 2021.

At June 30, 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.

At September 30, 2022, the allowance for credit losses was 1.50% of total loans outstanding, versus 1.58% of total loans outstanding at December 31, 2021.

At September 30, 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.

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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 June 30, 2022, based on management’s review of the loan portfolio, the Company had 57 credit relationships totaling $192.1 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 six months of 2022 resulted primarily from paydowns and borrower risk rating upgrades to previously classified loans on the non-individually analyzed portion of the watchlist.

As of June 30, 2022, the Company had $149.8 million of assets classified as Special Mention, $42.3 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.

The Company manages this risk by utilizing relatively 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 September 30, 2022, based on management’s review of the loan portfolio, the Company had 55 credit relationships totaling $163.2 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 nine months of 2022 resulted primarily from paydowns and borrower risk rating upgrades to previously classified loans on the non-individually analyzed portion of the watchlist.

As of September 30, 2022, the Company had $121.0 million of assets classified as Special Mention, $42.1 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.

Watch list loans as a percentage of total loans, excluding PPP loans, decreased to a historical low of 3.64% as of September 30, 2022, compared to 5.50% as of 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.

1 unchanged sentence

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.

In accordance with applicable 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 $250,000, from $67.8 million at December 31, 2021 to $67.5 million at June 30, 2022.

The allowance for credit losses decreased $534,000, from $67.8 million at December 31, 2021 to $67.2 million at September 30, 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.

1 unchanged sentence

Sources of Funds

The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the six months ended June 30, 2022 and 2021 are summarized in the following table:

Six months ended June 30,

The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the nine months ended September 30, 2022 and 2021 are summarized in the following table:

Nine months ended September 30,

(dollars in thousands) Balance Rate Balance Rate

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Deposits and Borrowings

As of June 30, 2022, total deposits decreased by $113.8 million, or 2.0%, from December 31, 2021.

Core deposits decreased by $113.8 million to $5.612 billion as of June 30, 2022 from $5.725 billion as of December 31, 2021.

Total brokered deposits were $10.0 million at June 30, 2022 compared to $10.0 million at December 31, 2021 reflecting a $5,000 increase during the first six months of 2022.

Since December 31, 2021, the change in core deposits was comprised of increases in public funds deposits of $173.5 million, and decreases of commercial deposits of $169.9 million, and retail deposits of $117.5 million.

funds deposits, including public funds transaction accounts, were $1.458 billion at June 30, 2022 and $1.285 billion at December 31, 2021.

The following table summarizes deposit composition at June 30, 2022 and December 31, 2021:

(dollars in thousands) June 30,

As of September 30, 2022, total deposits decreased by $71.3 million, or 1.2%, from December 31, 2021.

Core deposits, which excludes brokered deposits, decreased by $71.3 million to $5.654 billion as of September 30, 2022 from $5.725 billion as of December 31, 2021.

Total brokered deposits were $10.0 million at September 30, 2022 and December 31, 2021.

Since December 31, 2021, the change in core deposits was comprised of increases in public funds deposits of $196.5 million, and decreases in commercial deposits of $145.8 million, and in retail deposits of $121.9 million.

Total public funds deposits, including public funds transaction accounts, were $1.481 billion at September 30, 2022 and $1.285 billion at December 31, 2021.

The following table summarizes deposit composition at September 30, 2022 and December 31, 2021:

(dollars in thousands) September 30,

2022 December 31,

5 unchanged sentences

Total deposits $ 5,664,133 $ 5,735,407 $ (71,274)

During the three months ended June 30, 2022, the Company repaid a $75.0 million putable advance with the FHLB.

During the nine months ended September 30, 2022, the Company repaid a $75.0 million putable advance with the FHLB.

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.

As of June 30, 2022, total stockholders’ equity was $562.1 million, a decrease of $142.8 million, or 20.3%, from $704.9 million at December 31, 2021.

As of September 30, 2022, total stockholders’ equity was $519.2 million, a decrease of $185.7 million, or 26.3%, from $704.9 million at December 31, 2021.

Net income of $77.8 million increased equity.

Offsetting the increase to stockholders’ equity was a decrease of $174.6 million in accumulated other comprehensive income (loss), which was primarily driven by a net decrease in the fair value of available-for-sale securities.

Offsetting this increase to stockholders’ equity was a decrease of $237.8 million in accumulated other comprehensive income (loss), which was primarily driven by a net decrease in the fair value of available-for-sale securities.

Dividends declared and paid of $1.20 per share, or $30.6 million, also contributed the decrease to total stockholders' equity.

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banking organizations.

As of June 30, 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 June 30, 2022 and December 31, 2021, are presented in the table below.

Capital ratios for June 30, 2022 are preliminary until the Call Report and FR Y-9C are filed.

As of September 30, 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 September 30, 2022 and December 31, 2021, are presented in the table below.

Capital ratios for September 30, 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 June 30, 2022:

As of September 30, 2022:

Total Capital (to Risk Weighted Assets)

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• 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 prices, values and sales volumes of residential and commercial real estate;

• 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 outcome of pending litigation and other claims we may be subject to from time to time;

• the anticipated phase out of most LIBOR tenors by mid-2023 and establishment of a new reference rate or rates;

10 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis