LAKELAND FINANCIAL CORP 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Stockholders and the Board of Directors of Lakeland Financial Corporation Warsaw, Indiana Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Lakeland Financial Corporation (the "Company") as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2022 and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO. Change in Accounting Principle As discussed in Note 4 to the financial statements, the Company has changed its method of accounting for credit losses effective January 1, 2021 due to the adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification No. 326, Financial Instruments - Credit Losses (“ASC 326”). The Company adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. Basis for Opinions The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. 56 Table of Contents Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Allowance for Credit Losses (ACL) – Qualitative Adjustments As described in Notes 1 and 4 to the consolidated financial statements and referred to in the change in accounting principle explanatory paragraph above, the Company adopted ASC 326 as of January 1, 2021, which among other things, required the Company to recognize expected credit losses over the contractual lives of financial asset carried at amortized costs, including loans receivables, utilizing the Current Expected Credit Losses (“CECL”) methodology. As of December 31, 2022, the ACL balance was $72,606,000. Estimates of expected credit losses are based on relevant information about current conditions, past events, and reasonable and supportable forward-looking forecasts regarding collectability of the reported amounts. The Company utilized a Probability of Default/ Loss Given Default model derived from historical charge-off data to construct a loss rate for each identified loan segment. The loss rates, subject to a floor, are then adjusted, for reasonable and supportable forecasts of relevant economic indicators as well as other environmental factors based on the risks present for each portfolio segment. The environmental factors (“qualitative adjustments”) include consideration of economic conditions and portfolio trends. We have identified auditing the qualitative adjustments as a critical audit matter as management’s determination of the qualitative adjustments used in the ACL is subjective and involves significant management judgments; and our audit procedures related to the qualitative adjustments involved a high degree of auditor judgment and required significant audit effort, including the need to involve more experienced audit personnel. The primary procedures we performed to address this critical audit matter included: • Testing th e effectiveness of controls over the qualitative adjustments used in the ACL calculation including controls addressing the: ◦ Significant assumptions and judgments applied in the development of the qualitative adjustments. ◦ Mathematical accuracy of the qualitative adjustments applied to the loan segments in the ACL calculation. • Substantively testing management's determination of the qualitative adjustments used in the ACL estimate, including: ◦ Testing management’s process for developing the qualitative adjustments, which included assessing the relevance and reliability of data used to develop the qualitative adjustments, including evaluating their judgments and assumptions for reasonableness. Among other procedures, our evaluation considered evidence from internal and external sources. 57 Table of Contents ◦ Analytically evaluating the qualitative adjustments for directional consistency, testing for reasonableness, and obtaining evidence for significant changes. ◦ Testing the mathematical accuracy of the qualitative adjustments applied to the loan segments in the ACL calculation. /s/ Crowe LLP Crowe LLP We have served as the Company’s auditor since 1983. South Bend, Indiana February 22, 2023 58 Table of Contents CONSOLIDATED BALANCE SHEETS (in thousands, except share data) December 31 2022 2021 ASSETS Cash and due from banks $ 80,992 $ 51,830 Short-term investments 49,290 631,410 Total cash and cash equivalents 130,282 683,240 Securities available-for-sale, at fair value 1,185,528 1,398,558 Securities held-to-maturity, at amortized cost (fair value of $ 111,029 and $ 0 respectively) 128,242 0 Real estate mortgage loans held-for-sale 357 7,470 Loans, net of allowance for credit losses of $ 72,606 and $ 67,773 4,637,790 4,220,068 Land, premises and equipment, net 58,097 59,309 Bank owned life insurance 108,407 97,652 Federal Reserve and Federal Home Loan Bank Stock 15,795 13,772 Accrued interest receivable 27,994 17,674 Goodwill 4,970 4,970 Other assets 134,909 54,610 Total assets $ 6,432,371 $ 6,557,323 LIABILITIES AND STOCKHOLDERS’ EQUITY LIABILITIES Noninterest bearing deposits $ 1,736,761 $ 1,895,481 Interest bearing deposits 3,723,859 3,839,926 Total deposits 5,460,620 5,735,407 Federal Funds purchased 22,000 0 Federal Home Loan Bank advances 275,000 75,000 Total borrowings 297,000 75,000 Accrued interest payable 3,186 2,619 Other liabilities 102,678 39,391 Total liabilities 5,863,484 5,852,417 Commitments, off-balance sheet risks and contingencies (Notes 1 and 17) STOCKHOLDERS’ EQUITY Common stock: 90,000,000 shares authorized, no par value 25,825,127 shares issued and 25,349,225 outstanding as of December 31, 2022 25,777,609 shares issued and 25,300,793 outstanding as of December 31, 2021 127,004 120,615 Retained earnings 646,100 583,134 Accumulated other comprehensive income (loss) ( 188,923 ) 16,093 Treasury stock, at cost ( 475,902 shares and 476,816 shares as of December 31, 2022 and 2021, respectively) ( 15,383 ) ( 15,025 ) Total stockholders’ equity 568,798 704,817 Noncontrolling interest 89 89 Total equity 568,887 704,906 Total liabilities and equity $ 6,432,371 $ 6,557,323 The accompanying notes are an integral part of these consolidated financial statements. 59 Table of Contents CONSOLIDATED STATEMENTS OF INCOME (in thousands, except share and per share data) Years Ended December 31 2022 2021 2020 NET INTEREST INCOME Interest and fees on loans Taxable $ 202,004 $ 170,081 $ 176,538 Tax exempt 1,664 470 647 Interest and dividends on securities Taxable 14,132 9,086 6,973 Tax exempt 19,553 13,033 8,577 Other interest income 2,214 549 368 Total interest income 239,567 193,219 193,103 Interest on deposits 36,281 14,827 29,342 Interest on borrowings Short-term 272 7 506 Long-term 127 297 247 Total interest expense 36,680 15,131 30,095 NET INTEREST INCOME 202,887 178,088 163,008 Provision for credit losses 9,375 1,077 14,770 NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 193,512 177,011 148,238 NONINTEREST INCOME Wealth advisory fees 8,636 8,750 7,468 Investment brokerage fees 2,318 1,975 1,670 Service charges on deposit accounts 11,595 10,608 10,110 Loan and service fees 12,214 11,922 10,085 Merchant and interchange fee income 3,560 3,023 2,408 Bank owned life insurance income 432 2,467 2,105 Interest rate swap fee income 579 1,035 5,089 Mortgage banking income 633 1,418 3,911 Net securities gains 21 797 433 Other income 1,874 2,725 3,564 Total noninterest income 41,862 44,720 46,843 NONINTEREST EXPENSE Salaries and employee benefits 58,530 57,882 49,413 Net occupancy expense 6,287 5,728 5,851 Equipment costs 5,763 5,530 5,766 Data processing fees and supplies 12,826 12,674 11,864 Corporate and business development 5,198 4,262 3,093 FDIC insurance and other regulatory fees 1,999 2,242 1,707 Professional fees 6,483 7,064 5,314 Other expense 13,124 8,905 8,197 Total noninterest expense 110,210 104,287 91,205 INCOME BEFORE INCOME TAX EXPENSE 125,164 117,444 103,876 Income tax expense 21,347 21,711 19,539 NET INCOME $ 103,817 $ 95,733 $ 84,337 BASIC WEIGHTED AVERAGE COMMON SHARES 25,528,328 25,475,994 25,469,242 BASIC EARNINGS PER COMMON SHARE $ 4.07 $ 3.76 $ 3.31 DILUTED WEIGHTED AVERAGE COMMON SHARES 25,712,538 25,620,105 25,573,941 DILUTED EARNINGS PER COMMON SHARE $ 4.04 $ 3.74 $ 3.30 The accompanying notes are an integral part of these consolidated financial statements. 60 Table of Contents CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands) Years Ended December 31 2022 2021 2020 Net income $ 103,817 $ 95,733 $ 84,337 Other comprehensive income (loss) Change in available-for-sale and transferred securities: Unrealized holding gain (loss) on securities available-for-sale arising during the period ( 261,256 ) ( 14,553 ) 20,148 Reclassification adjustment for amortization of unrealized losses on securities transferred to held-to-maturity 1,518 0 0 Reclassification adjustment for gains included in net income ( 21 ) ( 797 ) ( 433 ) Net securities gain (loss) activity during the period ( 259,759 ) ( 15,350 ) 19,715 Tax effect 54,549 3,224 ( 4,140 ) Net of tax amount ( 205,210 ) ( 12,126 ) 15,575 Defined benefit pension plans: Net gain (loss) on defined benefit pension plans 115 390 ( 105 ) Amortization of net actuarial loss 144 242 251 Net gain (loss) on activity during the period 259 632 146 Tax effect ( 65 ) ( 157 ) ( 36 ) Net of tax amount 194 475 110 Total other comprehensive income (loss), net of tax ( 205,016 ) ( 11,651 ) 15,685 Comprehensive income (loss) $ ( 101,199 ) $ 84,082 $ 100,022 The accompanying notes are an integral part of these consolidated financial statements. 61 Table of Contents CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (in thousands, except share and per share data) Accumulated Other Total Common Stock Retained Comprehensive Treasury Stockholders’ Noncontrolling Total Shares Amount Earnings Income (Loss) Stock Equity Interest Equity Balance at January 1, 2020 25,444,275 $ 114,858 $ 475,247 $ 12,059 $ ( 4,153 ) $ 598,011 $ 89 $ 598,100 Net income 84,337 84,337 84,337 Other comprehensive income, net of tax 15,685 15,685 15,685 Cash dividends declared, $ 1.20 per share ( 30,579 ) ( 30,579 ) ( 30,579 ) Treasury shares purchased under share repurchase plan ( 289,101 ) 0 ( 10,012 ) ( 10,012 ) ( 10,012 ) Treasury shares purchased under deferred directors' plan ( 11,566 ) 535 ( 535 ) 0 0 Treasury shares sold and distributed under deferred directors’ plan 5,748 ( 119 ) 119 0 0 Stock activity under equity incentive plans 90,392 ( 2,137 ) ( 2,137 ) ( 2,137 ) Stock based compensation expense 1,790 1,790 1,790 Balance at December 31, 2020 25,239,748 $ 114,927 $ 529,005 $ 27,744 $ ( 14,581 ) $ 657,095 $ 89 $ 657,184 Impact of adopting ASC 326, net of tax ( 6,951 ) ( 6,951 ) ( 6,951 ) Net income 95,733 95,733 95,733 Other comprehensive loss, net of tax ( 11,651 ) ( 11,651 ) ( 11,651 ) Cash dividends declared, $ 1.36 per share ( 34,653 ) ( 34,653 ) ( 34,653 ) Treasury shares purchased under deferred directors’ plan ( 8,820 ) 559 ( 559 ) 0 0 Treasury shares sold and distributed under deferred directors’ plan 5,664 ( 115 ) 115 0 0 Stock activity under equity incentive plans 64,201 ( 1,914 ) ( 1,914 ) ( 1,914 ) Stock based compensation expense 7,158 7,158 7,158 Balance at December 31, 2021 25,300,793 $ 120,615 $ 583,134 $ 16,093 $ ( 15,025 ) $ 704,817 $ 89 $ 704,906 Net income 103,817 103,817 103,817 Other comprehensive loss, net of tax ( 205,016 ) ( 205,016 ) ( 205,016 ) Cash dividends declared, $ 1.60 per share ( 40,851 ) ( 40,851 ) ( 40,851 ) Treasury shares purchased under deferred directors’ plan ( 7,641 ) 579 ( 579 ) 0 0 Treasury shares sold and distributed under deferred directors’ plan 8,555 ( 221 ) 221 0 0 Stock activity under equity incentive plans 47,518 ( 1,780 ) ( 1,780 ) ( 1,780 ) Stock based compensation expense 7,811 7,811 7,811 Balance at December 31, 2022 25,349,225 $ 127,004 $ 646,100 $ ( 188,923 ) $ ( 15,383 ) $ 568,798 $ 89 $ 568,887 The accompanying notes are an integral part of these consolidated financial statements. 62 Table of Contents CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Years Ended December 31 2022 2021 2020 Cash flows from operating activities: Net income $ 103,817 $ 95,733 $ 84,337 Adjustments to reconcile net income to net cash from operating activities: Depreciation 6,020 6,105 6,042 Provision for credit losses 9,375 1,077 14,770 Net loss on sale and write down of other real estate owned 96 67 0 Amortization of loan servicing rights 757 2,282 772 Net change in loan servicing rights valuation allowance ( 715 ) 0 715 Loans originated for sale, including participations ( 28,666 ) ( 119,439 ) ( 117,600 ) Net gain on sales of loans ( 1,028 ) ( 4,376 ) ( 4,510 ) Proceeds from sale of loans, including participations 36,454 126,391 114,244 Net (gain) loss on sale of premises and equipment 7 43 86 Net (gain) loss on sales and calls of securities available-for-sale ( 21 ) ( 797 ) ( 433 ) Net securities amortization 6,342 4,959 3,998 Stock based compensation expense 7,811 7,158 1,790 Earnings on life insurance ( 432 ) ( 2,467 ) ( 2,105 ) Gain on life insurance 0 ( 415 ) ( 730 ) Tax benefit of stock award issuances ( 514 ) ( 330 ) ( 71 ) Net change: Interest receivable and other assets ( 10,711 ) ( 1,852 ) ( 6,315 ) Interest payable and other liabilities 40,750 ( 371 ) ( 7,762 ) Total adjustments 65,525 18,035 2,891 Net cash from operating activities 169,342 113,768 87,228 Cash flows from investing activities: Proceeds from sale of securities available- for-sale 25,332 13,964 8,018 Proceeds from maturities, calls and principal paydowns of securities available-for-sale 108,129 137,812 97,998 Proceeds from maturities, calls and principal paydowns of securities held-to-maturity 30 0 0 Purchases of securities available-for-sale ( 315,272 ) ( 835,001 ) ( 216,478 ) Purchase of life insurance ( 10,808 ) ( 711 ) ( 10,409 ) Net (increase) decrease in total loans ( 427,097 ) 356,660 ( 587,377 ) Proceeds from sales of land, premises and equipment 6 8 658 Purchases of land, premises and equipment ( 4,821 ) ( 6,167 ) ( 5,719 ) Proceeds from redemption of Federal Home Loan Bank stock 932 0 0 Purchases of Federal Home Loan Bank stock ( 2,955 ) 0 0 Proceeds from sales of other real estate owned 0 946 0 Proceeds from life insurance 0 943 1,285 Net cash from investing activities ( 626,524 ) ( 331,546 ) ( 712,024 ) Cash flows from financing activities: Net increase (decrease) in total deposits ( 274,787 ) 698,602 902,986 Net increase (decrease) in short-term borrowings 22,000 ( 10,500 ) 10,500 Payments on short-term FHLB borrowings 0 0 ( 170,000 ) Proceeds from short-term FHLB borrowings 275,000 0 0 Payments on long-term FHLB borrowings ( 75,000 ) 0 0 Proceeds from long-term FHLB borrowings 0 0 75,000 Common dividends paid ( 40,838 ) ( 34,640 ) ( 30,566 ) Preferred dividends paid ( 13 ) ( 13 ) ( 13 ) Payments related to equity incentive plan ( 1,780 ) ( 1,914 ) ( 2,137 ) Purchase of treasury stock ( 579 ) ( 559 ) ( 10,547 ) Sales of treasury stock 221 115 119 Net cash from financing activities ( 95,776 ) 651,091 775,342 Net change in cash and cash equivalents ( 552,958 ) 433,313 150,546 Cash and cash equivalents at beginning of the year 683,240 249,927 99,381 Cash and cash equivalents at end of the year $ 130,282 $ 683,240 $ 249,927 Cash paid during the year for: Interest $ 36,113 $ 18,471 $ 35,740 Income taxes 20,580 25,947 19,355 Supplemental non-cash disclosures: Loans transferred to other real estate owned 0 893 35 Property transferred to held for sale 0 0 0 Right-of-use assets obtained in exchange for lease liabilities 1,612 0 0 The accompanying notes are an integral part of these consolidated financial statements. 63 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Principles of Consolidation: The consolidated financial statements include Lakeland Financial Corporation (the “Holding Company”) and its wholly owned subsidiaries, Lake City Bank (the “Bank”) and LCB Risk Management, Inc., together referred to as (the “Company”). On December 18, 2006, LCB Investments II, Inc. was formed as a wholly owned subsidiary of the Bank incorporated in Nevada to manage a portion of the Bank’s investment portfolio beginning in 2007. On December 21, 2006, LCB Funding, Inc., a real estate investment trust incorporated in Maryland, was formed as a wholly owned subsidiary of LCB Investments II, Inc. On December 28, 2012, LCB Risk Management, Inc., a captive insurance company incorporated in Nevada, was formed as a wholly owned subsidiary of the Holding Company. All intercompany transactions and balances are eliminated in consolidation. The Company provides financial services through the Bank, a full-service commercial bank with 52 branch offices in fifteen counties in Northern and Central Indiana. The Company provides commercial, retail, trust and investment services to its customers. Commercial products include commercial loans and technology-driven solutions to meet commercial customers’ treasury management needs such as mobile business banking and online treasury management services. Retail banking clients are provided a wide array of traditional retail banking services, including lending, deposit and investment services. Retail lending programs are focused on mortgage loans, home equity lines of credit and traditional retail installment loans. The Company provides credit card services to retail and commercial customers through its retail card program and merchant processing activity. The Company provides wealth advisory and trust clients with traditional personal and corporate trust services. The Company also provides retail brokerage services, including an array of financial and investment products such as annuities and life insurance. Other financial instruments, which represent potential concentrations of credit risk, include deposit accounts in other financial institutions. Use of Estimates: To prepare financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided and future results could differ. Cash Flows: Cash and cash equivalents include cash, demand deposits in other financial institutions and short-term investments and certificates of deposit with maturities of 90 days or less. Cash flows are reported net for customer loan and deposit transactions, and certain short-term borrowings. Securities: Securities are classified as available-for-sale when they might be sold before maturity. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss), net of tax. Securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Purchase premiums or discounts are recognized in interest income using the interest method over the terms of the securities or over estimated lives for mortgage-backed securities. Gains and losses on sales are based on the amortized cost of the security sold and recorded on the trade date. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likel y than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, nature of the security, the underlying collateral, and the financial condition of the issuer, among other factors. If this assessment indicates a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and a valuation allowance for securities losses is recorded for the credit loss, limited by the amount that the fair value is less than the 64 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) amortized cost basis. Any impairment that has not been recorded through a valuation allowance for securities losses is recognized in other comprehensive income (loss). Changes in the valuation allowance for securities losses are recorded as a component of credit loss expense. Losses are charged against the valuation allowance for securities losses when management believes the uncollectibility of the security is confirmed or when either criteria regarding intent or requirement to sell is met. A portion of the municipal bond portfolio is classified as held-to-maturity. The Company measures expected credit losses on investment securities held-to-maturity on a collective basis by major security type with each type sharing similar risk characteristics and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The Company considers (1) issuer bond ratings, (2) historical loss rates for given bond ratings, (3) the financial condition of the issuer, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities. Historical loss rates associated with securities having similar grades as those in the Company's portfolio have been insignificant. After completing this assessment, the Company determined any credit losses as of December 31, 2022 were not material to the consolidated financial statements. Real Estate Mortgage Loans Held-for-Sale: Loans held for sale are reported at the lower of cost or fair value on an aggregate basis. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Loan sales occur on the delivery date agreed to in the relevant commitment agreement. The Company retains servicing on the majority of loans sold. The carrying value of loans sold is reduced by the amount allocated to the servicing right. The gain or loss on the sale of loans is the difference between the carrying value of the loans sold and the funds received from the sale. Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for credit losses. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. All classes of commercial and industrial, commercial real estate and multi-family residential, agri-business and agricultural, other commercial and consumer 1-4 family mortgage loans for which collateral is insufficient to cover all principal and accrued interest are reclassified as nonaccrual loans, on or before the date when the loan becomes 90 days delinquent. When a loan is classified as a nonaccrual loan, interest on the loan is no longer accrued, all unpaid accrued interest is reversed and interest income is subsequently recorded on the cash-basis or cost-recovery method. Accrual status is resumed when all contractually due payments are brought current and future payments are reasonably assured. Other consumer loans are not placed on a nonaccrual status since these loans are charged-off when they have been delinquent from 90 to 180 days, and when the related collateral, if any, is not sufficient to offset the indebtedness. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated and individually analyzed loans. The recorded investment in loans is the loan balance net of unamortized deferred loan fees and costs. The total amount of accrued interest on loans as of December 31, 2022 and 2021 was $ 18.4 million and $ 10.0 million. Allowance for Credit Losses: The allowance for credit losses is a valuation allowance to provide for expected credit losses. Losses are charged against the allowance when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management's judgment, should be charged against the allowance. A provision for credit losses is taken based on management's ongoing evaluation of the appropriate allowance balance. A formal evaluation of the adequacy of the credit loss allowance is conducted monthly. The ultimate recovery of all loans is susceptible to future market factors beyond the Company's control. The determination of the appropriate allowance is inherently subjective, as it requires significant estimates by management. The Company has an established process to determine the adequacy of the allowance for credit losses that generally includes consideration of changes in the nature and volume of the loan portfolio and overall portfolio quality, along 65 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) with current and forecasted economic conditions that may affect borrowers' ability to repay. Consideration is not limited to these factors although they represent the most commonly cited factors. To determine the specific allocation levels for individual credits, management considers the current valuation of collateral and the amounts and timing of expected future cash flows as the primary measures. Management also considers trends in adversely classified loans based upon an ongoing review of those credits. With respect to pools of similar loans, an appropriate level of general allowance is determined by portfolio segment using a pr obability of default-loss given default ("PD/LGD") model, subject to a floor. A default can be triggered by one of several different asset quality factors, including past due status, nonaccrual status, material modification to a borrower experiencing financial difficulty or if the loan has had a charge-off. This PD is then combined with a LGD derived from historical charge-off data to construct a loss rate. This loss rate is then supplemented with adjustments for reasonable and supportable forecasts of relevant economic indicators, particularly the unemployment rate forecast from the Federal Open Market Committee's Summary of Economic Projections, as well as portfolio trends based on the risks present for each portfolio segment. These environmental factors include consideration of portfolio trends and conditions; industry conditions; and effects of changes in credit concentrations. It is also possible that these factors could include social, political, economic, and terrorist events or activities. All of these factors are susceptible to change, which may be significant. As a result of this detailed process, the allowance results in two forms of allocations, specific and general. These two components represent the total allowance for credit losses deemed adequate to cover expected losses within the loan portfolio. Commercial loans are subject to a dual standardized grading process administered by the credit administration function. These grade assignments are performed independent of each other, and a consensus is reached by credit administration and the loan officer. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that indicate it should be evaluated on an individual basis. Considerations with respect to specific allocations for these individual credits include, but are not limited to, the following: (a) the sufficiency of the customer's cash flow or net worth to repay the loan; (b) the adequacy of the discounted value of collateral relative to the loan balance; (c) whether the loan has been criticized in a regulatory examination; (d) whether the loan is nonperforming; (e) any other reasons the ultimate collectability of the loan may be in question; or (f) any unique loan characteristics that require special monitoring. Allocations are also applied to categories of loans considered not to be individually analyzed, but for which the rate of loss is expected to be consistent with or greater than historical averages. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. These general pooled loan allocations are performed for portfolio segments of commercial and industrial; commercial real estate, multi-family, and construction; agri-business and agricultural; other commercial loans; and consumer 1-4 family mortgage and other consumer loans. General allocations of the allowance are determined by a historical loss rate based on the calculation of each pool's probability of default-loss given default, subject to a floor. The length of the historical period for each pool is based on the average life of the pool. The historical loss rates are all supplemented with consideration of economic conditions and portfolio trends. The risk characteristics of each of the identified portfolio segments are as follows: Commercial and Industrial - Borrowers may be subject to industry conditions including decreases in product demand; increase in material or other production costs that cannot be immediately recaptured in the sales or distribution cycle; interest rate increases that could have an adverse impact on profitability; non-payment of credit that has been extended under normal vendor terms for goods sold or services; and interruption related to the importing or exporting of production materials or sold products. Commercial Real Estate and Multi-Family Residential - Borrowers may be subject to potential adverse market conditions that cause a decrease in market value or lease rates; the potential for environmental impairment from events occurring on subject or neighboring properties; and obsolescence in location or function. Multi-Family Residential is also subject to adverse market conditions associated with a change in governmental or personal funding sources for tenants; over supply of units in a specific region; a shift in population; and reputational risks. Construction and Land Development risks include slower absorption than anticipated on speculative projects; deterioration in market conditions that may impact a project's value; unforeseen costs not considered in the original construction budget; or any other factors that may impact the completion or success of the project. Agri-business and Agricultural - Borrowers may be subject to adverse market or weather conditions including changes in local or foreign demand; lower yields than anticipated; political or other impact on storage, distribution or use; foreign trade policies including tariffs; and exposure to increasing commodity prices which result in higher production, distribution or exporting costs. Other Commercial - Borrowers may be subject to an interruption in the flow of funds to states and other political subdivisions for the purpose of debt repayments on loans held by the Bank. 66 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Consumer 1-4 Family Mortgage - Borrowers may be subject to adverse employment conditions in the local economy leading to increased default rates; decreased market values from oversupply in a geographic area; and impact to the borrowers' ability to maintain payments in the event of incremental rate increases on adjustable rate mortgages. Other Consumer - Borrowers may be subject to adverse employment conditions in the local economy which may lead to higher default rates; and decreases in the value of underlying collateral. A loan is individually analyzed for specific allocation when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Allocations are analyzed individually or in total for smaller-balance loans of similar nature such as all classes of consumer 1-4 family and other consumer loans, and individually for all classes of commercial and industrial, commercial real estate and multi-family, agribusiness and agricultural and other commercial loans. The Company analyzes commercial loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis for Special Mention, Substandard and Doubtful grade loans and annually on Pass grade loans over $ 250,000 . Factors considered by management in determining individual evaluation include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as individually evaluated. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is individually evaluated, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral less anticipated costs to sell. All classes of commercial and industrial, commercial real estate and multifamily residential, agribusiness and agricultural, other commercial, consumer 1-4 family mortgage loans and other consumer loans that become delinquent beyond 90 days are analyzed and a charge-off is taken when it is determined that the underlying collateral, if any, is not sufficient to offset the indebtedness. Loans, for which the terms have been modified for borrowers experiencing financial difficulties and a concession has been granted that could materially change the Company's expected future cash flows, are classified as individually evaluated and may be either accruing or non-accruing. Modifications to borrowers experiencing financial difficulties on nonaccrual status follow the same policy as described above for other loans. Individual evaluation for modifications to borrowers experiencing financial difficulty is measured at the present value of estimated future cash flows using the loan’s effective rate at inception or at discounted collateral value for collateral dependent loans. Due to the imprecise nature of estimating the allowance for credit losses, the Company's allowance for credit losses includes an immaterial unallocated component. The unallocated component of the allowance for credit losses incorporates the Company's judgmental determination of potential expected losses that may not be fully reflected in other allocations. As a practical expedient, the Company has elected to disclose accrued interest separately from loan principal balances on the consolidated balance sheet. Additionally, when a loan is placed on non-accrual, interest payments are reversed through interest income. For off balance sheet credit exposures outlined in the ASC at 326-20-30-11, it is the Company's position that nearly all of the unfunded amounts on lines of credit are unconditionally cancellable, and therefore not subject to having a liability recorded. Investments in Limited Partnerships: The Company enters into and invests in limited partnerships in order to invest in affordable housing projects to support Community Reinvestment Act activities and secondarily to obtain available tax benefits. The Company also invests in Small Business Investment Company Program funds. The Company is a limited partner in these investments and, as such, the Company is not involved in the management or operation of such investments. These investments are accounted for using the equity method of accounting. Under the equity method of accounting, the Company records its share of the partnership’s earnings or losses in its income statement and adjusts the carrying amount of the investments on the consolidated balance sheet. These investments are evaluated for impairment when events indicate the carrying amount may not be recoverable. The investments recorded at December 31, 2022 and 2021 were $ 12.2 million and $ 9.4 million, respectively and are included with other assets in the consolidated balance sheet. The Company also has a commitment to fund an additional $ 3.9 million at December 31, 2022 in six of the limited partnerships compared to $ 2.2 million in five of the limited partnerships at December 31, 2021, which is included with other liabilities in the consolidated balance sheet. 67 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Foreclosed Assets: Assets acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. If fair value declines, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed. At December 31, 2022 and 2021, the balance of other real estate owned was $ 100,000 and $ 196,000 , respectively, and is included with other assets on the consolidated balance sheet. Land, Premises and Equipment, Net: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the useful lives of the assets. Premises and improvements assets have useful lives between 5 and 40 years. Equipment and furniture assets have useful lives between 3 and 7 years. Loan Servicing Rights: Servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in mortgage banking income . Fair value is based on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. The amortization of servicing rights is netted against mortgage banking income. Servicing fees were $ 1.2 million for the years ended 2022, 2021 and 2020. Late fees and ancillary fees related to loan servicing are not material. Servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as loan type, term and interest rate. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in the valuation allowance are reported with mortgage banking income on the income statement. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses. The carrying value of mortgage servicing rights, which is included with other assets in the consolidated balance sheet, was $ 2.7 million and $ 2.4 million as of December 31, 2022 and 2021, respectively. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans were $ 364.3 million and $ 375.4 million at December 31, 2022 and 2021, respectively. Custodial escrow balances maintained in connection with serviced loans were $ 1.7 million at year end 2022 and 2021. Servicing fee income (loss), which is included in loan and service fees on the income statement, is recorded for fees earned for servicing loans. Fees earned for servicing loans are based on a contractual percentage of the outstanding principal amount of the loan and are recorded as income when earned. Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. 68 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Mortgage Banking Derivatives: Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free-standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in fair values of these derivatives are included in mortgage banking income. Interest Rate Swap Derivatives: The Company offers a derivative product to certain creditworthy commercial banking customers. This product allows the commercial banking customers to enter into an agreement with the Company to swap a variable rate loan to a fixed rate. These derivative products are designed to reduce, eliminate or modify the borrower’s interest rate exposure. The extension of credit incurred in connection with these derivative products is subject to the same approval and underwriting standards as traditional credit products. The Company limits its risk exposure by simultaneously entering into a similar, offsetting swap agreement with a separate, well-capitalized and highly rated counterparty previously approved by the Company’s Asset Liability Committee. By using these interest rate swap arrangements, the Company is also better insulated from the interest rate risk associated with underwriting fixed-rate loans and is better able to meet customer demand for fixed rate loans. These derivative contracts are not designated against specific assets or liabilities and, therefore, do not qualify for hedge accounting. The derivatives are recorded as assets and liabilities on the balance sheet at fair value with changes in fair value recorded in non-interest income for both the commercial banking customer swaps and the related offsetting swaps. The fair value of the derivative instruments incorporates a consideration of credit risk (in accordance with ASC 820), resulting in some potential volatility in earnings each period. The notional amount of the combined interest rate swaps with customers and counterparties at December 31, 2022 and 2021 was $ 760.5 million and $ 796.0 million, respectively. The fair value of the interest rate swap asset was $ 36.9 million and $ 14.3 million and the fair value of the interest rate swap liability was $ 36.9 million and $ 14.3 million at December 31, 2022 and 2021, respectively. The Company was a party in risk participation transactions of interest rate swaps. There were no total notional swaps at December 31, 2022 compared to $ 4.6 million at December 31, 2021. Bank Owned Life Insurance: At December 31, 2022 and 2021, the Company owned $ 102.5 million and $ 91.1 million, respectively, of life insurance policies on certain officers to provide a life insurance benefit for these officers. At December 31, 2022 and 2021, the Company also owned $ 5.9 million and $ 6.6 million, respectively, of variable life insurance on certain officers related to a deferred compensation plan. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, i.e., the cash surrender value adjusted for other changes or other amounts due that are probable at settlement. Goodwill and Other Intangible Assets: All goodwill on the Company’s consolidated balance sheet resulted from business combinations prior to January 1, 2009 and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is not amortized, but assessed at least annually for impairment and any such impairment would be recognized in the period identified. FHLB and Federal Reserve Bank Stock: FHLB and Federal Reserve Bank stock are carried at cost in other assets, classified as a restricted security and are periodically evaluated for impairment based on ultimate recoverability of par value. Both cash and stock dividends are reported as income. Long-term Assets: Premises and equipment, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. There was no such impairment identified for the years ended December 31, 2022, 2021 and 2020. 69 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Benefit Plans: The Company has a noncontributory defined benefit pension plan, which covered substantially all employees until the plan was frozen effective April 1, 2000. Funding of the plan equals or exceeds the minimum funding requirement determined by the actuary. Pension expense is the net of interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Benefits are based on years of service and compensation levels. The Company maintains a 401(k) profit sharing plan for all employees meeting certain age and service requirements. The Company contributions are based upon the percentage of budgeted net income earned during the year. An employee deferred compensation plan is available to certain employees with returns based on investments in mutual funds. The Company maintains a directors’ deferred compensation plan. Effective January 1, 2003, the directors’ deferred compensation plan was amended to restrict the deferral to be in stock only and deferred directors’ fees are included in equity. The Company acquires shares on the open market and records such shares as treasury stock. Revenue Recognition: All of the Company’s revenue from contracts with customers in the scope of ASC 606 is recognized within noninterest income. The following is a description of principal activities from which we generate revenue. Revenues are recognized as the Company satisfies its obligations with our customers, in an amount that reflects the consideration that we expect to receive in exchange for those services. Wealth advisory fees The Company provides wealth advisory services to its customers and earns fees from its contracts with trust customers to manage assets for investment and/or to transact on their accounts. These fees are primarily earned over time as the Company provides the contracted monthly, quarterly, or annual services and are generally assessed based on a tiered scale of the market value of assets under management (AUM) at month-end. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed. Other related services, such as escrow accounts that are based on a fixed schedule, are recognized when the services are rendered. Investment brokerage services The Company provides investment brokerage services through a full service brokerage and investment and advisory firm, Cetera Investment Services LLC (“Cetera”). The Company receives commissions from Cetera on a monthly basis based upon customer activity for the month. The fees are recognized monthly and a receivable is recorded until commissions are generally paid by the 5th business day of the following month. Because the Company (i) acts as an agent in arranging the relationship between the customer and the Cetera and (ii) does not control the services to the customers, investment brokerage service fees are presented net of Cetera’s related costs. Service charges on deposit accounts The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s balance. Interchange income The Company provides the ability to transact on certain deposit accounts through the use of debit cards by outsourcing the services through third party service providers. Performance obligations are met on a transactional basis and income is recognized monthly based on transaction type and volume. Under the accounting standards in effect in the prior period, revenue was previously recognized net of the third party’s costs. Under ASC 606, fees from interchange income related to its customers use of debit cards will be reported gross in loan and service fees under noninterest income. The cost of using third party providers for these interchange services are reported in data processing fees and supplies under noninterest expense. 70 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Gain on sale of other real estate owned ("OREO") financed by seller On occasion, the Company underwrites a loan to purchase property owned by the Company. Under ASC 606, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. Debit card incentive rebates The Company receives incentive rebates based on debit card transaction volume. Performance obligations are met on a transactional basis and income is recognized monthly based on transaction volume. Under ASC 606, these rebates related to debit card transaction volume are reported as a contra expense in data processing fees and supplies under noninterest expense. Stock Based Compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant adjusted for the present value of expected dividends is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. Certain of the restricted stock awards are performance based, as more fully discussed in Note 14 – Stock Based Compensation. Income Taxes: Annual consolidated federal and state income tax returns are filed by the Company. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Income tax expense is recorded based on the amount of taxes due on its tax return plus net deferred taxes computed based upon the expected future tax consequences of temporary differences between carrying amounts and tax basis of assets and liabilities, using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is more likely of being realized on examination than not. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters in income tax expense. Off-Balance Sheet Financial Instruments: Financial instruments include credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. The fair value of standby letters of credit is recorded as a liability during the commitment period. Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options, restricted stock awards and warrants. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements. The common shares included in treasury stock for 2022 and 2021 were 475,902 and 476,816 shares, respectively. Common stock that has been purchased under the directors’ deferred compensation plan, described above, is included in the treasury stock total and represented 186,801 and 187,715 shares of treasury stock as of December 31, 2022 and 2021, respectively. Because these shares are held in trust for the participants, 71 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) they are treated as outstanding when computing the weighted-average common shares outstanding for the calculation of both basic and diluted earnings per share. During the year ended December 31, 2020, the Company repurchased 289,101 of its common shares at a weighted average price of $ 34.63 per share. Treasury stock is carried at cost. Comprehensive Income (Loss): Comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale, reclassification adjustments for securities transferred to held-to-maturity, reclassification adjustments for gains on the sale of available-for-sale securities and changes in the funded status of the pension plan, which are also recognized as separate components of equity. Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. 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 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. On October 26, 2022, the trustee filed his second amended complaint which was virtually identical to his amended complaint. On January 5, 2023, the Bank, the Company and the five individual bank representatives filed motions to dismiss the second amended complaint. The motions are being briefed and will then be considered by the court. 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 this amended complaint. Restrictions on Cash: The Federal Reserve Bank eliminated the reserve requirement for all depository institutions in March of 2020. Therefore, the Company was not required to have cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve and clearing requirements at December 31, 2022 and 2021. Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to its stockholders. These restrictions currently pose no practical limit on the ability of the Bank or Company to pay dividends at historical levels. Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disc losed in Note 5 - Fair Value. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. 72 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Operating Segments: The Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. All of the Company’s financial service operations are similar and considered by management to be aggregated into one reportable operating segment. While the Company has assigned certain management responsibilities by region and business-line, the Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. The majority of the Company’s revenue is from the business of banking and the Company’s assigned regions have similar economic characteristics, products, services and customers. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable operating segment. Newly Issued Accounting Standards: On March 12, 2020, the FASB issued Accounting Standards Update (ASU) 2020-04, "Reference Rate Reform (ASC 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." ASC 848 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The Company has formed a cross-functional project team to lead the transition from LIBOR to a planned adoption of reference rates which could include Secured Overnight Financing Rate ("SOFR"), amongst others. The Company has identified certain loans that renewed prior to 2021 and obtained updated reference rate language at the time of the renewal. Additionally, management is utilizing the timeline guidance published by the Alternative Reference Rates Committee to develop and achieve internal milestones during this transitional period. The Company's policy is to adhere to the International Swaps and Derivatives Association 2020 IBOR Fallbacks Protocol that was released on October 23, 2020. The Company discontinued the use of new LIBOR-based loans by December 31, 2021, according to regulatory guidelines. The Company is working to transition LIBOR-based loans to an alternative reference rate before June 30, 2023. On December 22, 2022, the FASB issued ASU 2022-06, "Reference Rate Reform (ASC 848): Deferral of the Sunset Date of Topic 848", which definitively provided a sunset date of December 31, 2024 for the relief guidance allowed under Topic 848. The ASU was effective immediately upon issuance. The Company adopted the LIBOR transition relief allowed under this standard, and does not expect final adoption to have a material impact on the consolidated financial statements. On March 28, 2022, the FASB issued ASU 2022-01, "Derivatives and Hedging (ASC 815): Fair Value Hedging - Portfolio Layer Method." ASC 815 currently permits only prepayable financial assets and one or more beneficial interests secured by a portfolio of prepayable financial instruments to be included in a last-of-layer closed portfolio. The amendment in this update allows nonrepayable financial assets to also be included in a closed portfolio hedged using the portfolio layer method. That expanded scope permits an entity to apply the same portfolio hedging method to both prepayable and nonprepayable financial assets, thereby allowing consistent accounting for similar hedges. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. The Company does not expect the adoption of this standard to have a material impact on the consolidated financial statements. On March 31, 2022, the FASB issued ASU 2022-02, "Financial Instruments - Credit Losses (ASC 326): Troubled Debt Restructurings (TDRs) and Vintage Disclosures." The guidance amends ASC 326 to eliminate the accounting guidance for TDR's by creditors, while enhancing disclosure requirements for certain loan refinancing and restructuring activities by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying TDR recognition and measurement guidance, creditors will determine whether a modification results in a new loan or continuation of an existing loan. These amendments are intended to enhance existing disclosure requirements and introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty. Additionally, the amendments to ASC 326 require that an entity disclose current-period gross write-offs by year of origination within the vintage disclosures, which requires that an entity disclose the amortized cost basis of financing receivables by credit quality indicator and and class of financing receivable by year of origination. The guidance is only for entities that have adopted the amendments in update 2016-13 for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption using prospective application, including adoption in an interim period where the guidance should be applied as of the beginning of the fiscal year, is permitted. The Company elected to early adopt the provisions of the ASU related to modifications made to borrowers experiencing financial difficulty during the second quarter of 2022, with retrospective application to January 1, 2022. Adoption of this portion of the standard did not have a material impact on the consolidated financial statements. The Company is currently assessing the impact of the vintage disclosure provisions of ASU 2022-02 on its disclosures; however, the Company does not expect the adoption of this portion of the standard to have a material impact on the consolidated financial statements. 73 Table of Contents NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Newly Proposed Accounting Standards On August 22, 2022, the FASB released a proposed ASU, "Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (a consensus of the Emerging Issues Task Force)." The amendments in this proposed update would permit reporting entities to account for their tax equity investments, regardless of the program from which the tax credits are received, using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the income tax credits and other income tax benefits received and recognizes the net amortization and income tax credits and other income tax benefits in the income statement as a component of income tax expense (benefit). A reporting entity would make an accounting policy election to apply the proportional amortization method on a tax-credit-program-by-tax-credit-program basis rather than to apply the proportional amortization method at the reporting entity level or to individual investments. The proposal would require specific disclosures for all tax equity investments in a program to which an entity has elected to apply the proportional amortization method. The proposed amendments call for application on a modified prospective or a retrospective basis. The proposed ASU includes an effective date for fiscal years, and interim fiscal periods within those fiscal years, beginning after December 15, 2023. The Company plans to assess the impact of the proposed amendments on the consolidated financial statements once the final ASU is issued. On October 6, 2022, the FASB released a proposed ASU, "Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures." The amendments in this proposed update would improve reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses on an interim and annual basis. Significant expense categories and amounts subject to disclosure would be derived from expenses that are (1) regularly reported to an entity's chief operating decision-maker (CODM) and (2) included in a segment's reported measure of profit or loss. Public entities would also be required to disclose an amount for other segment items by reportable segment and a description of composition. The other segment items category is the difference between segment revenue less the significant expenses disclosed under the significant expense principle and each reported measure of segment profit or loss. The amendment would also require all annual disclosures about a reportable segment's profit or loss and assets currently required by Topic 280 to be disclosed for interim periods. Additionally, the proposed amendments would also require the disclosure of the name and title of the CODM. The proposed amendments call for retrospective application. The proposed ASU does not yet include an effective date. The Company plans to assess the impact of the proposed amendments on the consolidated financial statements once the final ASU is issued. Reclassifications: Certain amounts appearing in the financial statements and notes thereto for prior periods have been reclassified to conform with the current presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported. NOTE 2 – SECURITIES Debt securities purchased with the intent and ability to hold to their maturity are classified as held-to-maturity securities. All other investment securities are classified as available-for-sale securities. Available-for-Sale Securities Information related to the amortized cost, fair value and allowance for credit losses of securities available-for-sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) at December 31, 2022 and 2021 is provided in the tables on the next page. 74 Table of Contents NOTE 2 – SECURITIES (continued) (dollars in thousands) Amortized Cost Gross Unrealized Gain Gross Unrealized Losses Allowance for Credit Losses Fair Value 2022 U.S. Treasury securities $ 3,057 $ 0 $ ( 23 ) $ 0 $ 3,034 U.S. government sponsored agencies 156,184 0 ( 29,223 ) 0 126,961 Mortgage-backed securities: residential 578,175 67 ( 85,934 ) 0 492,308 Mortgage-backed securities: commercial 0 0 0 0 0 State and municipal securities 663,367 157 ( 100,299 ) 0 563,225 Total $ 1,400,783 $ 224 $ ( 215,479 ) $ 0 $ 1,185,528 2021 U.S. Treasury securities $ 900 $ 0 $ 0 $ 0 $ 900 U.S. government sponsored agencies 145,858 39 ( 2,445 ) 0 143,452 Mortgage-backed securities: residential 487,157 4,455 ( 4,936 ) 0 486,676 Mortgage-backed securities: commercial 522 1 0 0 523 State and municipal securities 742,532 25,749 ( 1,274 ) 0 767,007 Total $ 1,376,969 $ 30,244 $ ( 8,655 ) $ 0 $ 1,398,558 Held-to-Maturity Securities Information related to the amortized cost, fair value and allowance for credit losses of securities held-to-maturity and the related gross gains and unrealized gains and losses at December 31, 2022 is presented in the table below. (dollars in thousands) Amortized Cost Gross Unrealized Gain Gross Unrealized Losses Allowance for Credit Losses Fair Value 2022 State and municipal securities $ 128,242 $ 0 $ ( 17,213 ) $ 0 $ 111,029 On April 1, 2022, the Company elected to transfer securities from available-for-sale to held-to-maturity as an overall balance sheet management strategy. The fair value of securities transferred was $ 127.0 million from available-for-sale to held-to-maturity. The unrealized loss on the securities transferred from available-for-sale to held-to-maturity was $ 24.4 million ($ 19.3 million, net of tax) based on the fair value of the securities on the transfer date and was $ 22.9 million ($ 18.1 million, net of tax) at December 31, 2022. The Company has the current intent and ability to hold the transferred securities until maturity. Any net unrealized gain or loss on the transferred securities included in accumulated other comprehensive income (loss) at the time of the transfer will be amortized over the remaining life of the underlying security as an adjustment to the yield on those securities. There were no securities transferred from available-for-sale to held-to-maturity during the year ended December 31, 2021 and there were no securities classified as held-to-maturity at December 31, 2021. Information regarding the fair value and amortized cost of available-for-sale and held-to-maturity debt securities by maturity as of December 31, 2022 is presented on the next page. Maturity information is based on contractual maturity for all securities other than mortgage-backed securities. Actual maturities of securities may differ from contractual maturities because borrowers may have the right to prepay the obligation without prepayment penalty. 75 Table of Contents NOTE 2 – SECURITIES (continued) Available-for-Sale Held-to-Maturity (dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Due in one year or less $ 3,073 $ 3,059 $ 0 $ 0 Due after one year through five years 6,443 6,431 0 0 Due after five years through ten years 57,481 55,437 0 0 Due after ten years 755,611 628,293 128,242 111,029 822,608 693,220 128,242 111,029 Mortgage-backed securities 578,175 492,308 0 0 Total debt securities $ 1,400,783 $ 1,185,528 $ 128,242 $ 111,029 Security proceeds, gross gains and gross losses for 2022, 2021 and 2020 were as follows: (dollars in thousands) 2022 2021 2020 Sales of securities available-for-sale Proceeds $ 25,332 $ 13,964 $ 8,018 Gross gains 140 797 433 Gross losses ( 119 ) 0 0 Number of securities 30 9 17 In accordance with ASU No. 2017-8, purchase premiums for callable securities are amortized to the earliest call date and premiums on non-callable securities as well as discounts are recognized in interest income using the interest method over the terms of the securities or over the estimated lives of mortgage-backed securities. Gains and losses on sales are based on the amortized cost of the security sold and recorded on the trade date. Securities with fair values of $ 298.2 million and $ 300.8 million were pledged as of December 31, 2022 and 2021, respectively, as collateral for borrowings from the FHLB and Federal Reserve Bank and for other purposes as permitted or required by law. Unrealized Loss Analysis on Available-for-Sale and Held-to-Maturity Securities Information regarding available-for-sale securities securities with unrealized losses as of December 31, 2022 and 2021 is prese nted below. Th e tables distribute the securities between those with unrealized losses for less than twelve months and those with unrealized losses for twelve months or more. Less than 12 months 12 months or more Total (dollars in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses 2022 U.S. Treasury securities $ 3,034 $ 23 $ 0 $ 0 $ 3,034 $ 23 U.S. government sponsored agencies 8,420 1,350 118,541 27,873 126,961 29,223 Mortgage-backed securities: residential 165,897 18,637 323,727 67,297 489,624 85,934 State and municipal securities 277,967 33,405 244,436 66,894 522,403 100,299 Total temporarily impaired $ 455,318 $ 53,415 $ 686,704 $ 162,064 $ 1,142,022 $ 215,479 2021 U.S. government sponsored agencies $ 85,968 $ 1,364 $ 28,676 $ 1,081 $ 114,644 $ 2,445 Mortgage-backed securities: residential 272,264 4,076 22,792 860 295,056 4,936 State and municipal securities 138,659 1,274 0 0 138,659 1,274 Total temporarily impaired $ 496,891 $ 6,714 $ 51,468 $ 1,941 $ 548,359 $ 8,655 76 Table of Contents NOTE 2 – SECURITIES (continued) Information regarding held-to-maturity securities with unrealized losses as of December 31, 2022 is presented below. The table divides the securities between those with unrealized losses for less than twelve months and those with unrealized losses for twelve months or more. No investment securities were designated as held-to-maturity at December 31, 2021. Less than 12 months 12 months or more Total (dollars in thousands) Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses December 31, 2022 State and municipal securities $ 0 $ 0 $ 111,029 $ 17,213 $ 111,029 $ 17,213 The number of securities with unrealized losses as of December 31, 2022 and 2021 is presented below. Available-for-Sale Held-to-Maturity Less than 12 months 12 months or more Total Less than 12 months 12 months or more Total 2022 U.S. Treasury securities 7 0 7 0 0 0 U.S. government sponsored agencies 1 16 17 0 0 0 Mortgage-backed securities: residential 95 41 136 0 0 0 State and municipal securities 269 223 492 0 41 41 Total temporarily impaired 372 280 652 0 41 41 2021 U.S. government sponsored agencies 8 5 13 0 0 0 Mortgage-backed securities: residential 29 3 32 0 0 0 State and municipal securities 80 0 80 0 0 0 Total temporarily impaired 117 8 125 0 0 0 Available-for-sale and held-to-maturity debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For available-for sale debt securities in an unrealized loss position, management first assesses whether it intends to sell, or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through the consolidated income statement. For available-for sale debt securities that do not meet the criteria and for held-to-maturity securities, management evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors. If this assessment indicates that a credit loss exists, management compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. For available-for-sale debt securities, any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income (loss), net of applicable taxes. No allowance for credit losses for available-for-sale securities was recorded at December 31, 2022 or 2021. No allowance for credit losses for held-to-maturity debt securities was recorded at December 31, 2022. Accrued interest receivable on available-for-sale and held-to-maturity debt securities totaled $ 8.9 million and $ 7.4 million at December 31, 2022 and 2021, respectively, and is excluded from the estimate of credit losses. Ninety-nine percent of the securities are backed by the U.S. government, government agencies, government sponsored agencies or are rated above investment grade with a long history of no credit losses, except for certain non-local or local municipal securities, which are not rated. Prior to the adoption of ASC 326, there was no other-than-tempoarary impairment ("OTTI") recorded during the year ended December 31, 2020. 77 Table of Contents NOTE 3 – LOANS Total loans outstanding as of the years ended December 31, 2022 and 2021 consisted of the following: (dollars in thousands) 2022 2021 Commercial and industrial loans: Working capital lines of credit loans $ 650,948 $ 652,861 Non-working capital loans 842,101 736,608 Total commercial and industrial loans 1,493,049 1,389,469 Commercial real estate and multi-family residential loans: Construction and land development loans 517,664 379,813 Owner occupied loans 758,091 739,371 Nonowner occupied loans 706,107 588,458 Multi-family loans 197,232 247,204 Total commercial real estate and multi-family residential loans 2,179,094 1,954,846 Agri-business and agricultural loans: Loans secured by farmland 201,200 206,331 Loans for agricultural production 230,888 239,494 Total agri-business and agricultural loans 432,088 445,825 Other commercial loans 113,593 73,490 Total commercial loans 4,217,824 3,863,630 Consumer 1-4 family mortgage loans: Closed end first mortgage loans 212,742 176,561 Open end and junior lien loans 175,575 156,238 Residential construction and land development loans 19,249 11,921 Total consumer 1-4 family mortgage loans 407,566 344,720 Other consumer loans 88,075 82,755 Total consumer loans 495,641 427,475 Gross loans 4,713,465 4,291,105 Less: Allowance for credit losses ( 72,606 ) ( 67,773 ) Net deferred loan fees ( 3,069 ) ( 3,264 ) Loans, net $ 4,637,790 $ 4,220,068 The recorded investment in loans does not include accrued interest, which totaled $ 18.4 million and $ 10.0 million at December 31, 2022 and 2021, respectively. The Company had $ 306,000 and $ 350,000 in residential real estate loans in process of foreclosure as of December 31, 2022 and 2021, respectively. 78 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY The Company adopted ASC 326 using the modified retrospective for all financial assets measured at amortized cost. Results for reporting periods after January 1, 2021 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The following table presents the activity in the allowance for credit losses by portfolio segment for the year ended December 31, 2022 and 2021: (dollars in thousands) Commercial and Industrial Commercial Real Estate and Multi-family Residential Agri-business and Agricultural Other Commercial Consumer 1-4 Family Mortgage Other Consumer Unallocated Total 2022 Beginning balance $ 30,595 $ 26,535 $ 5,034 $ 1,146 $ 2,866 $ 1,147 $ 450 $ 67,773 Provision for credit losses 8,646 1,179 ( 605 ) ( 229 ) 125 155 104 9,375 Loans charged-off ( 4,022 ) ( 597 ) 0 0 ( 42 ) ( 473 ) 0 ( 5,134 ) Recoveries 71 277 0 0 52 192 0 592 Net loans (charged-off) recovered ( 3,951 ) ( 320 ) 0 0 10 ( 281 ) 0 ( 4,542 ) Ending balance $ 35,290 $ 27,394 $ 4,429 $ 917 $ 3,001 $ 1,021 $ 554 $ 72,606 (dollars in thousands) Commercial and Industrial Commercial Real Estate and Multi-family Residential Agri-business and Agricultural Other Commercial Consumer 1-4 Family Mortgage Other Consumer Unallocated Total 2021 Beginning balance $ 28,333 $ 22,907 $ 3,043 $ 416 $ 2,619 $ 951 $ 3,139 $ 61,408 Impact of adopting ASC 326 4,312 4,316 1,060 941 953 349 ( 2,881 ) 9,050 Provision for credit losses 1,966 ( 632 ) 611 ( 211 ) ( 777 ) ( 72 ) 192 1,077 Loans charged-off ( 5,575 ) ( 70 ) 0 0 ( 51 ) ( 287 ) 0 ( 5,983 ) Recoveries 1,559 14 320 0 122 206 0 2,221 Net loans (charged-off) recovered ( 4,016 ) ( 56 ) 320 0 71 ( 81 ) 0 ( 3,762 ) Ending balance $ 30,595 $ 26,535 $ 5,034 $ 1,146 $ 2,866 $ 1,147 $ 450 $ 67,773 Credit Quality Indicators: The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes commercial loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis for Special Mention, Substandard and Doubtful grade loans and annually on Pass grade loans over $ 250,000 . The Company uses the following definitions for risk ratings: Special Mention. Loans classified as Special Mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Substandard. Loans classified as Substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized as the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. 79 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) Doubtful. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans are considered to be "Pass" rated when they are reviewed as part of the previously described process and do not meet the criteria above with the exception of consumer troubled debt restructurings, which are evaluated and listed with Substandard commercial grade loans and consumer nonaccrual loans which are evaluated individually and listed with “Not Rated” loans. Loans listed as Not Rated are consumer loans or commercial loans with consumer characteristics included in groups of homogenous loans which are analyzed for credit quality indicators utilizing delinquency status. 80 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) The following tables summarize the risk category of loans by loan segment and origination date as of December 31, 2022 and 2021. Balances presented are at the amortized cost basis by origination year. (dollars in thousands) 2022 2021 2020 2019 2018 Prior Term Total Revolving Total Commercial and industrial loans: Working capital lines of credit loans: Pass $ 2,207 $ 2,718 $ 1,601 $ 0 $ 0 $ 0 $ 6,526 $ 597,108 $ 603,634 Special Mention 0 0 0 0 0 0 0 36,410 36,410 Substandard 200 0 0 300 0 0 500 10,495 10,995 Total 2,407 2,718 1,601 300 0 0 7,026 644,013 651,039 Non-working capital loans: Pass 272,273 124,600 91,850 47,711 9,981 13,670 560,085 240,490 800,575 Special Mention 448 1,620 0 109 159 2,961 5,297 2,153 7,450 Substandard 11,831 872 5,021 194 1,351 3,979 23,248 4,171 27,419 Not Rated 2,891 1,550 1,254 413 120 23 6,251 0 6,251 Total 287,443 128,642 98,125 48,427 11,611 20,633 594,881 246,814 841,695 Commercial real estate and multi-family residential loans: Construction and land development loans: Pass 26,889 19,944 14,026 356 0 0 61,215 453,953 515,168 Total 26,889 19,944 14,026 356 0 0 61,215 453,953 515,168 Owner occupied loans: Pass 113,656 179,014 139,880 97,353 65,519 97,335 692,757 40,533 733,290 Special Mention 2,960 7,608 0 446 1,491 8,054 20,559 0 20,559 Substandard 308 105 1,491 373 1,161 229 3,667 0 3,667 Total 116,924 186,727 141,371 98,172 68,171 105,618 716,983 40,533 757,516 Nonowner occupied loans: Pass 194,294 125,190 134,661 91,907 15,109 64,874 626,035 68,603 694,638 Special Mention 0 11,024 0 0 0 0 11,024 0 11,024 Total 194,294 136,214 134,661 91,907 15,109 64,874 637,059 68,603 705,662 Multi-family loans: Pass 38,460 25,741 36,929 35,695 2,046 28,866 167,737 7,349 175,086 Special Mention 21,855 0 0 0 0 0 21,855 0 21,855 Total 60,315 25,741 36,929 35,695 2,046 28,866 189,592 7,349 196,941 Agri-business and agricultural loans: Loans secured by farmland: Pass 38,344 28,684 29,741 9,656 8,145 19,638 134,208 63,094 197,302 Special Mention 260 0 1,676 1,780 0 15 3,731 0 3,731 Substandard 0 0 0 0 0 145 145 0 145 Total 38,604 28,684 31,417 11,436 8,145 19,798 138,084 63,094 201,178 Loans for agricultural production: Pass 6,040 30,262 22,167 3,625 9,248 4,539 75,881 143,599 219,480 Special Mention 947 243 7,262 928 0 0 9,380 2,129 11,509 Total 6,987 30,505 29,429 4,553 9,248 4,539 85,261 145,728 230,989 Other commercial loans: Pass 27,097 4,815 17,911 147 931 10,985 61,886 48,295 110,181 Special Mention 0 0 0 0 0 3,160 3,160 0 3,160 Total 27,097 4,815 17,911 147 931 14,145 65,046 48,295 113,341 Consumer 1-4 family mortgage loans: Closed end first mortgage loans Pass 8,768 12,809 12,289 4,805 4,045 3,860 46,576 5,634 52,210 Special Mention 0 0 552 0 0 0 552 0 552 Substandard 0 0 0 0 83 1,944 2,027 0 2,027 Not Rated 57,404 44,331 20,023 5,936 2,970 27,004 157,668 0 157,668 Total 66,172 57,140 32,864 10,741 7,098 32,808 206,823 5,634 212,457 Open end and junior lien loans Pass 137 541 357 63 75 0 1,173 5,841 7,014 Substandard 0 0 0 31 49 0 80 111 191 Not Rated 44,472 13,597 3,014 3,616 1,476 2,252 68,427 101,750 170,177 Total 44,609 14,138 3,371 3,710 1,600 2,252 69,680 107,702 177,382 Residential construction loans Not Rated 14,463 2,167 897 291 129 1,223 19,170 0 19,170 Total 14,463 2,167 897 291 129 1,223 19,170 0 19,170 Other consumer loans Pass 1,344 1,841 432 600 0 948 5,165 16,152 21,317 Substandard 0 0 0 210 0 0 210 0 210 Not Rated 24,395 14,563 9,168 3,606 2,755 1,352 55,839 10,492 66,331 Total 25,739 16,404 9,600 4,416 2,755 2,300 61,214 26,644 87,858 TOTAL $ 911,943 $ 653,839 $ 552,202 $ 310,151 $ 126,843 $ 297,056 $ 2,852,034 $ 1,858,362 $ 4,710,396 81 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) (dollars in thousands) 2021 2020 2019 2018 2017 Prior Term Total Revolving Total Commercial and industrial loans: Working capital lines of credit loans: Pass $ 3,699 $ 830 $ 3,360 $ 0 $ 0 $ 0 $ 7,889 $ 558,634 $ 566,523 Special Mention 0 0 0 0 0 0 0 60,441 60,441 Substandard 0 0 35 0 0 0 35 25,928 25,963 Total 3,699 830 3,395 0 0 0 7,924 645,003 652,927 Non-working capital loans: Pass 185,374 139,157 79,477 38,899 19,415 18,489 480,811 203,794 684,605 Special Mention 17,728 0 225 979 2,350 1,426 22,708 0 22,708 Substandard 2,996 6,948 1,091 2,534 5,465 426 19,460 3,321 22,781 Not Rated 2,265 1,758 837 563 128 14 5,565 0 5,565 Total 208,363 147,863 81,630 42,975 27,358 20,355 528,544 207,115 735,659 Commercial real estate and multi-family residential loans: Construction and land development loans: Pass 35,136 30,224 1,276 998 0 0 67,634 310,396 378,030 Total 35,136 30,224 1,276 998 0 0 67,634 310,396 378,030 Owner occupied loans: Pass 135,861 169,404 124,117 85,070 78,155 93,925 686,532 29,611 716,143 Special Mention 6,555 0 880 933 7,387 1,235 16,990 0 16,990 Substandard 489 1,570 909 1,758 694 238 5,658 0 5,658 Total 142,905 170,974 125,906 87,761 86,236 95,398 709,180 29,611 738,791 Nonowner occupied loans: Pass 146,342 154,433 107,262 19,054 31,023 59,154 517,268 44,362 561,630 Special Mention 11,825 331 0 0 0 14,253 26,409 0 26,409 Total 158,167 154,764 107,262 19,054 31,023 73,407 543,677 44,362 588,039 Multi-family loans: Pass 84,678 53,195 36,575 12,286 14,574 9,793 211,101 13,434 224,535 Special Mention 0 0 0 0 22,252 0 22,252 0 22,252 Total 84,678 53,195 36,575 12,286 36,826 9,793 233,353 13,434 246,787 Agri-business and agricultural loans: Loans secured by farmland: Pass 47,532 37,035 16,249 10,469 10,454 17,021 138,760 61,774 200,534 Special Mention 0 1,985 2,303 0 180 30 4,498 918 5,416 Substandard 207 0 0 0 0 145 352 0 352 Total 47,739 39,020 18,552 10,469 10,634 17,196 143,610 62,692 206,302 Loans for agricultural production: Pass 36,238 25,855 4,224 11,072 1,331 4,178 82,898 138,142 221,040 Special Mention 448 8,642 1,171 0 0 0 10,261 8,272 18,533 Total 36,686 34,497 5,395 11,072 1,331 4,178 93,159 146,414 239,573 Other commercial loans: Pass 6,556 21,111 3,243 1,273 8,592 7,460 48,235 21,145 69,380 Special Mention 0 0 0 0 0 3,798 3,798 0 3,798 Total 6,556 21,111 3,243 1,273 8,592 11,258 52,033 21,145 73,178 Consumer 1-4 family mortgage loans: Closed end first mortgage loans Pass 14,635 16,173 5,312 5,903 3,049 3,221 48,293 5,005 53,298 Substandard 0 0 0 0 0 1,274 1,274 0 1,274 Not Rated 45,089 27,738 9,248 5,217 7,628 26,321 121,241 482 121,723 Total 59,724 43,911 14,560 11,120 10,677 30,816 170,808 5,487 176,295 Open end and junior lien loans Pass 679 379 159 313 0 0 1,530 5,074 6,604 Substandard 0 0 0 0 0 0 0 98 98 Not Rated 21,945 5,624 5,987 3,899 1,653 1,526 40,634 110,523 151,157 Total 22,624 6,003 6,146 4,212 1,653 1,526 42,164 115,695 157,859 Residential construction loans Not Rated 7,926 1,537 960 138 171 1,125 11,857 0 11,857 Total 7,926 1,537 960 138 171 1,125 11,857 0 11,857 Other consumer loans Pass 3,401 957 1,523 0 1,155 0 7,036 12,998 20,034 Substandard 36 23 230 0 0 0 289 0 289 Not Rated 21,652 14,931 7,474 5,844 1,890 1,203 52,994 9,227 62,221 Total 25,089 15,911 9,227 5,844 3,045 1,203 60,319 22,225 82,544 TOTAL $ 839,292 $ 719,840 $ 414,127 $ 207,202 $ 217,546 $ 266,255 $ 2,664,262 $ 1,623,579 $ 4,287,841 82 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) As of December 31, 2022 and 2021, $ 1.5 million and $ 26.2 million, respectively, in PPP loans were included in the "Pass" category of non-working capital commercial and industrial loans. These loans were included in this risk rating category because they are fully guaranteed by the Small Business Administration ("SBA"). Nonaccrual and Past Due Loans: For all loan classes, a loan is generally placed on nonaccrual status when principal or interest becomes 90 days past due unless it is well secured and in process of collection, or earlier when concern exists as to the ultimate collectability of principal or interest. Interest accrued but not received is reversed against earnings. Cash interest received on these loans is applied to the principal balance until the principal is recovered or until the loan returns to accrual status. Loans may be returned to accrual status when all the principal and interest amounts contractually due are brought current, remain current for a prescribed period, and the payments are reasonably assured. The following table presents the aging of the amortized cost basis in past due loans as of December 31, 2022 and 2021 by class of loans and loans past due 90 days or more and still accruing by class of loan: (dollars in thousands) Loans Not Past Due 30-89 Days Past Due Greater than 89 Days Past Due and Accruing Total Accruing Total Nonaccrual Nonaccrual With No Allowance For Credit Loss Total 2022 Commercial and industrial loans: Working capital lines of credit loans $ 649,529 $ 68 $ 0 $ 649,597 $ 1,442 $ 0 $ 651,039 Non-working capital loans 830,033 39 1 830,073 11,622 727 841,695 Commercial real estate and multi-family residential loans: Construction and land development loans 515,168 0 0 515,168 0 0 515,168 Owner occupied loans 754,451 0 0 754,451 3,065 1,469 757,516 Nonowner occupied loans 705,662 0 0 705,662 0 0 705,662 Multi-family loans 196,941 0 0 196,941 0 0 196,941 Agri-business and agricultural loans: Loans secured by farmland 201,033 0 0 201,033 145 0 201,178 Loans for agricultural production 230,989 0 0 230,989 0 0 230,989 Other commercial loans 113,341 0 0 113,341 0 0 113,341 Consumer 1‑4 family mortgage loans: Closed end first mortgage loans 211,736 306 122 212,164 293 225 212,457 Open end and junior lien loans 176,758 436 0 177,194 188 188 177,382 Residential construction loans 19,170 0 0 19,170 0 0 19,170 Other consumer loans 87,333 316 0 87,649 209 6 87,858 Total $ 4,692,144 $ 1,165 $ 123 $ 4,693,432 $ 16,964 $ 2,615 $ 4,710,396 As of December 31, 2022, there were an insignificant number of loans 30-89 days past due or greater than 89 days past due on nonaccrual. Additionally, interest income recognized on nonaccrual loans was insignificant during the year ended December 31, 2022. 83 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) (dollars in thousands) Loans Not Past Due 30-89 Days Past Due Greater than 89 Days Past Due and Accruing Total Accruing Total Nonaccrual Nonaccrual With No Allowance For Credit Loss Total 2021 Commercial and industrial loans: Working capital lines of credit loans $ 652,903 $ 24 $ 0 $ 646,961 $ 5,966 $ 5,200 $ 652,927 Non-working capital loans 735,658 1 0 731,063 4,596 229 735,659 Commercial real estate and multi-family residential loans: Construction and land development loans 378,030 0 0 378,030 0 0 378,030 Owner occupied loans 738,791 0 0 735,157 3,634 2,129 738,791 Nonowner occupied loans 588,039 0 0 588,039 0 0 588,039 Multi-family loans 246,787 0 0 246,787 0 0 246,787 Agri-business and agricultural loans: Loans secured by farmland 206,302 0 0 205,967 335 0 206,302 Loans for agricultural production 239,573 0 0 239,573 0 0 239,573 Other commercial loans 73,178 0 0 73,178 0 0 73,178 Consumer 1‑4 family mortgage loans: Closed end first mortgage loans 175,678 500 117 176,240 55 55 176,295 Open end and junior lien loans 157,729 130 0 157,761 98 98 157,859 Residential construction loans 11,857 0 0 11,857 0 0 11,857 Other consumer loans 82,472 72 0 82,255 289 0 82,544 Total $ 4,286,997 $ 727 $ 117 $ 4,272,868 $ 14,973 $ 7,711 $ 4,287,841 As of December 31, 2021, there were an insignificant number of loans 30-89 days past due or greater than 89 days past due on nonaccrual. Additionally, interest income recognized on nonaccrual loans was insignificant during the year ended December 31, 2021. When management determines that foreclosure is probable, expected credit losses for collateral dependent loans are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. A loan is considered collateral dependent when the borrower is experiencing financial difficulty and the loan is expected to be repaid substantially through the operation or sale of the collateral. The class of loan represents the primary collateral type associated with the loan. Significant year over year changes are reflective of changes in nonaccrual status and not necessarily associated with credit quality indicators like appraisal value. 84 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) The following tables present the amortized cost basis of collateral dependent loans by class of loan as of December 31, 2022 and 2021: (dollars in thousands) Real Estate General Business Assets Other Total 2022 Commercial and industrial loans: Working capital lines of credit loans $ 50 $ 5,402 $ 0 $ 5,452 Non-working capital loans 544 18,109 229 18,882 Commercial real estate and multi-family residential loans: Owner occupied loans 413 1,491 1,161 3,065 Nonowner occupied loans 0 0 0 0 Agri-business and agricultural loans: Loans secured by farmland 0 145 0 145 Consumer 1-4 family mortgage loans: Closed end first mortgage loans 2,030 0 0 2,030 Open end and junior lien loans 188 0 0 188 Other consumer loans 0 0 7 7 Total $ 3,225 $ 25,147 $ 1,397 $ 29,769 (dollars in thousands) Real Estate General Business Assets Other Total 2021 Commercial and industrial loans: Working capital lines of credit loans $ 0 $ 5,966 $ 0 $ 5,966 Non-working capital loans 1,606 9,475 229 11,310 Commercial real estate and multi-family residential loans: Owner occupied loans 1,435 1,505 1,161 4,101 Nonowner occupied loans 0 0 0 0 Agri-business and agricultural loans: Loans secured by farmland 190 145 0 335 Consumer 1-4 family mortgage loans: Closed end first mortgage loans 3,081 0 0 3,081 Open end and junior lien loans 98 0 0 98 Other consumer loans 0 0 59 59 Total $ 6,410 $ 17,091 $ 1,449 $ 24,950 85 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) Modifications Made to Borrowers Experiencing Financial Difficulty The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon origination. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. The Company uses a probability of default/loss given default model to determine the allowance for credit losses. An assessment of whether a borrower is experiencing financial difficulty is made at the time of a modification. Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses, a change to the allowance for credit losses is generally not recorded upon modification. Occasionally, the Company modifies loans by providing principal forgiveness that is deemed to be uncollectible; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses. Additionally, the Company may allow a borrower to to make interest only payments for a specified period of time. During the year ended December 31, 2022, no loans received a material modification based on borrower financial difficulty. Troubled Debt Restructurings (Prior to January 1, 2022): Prior to the partial adoption of ASU 2022-02 on January 1, 2022, which had an immaterial impact on the Company's allowance for credit losses, troubled debt restructured loans were included in the total for individually analyzed loans. The following are disclosures related to troubled debt restructured loans in prior periods. Troubled debt restructured loans are included in the totals for individually analyz ed loans. The Company has allocated $ 5.8 million of specific allocations to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2021. The Company is not committed to lend additional funds to debtors whose loans have been modified in a troubled debt restructuring . (dollars in thousands) December 31, 2021 Accruing troubled debt restructured loans $ 5,121 Nonaccrual troubled debt restructured loans 6,218 Total troubled debt restructured loans $ 11,339 During the year ending December 31, 2021, certain loans were modified as troubled debt restructurings. The modified terms of these loans include one or a combination of the following: inadequate compensation for the terms of the restructure or renewal; a modification of the repayment terms which delays principal payment for some period; terms offered to borrowers in financial distress where no additional credit enhancements were obtained at the time of renewal. Additional concessions were granted to borrowers during 2021 with previously identified troubled debt restructured loans. There were 8 loans with recorded investments totaling $ 2.2 million where collateral values or cash flows were insufficient to support the loans. These troubled debt restructured loans with additional concessions decreased the allowance by $ 423,000 and resulted in no charge-offs for the year ending December 31, 2021. These concessions are not included in the table on the next page. 86 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) The following table presents loans by class modified as new troubled debt restructurings that occurred during the year ending December 31, 2021: Modified Repayment Terms (dollars in thousands) Number of Loans Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Number of Loans Extension Period or Range (in months) Troubled Debt Restructurings Consumer 1-4 family loans: Closed end first mortgage loans 2 $ 217 $ 217 2 172 - 204 Total 2 $ 217 $ 217 2 172 - 204 For the period ending December 31, 2021, the troubled debt restructurings described above had no impact to the allowance and no charge-offs were recorded. As of December 31, 2021, one retail loan in the amount of $ 11,000 had a COVID-19 related deferral. In accordance with Section 4013 of the CARES Act, this deferral was not considered to be a troubled debt restructuring. This provision was effective until its expiration on January 1, 2022 under the Consolidated Appropriations Act, 2021. During the year ended December 31, 2020, certain loans were modified as troubled debt restructurings. The modified terms of these loans include one or a combination of the following: inadequate compensation for the terms of the restructure or renewal; a modification of the repayment terms which delays principal repayment for some period; or renewal terms offered to borrowers in financial distress where no additional credit enhancements were obtained at the time of renewal. The following table presents loans by class modified as new troubled debt restructurings that occurred during the year ending December 31, 2020: Modified Repayment Terms (dollars in thousands) Number of Loans Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Number of Loans Extension Period or Range (in months) Troubled Debt Restructurings Commercial and industrial loans: Working capital lines of credit loans 1 $ 250 $ 315 1 0 Non-working capital lines of credit loans 2 4,288 3,691 2 0 Commercial real estate and multi-family residential loans: Owner occupied loans 1 1,528 1,527 1 0 Total 4 $ 6,066 $ 5,533 4 0 For the period ending December 31, 2020, the troubled debt restructurings described above had no impact to the allowance and no charge-offs were recorded. As of December 31, 2020, total deferrals attributed to COVID-19 were $ 100.7 million representing 49 borrowers. This represented 2.2 % of the total loan portfolio. Of that 22 were commercial loan borrowers representing $ 98.2 million in loans, or 2.3 % of commercial loans, and 27 were retail loan borrowers representing $ 2.5 million, or 0.7 % of total retail loans. The majority of all loan deferrals were for a period of 90 days. Of the total commercial deferrals attributed to COVID-19, $ 11.9 million represented a first deferral action, $ 22.8 million represented a second deferral action, $ 41.9 million represented a third deferral action and $ 24.1 million represented a fourth deferral action. Two borrowers represented 90 % of the fourth deferral population and were commercial real estate nonowner occupied loans supported by adequate collateral and personal guarantors and consist of loans to the hotel and accommodation industry. All COVID-19 related loan deferrals were on accrual status, as each deferral was individually analyzed, and management determined that all contractual cashflows were collectable at that 87 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) time. In accordance with Section 4013 of the CARES Act, these were not considered to be troubled debt restructurings and were excluded from the table above. A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. There were no loans modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the period ending December 31, 2021 and 2020. Allowance for Loan Losses (Prior to January 1, 2021) Prior to the adoption of ASC 326 on January 1, 2021 the Company calculated the allowance for loan losses using the incurred losses methodology. The following tables are disclosures related to the allowance for loan losses in prior periods. The following tables present the activity and balance in the allowance for loan losses by portfolio segment for the year ended December 31, 2020. PPP loans are fully guaranteed by the SBA and have not been allocated for within the allowance for loan losses. (dollars in thousands) Commercial and Industrial Commercial Real Estate and Multi-family Residential Agri-business and Agricultural Other Commercial Consumer 1-4 Family Mortgage Other Consumer Unallocated Total Beginning balance $ 25,789 $ 15,796 $ 3,869 $ 447 $ 2,086 $ 345 $ 2,320 $ 50,652 Provision for loan losses 6,640 6,868 ( 826 ) ( 31 ) 341 959 819 14,770 Loans charged-off ( 4,524 ) ( 72 ) 0 0 ( 141 ) ( 516 ) 0 ( 5,253 ) Recoveries 428 315 0 0 333 163 0 1,239 Net loans (charged-off) recovered ( 4,096 ) 243 0 0 192 ( 353 ) 0 ( 4,014 ) Ending balance $ 28,333 $ 22,907 $ 3,043 $ 416 $ 2,619 $ 951 $ 3,139 $ 61,408 88 Table of Contents NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued) The following table presents loans individually evaluated for impairment by class of loans for the year ended December 31, 2020: (dollars in thousands) Average Recorded Investment Interest Income Recognized Cash Basis Interest Income Recognized With no related allowance recorded: Commercial and industrial loans: Working capital lines of credit loans $ 375 $ 0 $ 0 Non-working capital loans 816 21 21 Commercial real estate and multi-family residential loans: Owner occupied loans 2,156 13 12 Agri-business and agricultural loans: Loans secured by farmland 283 0 0 Loans for agricultural production 4 0 0 Consumer 1-4 family loans: Closed end first mortgage loans 291 3 2 Open end and junior lien loans 49 0 0 With an allowance recorded: Commercial and industrial loans: Working capital lines of credit loans 2,433 0 0 Non-working capital loans 11,579 287 287 Commercial real estate and multi-family residential loans: Construction and land development loans Owner occupied loans 3,156 30 30 Agri-business and agricultural loans: Loans secured by farmland 147 0 0 Consumer 1-4 family mortgage loans: Closed end first mortgage loans 1,557 36 33 Open end and junior lien loans 481 0 0 Residential construction loans 35 0 0 Other consumer loans 0 0 0 Total $ 23,362 $ 390 $ 385 Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. 89 Table of Contents NOTE 5 – FAIR VALUE Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values: Level 1 Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2 Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3 Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument: Securities: Securities available-for-sale are valued primarily by a third party pricing service. The fair values of securities available-for-sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or pricing models which utilize significant observable inputs such as matrix pricing. This is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). These models utilize the market approach with standard inputs that include, but are not limited to benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. For certain municipal securities that are not rated and observable inputs about the specific issuer are not available, fair values are estimated using observable data from other municipal securities presumed to be similar or other market data on other non-rated municipal securities (Level 3 inputs). The Company’s Finance Department, which is responsible for all accounting and SEC compliance, and the Company’s Treasury Department, which is responsible for investment portfolio management and asset/liability modeling, are the two areas that determine the Company’s valuation policies and procedures. Both of these areas report directly to the Executive Vice President and Chief Financial Officer of the Company. For assets or liabilities that may be considered for Level 3 fair value measurement on a recurring basis, these two departments and the Executive Vice President and Chief Financial Officer determine the appropriate level of the assets or liabilities under consideration. If there are assets or liabilities that are determined to be Level 3 by this group, the Risk Management Committee of the Company and the Audit Committee of the board of directors (the “Board”) are made aware of such assets at their next scheduled meeting. Securities pricing is obtained on securities from a third party pricing service and all security prices are tested annually against prices from another third party provider and reviewed with a market value price tolerance variance that varies by sector: municipal securities +/- 5 %, government agency/MBS/CMO +/- 3 % and U.S. treasuries +/- 1 %. If any securities fall outside the tolerance threshold and have a variance of $ 100,000 or more, a determination of materiality is made for the amount over the threshold. Any security that would have a material threshold difference would be further investigated to determine why the variance exists and if any action is needed concerning the security pricing for that individual security. Changes in market value are reviewed monthly in aggregate by security type and any material differences are reviewed to determine why they exist. At least annually, the pricing methodology of the pricing service is received and reviewed to support the fair value levels used by the Company. A detailed pricing evaluation is requested and reviewed on any security determined to be fair valued using unobservable inputs by the pricing service. Mortgage banking derivative: The fair values of mortgage banking derivatives are based on observable market data as of the measurement date (Level 2). Interest rate swap derivatives: Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing 90 Table of Contents NOTE 5 – FAIR VALUE (continued) services. The fair value of interest rate swap derivatives is determined by pricing or valuation models using observable market data as of the measurement date (Level 2). Collateral dependent loans: Collateral dependent loans with specific allocations of the allowance for credit losses generally based on the fair value of the underlying collateral when repayment is expected solely from the collateral. Fair value is determined using several methods. Generally, the fair value of real estate is based on appraisals by qualified third party appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and result in a Level 3 classification of the inputs for determining fair value. In addition, the Company’s management routinely applies internal discount factors to the value of appraisals used in the fair value evaluation of collateral dependent loans. The deductions to the appraisals take into account changing business factors and market conditions, as well as value impairment in cases where the appraisal date predates a likely change in market conditions. Commercial real estate is generally discounted from its appraised value by 30 - 50 % with the higher discounts applied to real estate that is determined to have a thin trading market or to be specialized collateral. In addition to real estate, the Company’s management evaluates other types of collateral as follows: (a) raw materials inventory is discounted from its cost or book value by 40 %- 60 %, depending on the marketability of the goods (b) finished goods are generally discounted by 40 %- 60 %, depending on the ease of marketability, cost of transportation or scope of use of the finished good (c) work in process inventory is typically discounted by 60 %- 100 %, depending on the length of manufacturing time, types of components used in the completion process, and the breadth of the user base (d) equipment is valued at a percentage of depreciated book value or recent appraised value, if available, and is typically discounted at 20 %- 50 % after various considerations including age and condition of the equipment, marketability, breadth of use, and whether the equipment includes unique components or add-ons; and (e) marketable securities are discounted by 10 %- 30 %, depending on the type of investment, age of valuation report and general market conditions. This methodology is based on a market approach and typically results in a Level 3 classification of the inputs for determining fair value. Mortgage servicing rights: As of December 31, 2022, the fair value of the Company’s Level 3 servicing assets for residential mortgage loans (“MSRs”) was $ 2.7 million, carried at amortized cost and no valuation reserve. These residential mortgage loans have a weighted average interest rate of 3.5 %, a weighted average maturity of 21 years and are secured by homes generally within the Company’s market area of Northern Indiana and Indianapolis. A valuation model is used to estimate fair value by stratifying the portfolios on the basis of certain risk characteristics, including loan type and interest rate. Impairment is estimated based on an income approach. The inputs used include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, late fees, and float income. The most significant assumption used to value MSRs is prepayment rate. Prepayment rates are estimated based on published industry consensus prepayment rates. The most significant unobservable assumption is the discount rate. At December 31, 2022, the constant prepayment speed (“PSA”) used was 159 and discount rate used was 9.5 %. At December 31, 2021, the PSA used was 249 and the discount rate used was 9.5 %. Other real estate owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are reviewed by the Company’s internal appraisal officer. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable properties used to determine value. Such adjustments are usually significant and result in a Level 3 classification. In addition, the Company’s management may apply discount factors to the appraisals to take into account changing business factors and market conditions, as well as value impairment in cases where the appraisal date predates a likely change in market conditions. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized. Real estate mortgage loans held-for-sale : Real estate mortgage loans held for sale are carried at the lower of cost or fair value, as determined by outstanding commitments, from third party investors, and result in a Level 2 classification. 91 Table of Contents NOTE 5 – FAIR VALUE (continued) The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2022 and 2021: 2022 Fair Value Measurements Using Assets (dollars in thousands) Level 1 Level 2 Level 3 at Fair Value Assets: U.S. Treasury securities $ 3,034 $ 0 $ 0 $ 3,034 U.S. government sponsored agency securities 0 126,961 0 126,961 Mortgage-backed securities: residential 0 492,308 0 492,308 State and municipal securities 0 561,150 2,075 563,225 Total Available-for-Sale Securities 3,034 1,180,419 2,075 1,185,528 Mortgage banking derivative 0 43 0 43 Interest rate swap derivative 0 36,920 0 36,920 Total assets $ 3,034 $ 1,217,382 $ 2,075 $ 1,222,491 Liabilities: Interest rate swap derivative $ 0 $ 36,921 $ 0 $ 36,921 Total liabilities $ 0 $ 36,921 $ 0 $ 36,921 2021 Fair Value Measurements Using Assets (dollars in thousands) Level 1 Level 2 Level 3 at Fair Value Assets: U.S. Treasury securities $ 900 $ 0 $ 0 $ 900 U.S. government sponsored agency securities 0 143,452 0 143,452 Mortgage-backed securities: residential 0 486,676 0 486,676 Mortgage-backed securities: commercial 0 523 0 523 State and municipal securities 0 764,964 2,043 767,007 Total Available-for-Sale Securities 900 1,395,615 2,043 1,398,558 Mortgage banking derivative 0 398 0 398 Interest rate swap derivative 0 14,309 0 14,309 Total assets $ 900 $ 1,410,322 $ 2,043 $ 1,413,265 Liabilities: Mortgage banking derivative $ 0 $ 2 $ 0 $ 2 Interest rate swap derivative 0 14,329 0 14,329 Total liabilities $ 0 $ 14,331 $ 0 $ 14,331 The fair value of Level 3 available-for-sale securities was immaterial to warrant additional recurring fair value disclosures as of December 31, 2022 and 2021. 92 Table of Contents NOTE 5 – FAIR VALUE (continued) The tables below present the amount of assets measured at fair value on a nonrecurring basis as of December 31, 2022 and 2021: 2022 Fair Value Measurements Using Assets (dollars in thousands) Level 1 Level 2 Level 3 at Fair Value Assets Collateral dependent loans: Commercial and industrial loans: Working capital lines of credit loans $ 0 $ 0 $ 3,178 $ 3,178 Non-working capital loans 0 0 8,354 8,354 Commercial real estate and multi-family residential loans: Owner occupied loans 0 0 425 425 Agri-business and agricultural loans: Loans secured by farmland 0 0 35 35 Total collateral dependent loans $ 0 $ 0 $ 11,992 $ 11,992 Other real estate owned 0 0 100 100 Total assets $ 0 $ 0 $ 12,092 $ 12,092 2021 Fair Value Measurements Using Assets (dollars in thousands) Level 1 Level 2 Level 3 at Fair Value Assets Collateral dependent loans: Commercial and industrial loans: Working capital lines of credit loans $ 0 $ 0 $ 247 $ 247 Non-working capital loans 0 0 5,095 5,095 Commercial real estate and multi-family residential loans: Owner occupied loans 0 0 791 791 Agri-business and agricultural loans: Loans secured by farmland 0 0 231 231 Total collateral dependent loans $ 0 $ 0 $ 6,364 $ 6,364 Other real estate owned 0 0 196 196 Total assets $ 0 $ 0 $ 6,560 $ 6,560 93 Table of Contents NOTE 5 – FAIR VALUE (continued) The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2022: (dollars in thousands) Fair Value Valuation Methodology Unobservable Inputs Average Range of Inputs Collateral dependent loans: Commercial and industrial $ 11,532 Collateral based measurements Discount to reflect current market conditions and ultimate collectability 62 % 29 %- 99 % Collateral dependent loans: Commercial real estate and multi-family residential 425 Collateral based measurements Discount to reflect current market conditions and ultimate collectability 57 % 37 %- 76 % Collateral dependent loans: Agri-business and agricultural 35 Collateral based measurements Discount to reflect current market conditions and ultimate collectability 76 % Other real estate owned 100 Appraisals Discount to reflect current market conditions and ultimate collectability 68 % 94 Table of Contents NOTE 5 – FAIR VALUE (continued) The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2021: (dollars in thousands) Fair Value Valuation Methodology Unobservable Inputs Average Range of Inputs Collateral dependent loans: Commercial and industrial $ 5,342 Collateral based measurements Discount to reflect current market conditions and ultimate collectability 65 % 22 %- 99 % Collateral dependent loans: Commercial real estate 791 Collateral based measurements Discount to reflect current market conditions and ultimate collectability 51 % 34 %- 68 % Collateral dependent loans: Agri-business and agricultural 231 Collateral based measurements Discount to reflect current market conditions and ultimate collectability 35 % 3 % - 68 % Other real estate owned 196 Appraisals Discount to reflect current market conditions and ultimate collectability 38 % 95 Table of Contents NOTE 5 – FAIR VALUE (continued) The following tables contain the estimated fair values and the related carrying values of the Company’s financial instruments at December 31, 2022 and 2021. Items which are not financial instruments are not included. 2022 Carrying Estimated Fair Value (dollars in thousands) Value Level 1 Level 2 Level 3 Total Financial Assets: Cash and cash equivalents $ 130,282 $ 129,069 $ 1,213 $ 0 $ 130,282 Securities available-for-sale 1,185,528 3,034 1,180,419 2,075 1,185,528 Securities held-to-maturity 128,242 0 111,029 0 111,029 Real estate mortgages held-for-sale 357 0 372 0 372 Loans, net 4,637,790 0 0 4,454,678 4,454,678 Mortgage banking derivative 43 0 43 0 43 Interest rate swap derivative 36,920 0 36,920 0 36,920 Federal Reserve and Federal Home Loan Bank Stock 15,795 N/A N/A N/A N/A Accrued interest receivable 27,994 0 9,598 18,396 27,994 Financial Liabilities: Certificates of deposit 626,186 0 621,206 0 621,206 All other deposits 4,834,434 4,834,434 0 0 4,834,434 Federal Funds purchased 22,000 22,000 0 0 22,000 Federal Home Loan Bank advances 275,000 275,000 0 0 275,000 Interest rate swap derivative 36,921 0 36,921 0 36,921 Standby letters of credit 249 0 0 249 249 Accrued interest payable 3,186 486 2,700 0 3,186 96 Table of Contents NOTE 5 – FAIR VALUE (continued) 2021 Carrying Estimated Fair Value (dollars in thousands) Value Level 1 Level 2 Level 3 Total Financial Assets: Cash and cash equivalents $ 683,240 $ 681,286 $ 1,954 $ 0 $ 683,240 Securities available-for-sale 1,398,558 900 1,395,615 2,043 1,398,558 Real estate mortgages held-for-sale 7,470 0 7,634 0 7,634 Loans, net 4,220,068 0 0 4,144,000 4,144,000 Mortgage banking derivative 398 0 398 0 398 Interest rate swap derivative 14,309 0 14,309 0 14,309 Federal Reserve and Federal Home Loan Bank Stock 13,772 N/A N/A N/A N/A Accrued interest receivable 17,674 0 7,689 9,985 17,674 Financial Liabilities: Certificates of deposit 829,518 0 833,617 0 833,617 All other deposits 4,905,889 4,905,889 0 0 4,905,889 Federal Home Loan Bank advances 75,000 0 66,118 0 66,118 Mortgage banking derivative 2 0 2 0 2 Interest rate swap derivative 14,329 0 14,329 0 14,329 Standby letters of credit 272 0 0 272 272 Accrued interest payable 2,619 84 2,535 0 2,619 97 Table of Contents NOTE 6 – LAND, PREMISES AND EQUIPMENT, NET Land, premises and equipment and related accumulated depreciation were as follows at December 31, 2022 and 2021: (dollars in thousands) 2022 2021 Land $ 12,472 $ 12,472 Premises and improvements 61,185 58,716 Equipment and furniture 37,460 39,278 Total cost 111,117 110,466 Less accumulated depreciation 53,020 51,157 Land, premises and equipment, net $ 58,097 $ 59,309 The Company had no land, premises and equipment held for sale and included in other assets as of December 31, 2022 and 2021. NOTE 7 – GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill There have been no changes in the $ 5.0 million carrying amount of goodwill since 2002. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. At December 31, 2022, the Company’s reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment. The Company’s annual impairment analysis was performed as of May 31, 2022. Circumstances did not substantially change during the second half of the year such that the Company believed it was necessary to perform an additional impairment analysis. NOTE 8 – DEPOSITS The following table details total deposits as of December 31, 2022 and 2021: (dollars in thousands) 2022 2021 Non-interest bearing demand deposits $ 1,736,761 $ 1,895,481 Savings and transaction accounts: Savings deposits 403,773 409,343 Interest bearing demand deposits 2,693,900 2,601,065 Time deposits: Other time deposits 170,759 202,395 Deposits of $100,000 to $250,000 185,194 227,606 Deposits of $250,000 or more 270,233 399,517 Total deposits $ 5,460,620 $ 5,735,407 98 Table of Contents NOTE 8 – DEPOSITS (continued) At December 31, 2022, the scheduled maturities of time deposits were as follows: (dollars in thousands) Amount Maturing in 2023 $ 379,460 Maturing in 2024 206,081 Maturing in 2025 15,132 Maturing in 2026 12,583 Maturing in 2027 12,546 Thereafter 384 Total time deposits $ 626,186 During 2022 and 2021 the Bank entered into agreements with IntraFi Network relative to their Insured Cash Sweep One-Way Buy program. As of December 31, 2022 and 2021 the total amount available to the Bank via this program was $ 100.0 million, of which, $ 10.0 million was drawn. NOTE 9 – BORROWINGS The following table details outstanding advances with the Federal Home Loan Bank ("FHLB") of Indianapolis for the years ended December 31, 2022 and 2021: (dollars in thousands) 2022 2021 FHLB of Indianapolis Bullet Advance, 4.21 %, Due January 5, 2023 $ 275,000 $ 0 FHLB of Indianapolis Putable Advance, 0.39 %, Due March 4, 2030, Called June 6, 2022 0 75,000 Total FHLB advances $ 275,000 75,000 The advance outstanding at December 31, 2022 was a fixed-rate bullet advance and could not be prepaid by the Company without a penalty. The note required payment at maturity and was secured by residential real estate loans and securities with a carrying value of $ 549.0 million at December 31, 2022. The advance outstanding at December 31, 2021 was a ten-year fixed-rate putable advance and could not be prepaid by the Company without penalty. The FHLB exercised the putable option on the advance during the second quarter of 2022 and the advance was repaid by the Company. The note was secured by residential real estate loans and securities with a carrying value of $ 478.4 million at December 31, 2021. At December 31, 2022 and 2021, the Company owned $ 12.4 million and $ 10.4 million, respectively, of FHLB stock which also secures debts owed to the FHLB. The Company is authorized by the Board to borrow up to $ 800.0 million at the FHLB, but availability is limited to $ 66.5 million based on collateral and outstanding borrowings. Federal Reserve Discount Window borrowings were secured by commercial loans and investment securities with a carrying value of $ 928.6 million and $ 804.4 million as of December 31, 2022 and 2021. The Company had a borrowing capacity of $ 758.3 million and $ 616.5 million at the Federal Reserve Bank as of December 31, 2022 and 2021, respectively. There were no borrowings outstanding at the Federal Reserve Bank at December 31, 2022 and 2021. The Company had $ 350.0 million of availability in federal funds lines with eleven correspondent banks as of December 31, 2022 and 2021; $ 22.0 million and $ 0 were drawn upon as of December 31, 2022 and 2021, respectively. The Bank is also a member of the American Financial Exchange (AFX) where overnight fed funds purchased can be obtained from other banks on the Exchange that have approved the Bank for an unsecured, overnight line. These funds are only available if the approving banks have an ‘offer’ out to sell that day. The total amount approved for the Bank via AFX banks was $ 319.0 million at December 31, 2022 and 2021. There were no amounts drawn as of December 31, 2022 and 2021. 99 Table of Contents NOTE 9 – BORROWINGS (continued) On August 2, 2019 the Company entered into an unsecured revolving credit agreement with another financial institution allowing the Company to borrow up to $ 30.0 million; this credit agreement was subsequently amended and renewed on July 30, 2022. Funds provided under the agreement may be used to repurchase shares of the Company’s common stock under the share repurchase program, which was reauthorized by the Company’s board of directors on April 13, 2021 and expires on April 30, 2023, and for general operations. The credit agreement includes a negative pledge agreement whereby the Company agrees not to pledge or otherwise encumber the stock of the Bank. The credit agreement has a one year term which may be amended, extended, modified or renewed. There were no outstanding borrowings on the credit agreement at December 31, 2022 and 2021, respectively. NOTE 10 – PENSION AND OTHER POSTRETIREMENT PLANS In April 2000, the Lakeland Financial Corporation Pension Plan was frozen. The Company also maintains a Supplemental Executive Retirement Plan (“SERP”) for select officers that was established as a funded, non-qualified deferred compensation plan. Currently, six retired officers are the only participants in the SERP. The measurement date for both the pension plan and SERP is December 31, 2022 and 2021. Information as to the Company’s employee benefit plans at December 31, 2022 and 2021 is as follows: Pension Benefits SERP Benefits (dollars in thousands) 2022 2021 2022 2021 Change in benefit obligation: Beginning benefit obligation $ 2,298 $ 2,710 $ 867 $ 968 Interest cost 53 52 20 18 Actuarial (gain) loss ( 611 ) ( 153 ) ( 52 ) 13 Benefits paid ( 194 ) ( 311 ) ( 135 ) ( 132 ) Ending benefit obligation 1,546 2,298 700 867 Change in plan assets (primarily equity and fixed income investments and money market funds), at fair value: Beginning plan assets 2,303 2,349 848 879 Actual return ( 289 ) 265 ( 107 ) 101 Employer contribution 0 0 0 0 Benefits paid ( 194 ) ( 311 ) ( 135 ) ( 132 ) Ending plan assets 1,820 2,303 606 848 Funded status at end of year $ 274 $ 5 $ ( 94 ) $ ( 19 ) Amounts recognized in the consolidated balance sheets consist of: Pension Benefits SERP Benefits (dollars in thousands) 2022 2021 2022 2021 Funded status included in other liabilities $ 274 $ 5 $ ( 94 ) $ ( 19 ) Amounts recognized in accumulated other comprehensive income consist of: Pension Benefits SERP Benefits (dollars in thousands) 2022 2021 2022 2021 Net actuarial loss $ 538 $ 852 $ 487 $ 431 The accumulated benefit obligation for the pension plan was $ 1.5 million and $ 2.3 million for December 31, 2022 and 2021, respectively. The accumulated benefit obligation for the SERP was $ 700,000 and $ 867,000 for December 31, 2022 and 2021, respectively. 100 Table of Contents NOTE 10 – PENSION AND OTHER POSTRETIREMENT PLANS (continued) Net period benefit cost and other amounts recognized in other comprehensive income (loss) include the following: Pension Benefits SERP Benefits (dollars in thousands) 2022 2021 2020 2022 2021 2020 Net pension expense: Service cost $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 Interest cost 53 52 75 20 18 27 Expected return on plan assets ( 130 ) ( 133 ) ( 140 ) ( 45 ) ( 47 ) ( 51 ) Recognized net actuarial (gain) loss 99 160 171 45 82 80 Settlement cost 23 65 115 0 0 0 Net pension expense $ 45 $ 144 $ 221 $ 20 $ 53 $ 56 Net (gain) loss $ ( 215 ) $ ( 350 ) $ 69 $ 100 $ ( 40 ) $ 36 Amortization of net loss ( 99 ) ( 160 ) ( 171 ) ( 45 ) ( 82 ) ( 80 ) Total recognized in other comprehensive income (loss) ( 314 ) ( 510 ) ( 102 ) 55 ( 122 ) ( 44 ) Total recognized in net pension expense and other comprehensive income (loss) $ ( 269 ) $ ( 366 ) $ 119 $ 75 $ ( 69 ) $ 12 The estimated net loss (gain) for the defined benefit pension plan and SERP that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost over the next fiscal year is ($ 31,000 ) for the pension plan and $ 37,000 for the SERP. The settlement costs in 2022, 2021 and 2020 were related to participants taking lump sum distributions from the pension plan during those years. For 2022, 2021 and 2020, the assumed form of payment elected by active participants upon retirement was a lump sum to reflect participant trends. The lump sum assumed interest rates, below, for December 31, 2022, 2021 and 2020 reflect the mortality table in effect for 2022, 2021 and 2020, respectively. For 2022, the mortality assumption was the PRI-2012 White Collar Mortality Table, with full generational Projection Scale MP-2021 as of December 31, 2022. For 2021, the mortality assumption was changed to the PRI-2012 White Collar Mortality Table, with full generational Projection Scale MP-2021 as of December 31, 2021, to reflect improved mortality expectations. For 2020, the mortality assumption was the PRI-2012 White Collar Mortality Table, with full generational Projection Scale MP-2020 as of December 31, 2020. 101 Table of Contents NOTE 10 – PENSION AND OTHER POSTRETIREMENT PLANS (continued) Pension Benefits SERP Benefits 2022 2021 2020 2022 2021 2020 The following assumptions were used in calculating the net benefit obligation: Weighted average discount rate 5.03 % 2.49 % 2.08 % 5.03 % 2.49 % 2.08 % Rate of increase in future compensation N/A N/A N/A N/A N/A N/A Lump sum assumed interest rates First 5 years 5.10 % 0.87 % 0.53 % N/A N/A N/A Next 15 years 5.83 % 2.74 % 2.31 % N/A N/A N/A All future years 5.68 % 3.16 % 3.09 % N/A N/A N/A The following assumptions were used in calculating the net pension expense: Weighted average discount rate 2.49 % 2.08 % 2.98 % 2.49 % 2.08 % 2.98 % Rate of increase in future compensation N/A N/A N/A N/A N/A N/A Expected long-term rate of return 6.50 % 6.50 % 6.50 % 6.50 % 6.50 % 6.50 % Pension Plan and SERP Assets The Company’s investment strategies are to invest in a prudent manner for the purpose of providing benefits to participants in the pension plan and the SERP. The investment strategies are targeted to maximize the total return of the portfolio net of inflation, spending and expenses. Risk is controlled through diversification of asset types and investments in domestic and international equities and fixed income securities. The target allocations for plan assets are shown in the tables below. Equity securities primarily include investments in common stocks. Debt securities include government agency and commercial bonds. Other investments consist of money market mutual funds. The weighted average expected long-term rate of return on pension plan and SERP assets is developed in consultation with the plans actuary. It is primarily based upon industry trends and consensus rates of return which are then adjusted to reflect the specific asset allocations and historical rates of return of the Company’s plan assets. The following assumptions were used in determining the total long-term rate of return: equity securities were assumed to have a long-term rate of return of approximately 8.85 % and debt securities were assumed to have a long-term rate of return of approximately 3.00 %. These rates of return were adjusted to reflect an approximate target allocation of 60 % equity securities and 40 % debt securities with a small downward adjustment due to investments in the “Other” category, which consist of low yielding money market mutual funds. Certain asset types and investment strategies are prohibited including, the investment in commodities, options, futures, short sales, margin transactions and non-marketable securities. 102 Table of Contents NOTE 10 – PENSION AND OTHER POSTRETIREMENT PLANS (continued) The Company’s pension plan asset allocation at year end 2022 and 2021, target allocation for 2023, and expected long-term rate of return by asset category are as follows: Target Allocation Percentage of Plan Assets at Year End Weighted Average Expected Long-Term Rate of Return Asset Category 2023 2022 2021 Equity securities 55 - 65 % 60 % 61 % 8.85 % Debt securities 35 - 45 % 39 % 37 % 3.00 % Other 5 - 10 % 1 % 2 % 0.10 % Total 100 % 100 % 6.50 % The Company’s SERP plan asset allocation at year end 2022 and 2021, target allocation for 2023, and expected long-term rate of return by asset category are as follows: Target Allocation Percentage of Plan Assets at Year End Weighted Average Expected Long-Term Rate of Return Asset Category 2023 2022 2021 Equity securities 55 - 65 % 62 % 59 % 8.85 % Debt securities 35 - 45 % 35 % 36 % 3.00 % Other 5 - 10 % 3 % 5 % 0.10 % Total 100 % 100 % 6.50 % Fair Value of Pension Plan and SERP Assets Fair value is the exchange price that would be received for an asset in the principal or most advantageous market for the asset in an orderly transaction between market participants on the measurement date. Also, a fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument: Equity and debt securities: The fair values of securities are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or pricing models, which utilize significant observable inputs such as matrix pricing. This is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). 103 Table of Contents NOTE 10 – PENSION AND OTHER POSTRETIREMENT PLANS (continued) The fair values of the Company’s pension plan assets at December 31, 2022, by asset category are as follows: Asset Category Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) Equity securities - US large cap common stocks $ 718 $ 718 $ 0 $ 0 Equity securities - US mid cap stock mutual funds 43 43 0 0 Equity securities - US small cap stock mutual funds 131 131 0 0 Equity securities - international stock mutual funds 158 158 0 0 Equity securities - emerging markets stock mutual funds 34 34 0 0 Debt securities - intermediate term bond mutual funds 232 232 0 0 Debt securities - short term bond mutual funds 484 484 0 0 Cash - money market account 20 20 0 0 Total $ 1,820 $ 1,820 $ 0 $ 0 The fair values of the Company’s pension plan assets at December 31, 2021, by asset category are as follows: Asset Category Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2 ) Significant Unobservable Inputs (Level 3) (dollars in thousands) Equity securities - US large cap common stocks $ 923 $ 923 $ 0 $ 0 Equity securities - US mid cap stock mutual funds 104 104 0 0 Equity securities - US small cap stock mutual funds 106 106 0 0 Equity securities - international stock mutual funds 193 193 0 0 Equity securities - emerging markets stock mutual funds 73 73 0 0 Debt securities - intermediate term bond mutual funds 273 273 0 0 Debt securities - short term bond mutual funds 572 572 0 0 Cash - money market account 59 59 0 0 Total $ 2,303 $ 2,303 $ 0 $ 0 There were no Level 2 or 3 securities during either year. 104 Table of Contents NOTE 10 – PENSION AND OTHER POSTRETIREMENT PLANS (continued) The fair values of the Company’s SERP assets at December 31, 2022, by asset category are as follows: Asset Category Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) Equity securities - US large cap common stocks $ 249 $ 249 $ 0 $ 0 Equity securities - US mid cap stock mutual funds 16 16 0 0 Equity securities - US small cap stock mutual funds 43 43 0 0 Equity securities - emerging markets stock mutual funds 12 12 0 0 Equity securities - international stock mutual funds 57 57 0 0 Debt securities - intermediate term bond mutual funds 63 63 0 0 Debt securities - short term bond mutual funds 149 149 0 0 Cash - money market account 17 17 0 0 Total $ 606 $ 606 $ 0 $ 0 The fair values of the Company’s SERP assets at December 31, 2021, by asset category are as follows: Asset Category Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (dollars in thousands) Equity securities - US large cap common stocks $ 327 $ 327 $ 0 $ 0 Equity securities - US mid cap stock mutual funds 38 38 0 0 Equity securities - US small cap stock mutual funds 38 38 0 0 Equity securities - emerging markets stock mutual funds 27 27 0 0 Equity securities - international stock mutual funds 71 71 0 0 Debt securities - intermediate term bond mutual funds 85 85 0 0 Debt securities - short term bond mutual funds 222 222 0 0 Cash - money market account 40 40 0 0 Total $ 848 $ 848 $ 0 $ 0 Total SERP plan assets available for benefits also include $ 1,000 in accrued interest and dividend income. There were no Level 2 or 3 securities during either year. Contributions The Company did not contribute to its pension or SERP plans in 2022. 105 Table of Contents NOTE 10 – PENSION AND OTHER POSTRETIREMENT PLANS (continued) Estimated Future Benefit Payments The following benefit payments are expected to be paid over the next ten years: Plan Year Pension Benefits SERP Benefits (dollars in thousands) 2023 $ 198 $ 130 2024 168 122 2025 177 112 2026 218 101 2027 141 90 2028-2032 544 262 NOTE 11 – OTHER BENEFIT PLANS 401(k) Plan The Company maintains a 401(k) profit sharing plan for all employees meeting certain age and service requirements. The 401(k) plan allows employee contributions up to the maximum amount allowable under the Internal Revenue Code, which are matched based upon the percentage of budgeted net income earned during the year on the first 6 % of the compensation contributed. The expense recognized from matching was $ 2.4 million, $ 2.3 million and $ 1.9 million in 2022, 2021 and 2020, respectively. Deferred Compensation Plan Effective January 1, 2004, the Company adopted the Lake City Bank Deferred Compensation Plan. The purpose of the deferred compensation plan is to extend full 401(k) type retirement benefits to certain individuals without regard to statutory limitations under tax qualified plans. A liability is accrued by the Company for its obligation under this plan. The expense recognized was ($ 1.0 million), $ 1.2 million and $ 1.0 million during the years ended December 31, 2022, 2021 and 2020, respectively. This resulted in a deferred compensation liability of $ 6.1 million and $ 7.0 million as of year end 2022 and 2021, respectively. The deferred compensation plan is funded solely by participant contributions and does not receive a Company match. Employee Agreements Under employment agreements with certain executives, certain events leading to separation from the Company could result in cash payments totaling $ 5.4 million as of December 31, 2022. On December 31, 2022, no amounts were accrued on these contingent obligations. Directors’ Deferred Compensation and Cash Plans The Company maintains a directors’ deferred compensation plan and a cash plan. The amount owed to directors for fees under the deferred directors’ compensation and cash plans as of December 31, 2022 and 2021 was $ 5.6 million and $ 5.2 million, respectively. The related expense for the deferred directors’ compensation and cash plans for the years ended December 31, 2022, 2021 and 2020 was $ 458,000 , $ 482,000 and $ 505,000 , respectively. 106 Table of Contents NOTE 12 – INCOME TAXES Income tax expense for the years ended December 31, 2022, 2021 and 2020 consisted of the following: (dollars in thousands) 2022 2021 2020 Current federal $ 22,825 $ 21,329 $ 20,032 Deferred federal ( 2,327 ) ( 1,249 ) ( 1,688 ) Current state 1,297 1,892 1,484 Deferred state ( 448 ) ( 261 ) ( 289 ) Total income tax expense $ 21,347 $ 21,711 $ 19,539 The differences between financial statement tax expense and amounts computed by applying the statutory federal income tax rate of 21 % to income before income taxes were as follows: (dollars in thousands) 2022 2021 2020 Income taxes at statutory federal rate of 21% $ 26,284 $ 24,663 $ 21,814 Increase (decrease) in taxes resulting from: Tax exempt income ( 4,438 ) ( 2,822 ) ( 1,925 ) Nondeductible expense 159 116 117 State income tax, net of federal tax effect 671 1,288 944 Captive insurance premium income ( 417 ) ( 303 ) ( 227 ) Tax credits ( 586 ) ( 578 ) ( 540 ) Bank owned life insurance ( 78 ) ( 596 ) ( 595 ) Long-term incentive plan and deferred compensation ( 530 ) ( 274 ) ( 58 ) Nondeductible compensation expense 181 156 0 Other 101 61 9 Total income tax expense $ 21,347 $ 21,711 $ 19,539 107 Table of Contents NOTE 12 – INCOME TAXES (continued) The net deferred tax asset recorded in the consolidated balance sheets at December 31, 2022 and 2021 consisted of the following: (dollars in thousands) 2022 2021 Deferred tax assets: Bad debts $ 18,561 $ 17,321 Pension and deferred compensation liability 2,272 2,351 Nonaccrual loan interest 256 600 Long-term incentive plan 2,894 1,896 Lease liability 1,354 1,078 Deferred loan fees 572 771 Accrued legal reserve 819 0 Other 1,130 191 27,858 24,208 Deferred tax liabilities: Depreciation 4,257 4,279 Loan servicing rights 694 717 State taxes 786 679 Intangible assets 1,270 1,270 REIT spillover dividend 1,290 1,180 Prepaid expenses 988 952 Lease right of use 1,354 1,078 Other 585 194 11,224 10,349 Valuation allowance 0 0 Net deferred tax asset $ 16,634 $ 13,859 In addition to the net deferred tax assets included above, the deferred income tax asset (liability) allocated to the unrealized net gain (loss) on securities available-for-sale included in equity was $ 50.0 million and ($ 4.5 million) for 2022 and 2021, respectively. The deferred income tax asset allocated to the pension plan and SERP included in equity was $ 255,000 and $ 319,000 for 2022 and 2021, respectively. The Company evaluated its deferred tax asset at year end 2022 and has concluded that it is more likely than not that it will be realized. The Company expects to have taxable income in the future such that the deferred tax asset will be realized. Therefore, no valuation allowance is required. Unrecognized Tax Benefits The Company did no t have any unrecognized tax benefits at December 31, 2022 or 2021. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. No interest or penalties were recorded in the income statement and no amount was accrued for interest and penalties for the periods ending December 31, 2022, 2021 and 2020. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is the Company’s policy to record such accruals in its income taxes accounts. The Company and its subsidiaries file a consolidated U.S. federal tax return and a combined unitary return in the States of Indiana and Michigan. These returns are subject to examinations by authorities for all years after 2018. 108 Table of Contents NOTE 13 – RELATED PARTY TRANSACTIONS Loans to principal officers, directors, and their affiliates as of December 31, 2022 and 2021 were as follows: (dollars in thousands) 2022 2021 Beginning balance $ 99,865 $ 104,694 New loans and advances 54,085 74,115 Effect of changes in related parties ( 10,463 ) ( 62 ) Repayments and renewals ( 30,052 ) ( 78,882 ) Ending balance $ 113,435 $ 99,865 Deposits from principal officers, directors, and their affiliates at year end 2022 and 2021 were $ 16.2 million and $ 30.2 million, respectively. The Company and Bank are an investor in certain funds managed by Centerfield Capital (“Centerfield”), a private equity investment firm. Faraz Abbasi, a director of the Company, is a Managing Partner and an owner of Centerfield. As of December 31, 2022 and 2021, the Company had an aggregate investment balance of approximately $ 2.3 million in such funds, which are included in other assets on the consolidated balance sheet, and had remaining commitments to invest up to approximately $ 2.8 million and $ 3.2 million, respectively. Under the terms of the applicable funds, Centerfield is entitled to customary management fees with respect to the amounts under management and investment gains, and it is estimated that Mr. Abbasi’s interest in such fees was less than $ 25,000 annually for the years ended December 31, 2022 and 2021. NOTE 14 – STOCK BASED COMPENSATION Effective April 8, 2008, the Company adopted the Lakeland Financial Corporation 2008 Equity Incentive Plan (the “2008 Plan”), which was approved by the Company’s stockholders. At its inception there were 1,125,000 shares of common stock reserved for grants of stock options, stock appreciation rights, stock awards and cash incentive awards to employees of the Company, its subsidiaries and Board. Effective April 9, 2013, the Company adopted the Lakeland Financial Corporation 2013 Equity Incentive Plan (the “2013 Plan”), which was also approved by the Company’s stockholders. At its inception the remaining shares of common stock available to grant under the 2008 Plan of 435,867 were transferred to the 2013 Plan and reserved for grants of stock options, stock appreciation rights, stock awards and cash incentive awards to employees of the Company, its subsidiaries and Board. Non-vested shares from the 2008 Plan that were unused at vesting were added to the shares available to grant of the 2013 Plan. Effective April 12, 2017, the Company adopted the Lakeland Financial Corporation 2017 Equity Incentive Plan (the “2017 Plan”), which was also approved by the Company’s stockholders and does not permit share recycling. At its inception there were 1,000,000 shares of common stock reserved for grants of stock options, stock appreciation rights, stock awards and cash incentive awards to employees of the Company, its subsidiaries and Board. As of December 31, 2022, 387,388 shares were available for future grants in the 2017 Plan, which is the only active plan. Certain stock awards provide for accelerated vesting if there is a change in control. The Company has a policy of issuing new shares to satisfy exercises of stock awards. Included in net income for the years ended December 31, 2022, 2021 and 2020 was employee stock compensation expense of $ 7.8 million, $ 7.2 million and $ 1.8 million, and a related tax benefit of $ 2.0 million, $ 1.8 million and $ 0.5 million, respectively. Stock Options The equity incentive plan requires that the exercise price for options be the market price on the date the options are granted. The maximum option term is ten years and the awards usually vest over three years . The fair value of each stock option is estimated with the Black-Scholes pricing model, using the following weighted-average assumptions as of the grant date for stock options granted during the years presented. Expected volatilities are based on historical volatility of the Company’s stock over the immediately preceding expected life period, as well as other factors known on the grant date that would have a significant effect on the stock price during the expected life period. The expected stock option life used is the historical option life of the similar employee base or Board. The turnover rate is based on historical data of the similar employee base as a group 109 Table of Contents NOTE 14 – STOCK BASED COMPENSATION (continued) and the Board as a group. The risk-free interest rate is the Treasury rate on the date of grant corresponding to the expected life period of the stock option. There were no stock option grants or modifications in 2022, 2021 or 2020. As of December 31, 2022, there was no unrecognized compensation cost related to non-vested stock options granted under the plan. There were no options exercised during the years ended December 31, 2022, 2021 or 2020. Restricted Stock Awards and Units The fair value of restricted stock awards and units is the closing price of the Company’s common stock on the date of grant adjusted for the present value of expected dividends. The restricted stock awards fully vest after one year or more of service, determined at the grant date, with the exception of 14,300 shares granted to non-employee directors of the Board included as vested, below, which vested on the grant date. A summary of the changes in the Company’s non-vested shares for the year follows: Nonvested Shares Shares Weighted-Average Grant-Date Fair Value Nonvested at January 1, 2022 1,500 $ 44.10 Granted 37,957 76.02 Vested ( 15,876 ) 72.84 Forfeited ( 516 ) 76.33 Nonvested at December 31, 2022 23,065 $ 76.13 As of December 31, 2022, there was $ 1.2 million unrecognized compensation cost related to non-vested shares granted under the plan. The cost is expected to be recognized over a weighted period of 2 years. The total fair value of shares vested during the years ended December 31, 2022, 2021 and 2020 was $ 1.2 million, $ 1.1 million and $ 0.7 million, respectively. Performance Stock Units The fair value of stock awards is the closing price of the Company’s common stock on the date of grant, adjusted for the present value of expected dividends. The expected dividend rate is assumed to be the most recent dividend rate declared by the Board on the grant date. The grant date fair value of stock awards is assumed at the target payout rate. The stock awards fully vest on the third anniversary of the grant date. The 2022-2024, 2021-2023 and 2020-2022 Long-Term Incentive Plans must be paid in stock and have performance conditions which include revenue growth, diluted earnings per share growth and average return on beginning equity. Shares granted below include the number of shares assumed granted based on actual performance criteria of the 2022-2024, 2021-2023 and 2020-2022 Long-Term Incentive Plans at December 31, 2022. Nonvested Shares Shares Weighted-Average Grant-Date Fair Value Nonvested at January 1, 2022 271,770 $ 49.83 Granted, net 92,713 72.80 Vested ( 53,670 ) 43.44 Forfeited ( 6,192 ) 57.45 Nonvested at December 31, 2022 304,621 $ 57.79 As of December 31, 2022, there wa s $ 6.6 million of total unrecognized compensation cost related to non-vested shares granted under the plan. The cost is expected to be recognized over a weighted period of 2 years. The total fair value of shares vested during the year ended December 31, 2022, 2021 and 2020 was $ 4.3 million , $ 5.2 million and $ 5.7 million, respectively. During the years ended December 31, 2022, 2021 and 2020, 53,670 , 83,216 and 120,204 shares vested, respectively. 110 Table of Contents NOTE 15 – CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS The Company became a financial holding company effective May 30, 2012 and is now required to be well capitalized under the applicable regulatory guidelines. The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet certain heightened minimum capital requirements can initiate certain mandatory, and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. The capital adequacy requirements were heightened by the Basel III Rule, previously defined, which went into effect on January 1, 2015 with a phase-in period for certain aspects of the rule through 2019. Under the Basel III rule, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in from 0.00 % for 2015 to 2.50 % by 2019. The capital conservation buffer for 2022 and 2021 was 2.50 %. The net unrealized gain or loss on available-for-sale securities is not included in computing regulatory capital. The quantitative measures established by regulation to ensure capital adequacy that were in effect on December 31, 2022 and 2021, require the Company and the Bank to maintain minimum capital amounts and ratios (set forth in the following table) of Total, Tier I and Common Equity Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined in the regulation), and of Tier I capital (as defined in the regulation) to average assets (as defined). Management believes, as of the years ended December 31, 2022 and 2021, that the Company and the Bank met all capital adequacy requirements to which they are subject. 111 Table of Contents NOTE 15 – CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS (continued) As of December 31, 2022, the most recent notification from the federal regulators categorized the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum Total risk-based capital ratios, Tier I risk-based capital ratios and Tier I leverage capital ratios as set forth in the table. There have been no conditions or events since that notification that management believes have changed the Company and the Bank’s category. 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 December 31, 2022 Total Capital (to Risk Weighted Assets) Consolidated $ 821,008 15.07 % $ 435,786 8.00 % $ 571,969 N/A N/A N/A Bank $ 801,044 14.74 % $ 434,758 8.00 % $ 570,620 10.50 % $ 543,448 10.00 % Tier I Capital (to Risk Weighted Assets) Consolidated $ 752,751 13.82 % $ 326,840 6.00 % $ 463,023 N/A N/A N/A Bank $ 732,966 13.49 % $ 326,069 6.00 % $ 461,930 8.50 % $ 434,758 8.00 % Common Equity Tier 1 (CET1) Consolidated $ 752,751 13.82 % $ 245,130 4.50 % $ 381,313 N/A N/A N/A Bank $ 732,966 13.49 % $ 244,551 4.50 % $ 380,413 7.00 % $ 353,241 6.50 % Tier I Capital (to Average Assets) Consolidated $ 752,751 11.50 % $ 261,859 4.00 % $ 261,859 N/A N/A N/A Bank $ 732,966 11.22 % $ 261,222 4.00 % $ 261,222 4.00 % $ 326,527 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 % The Bank is required to obtain the approval of the Indiana Department of Financial Institutions for the payment of any dividend if the total amount of all dividends declared by the Bank during the calendar year, including the proposed dividend, would exceed the sum of the retained net income for the year-to-date combined with the retained net income for the previous two years. Indiana law defines “retained net income” to mean the net income of a specified period, calculated under the consolidated report of income instructions, less the total amount of all dividends declared for the specified period. As of December 31, 2022, approximately $ 121.1 million was available to be paid as dividends to the Company by the Bank. The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2022. Notwithstanding the availability of funds for dividends, however, the FDIC may prohibit the payment of any dividends by the Bank if the FDIC determines such payment would constitute an unsafe or unsound practice. 112 Table of Contents NOTE 16 – OFFSETTING ASSETS AND LIABILITIES The following tables summarize gross and net information about financial instruments and derivative instruments that are offset in the statement of financial position or that are subject to an enforceable master netting arrangement at December 31, 2022 and 2021. 2022 Gross Amounts of Recognized Assets/ Liabilities Gross Amounts Offset in the Statement of Financial Position Net Amounts presented in the Statement of Financial Position Gross Amounts Not Offset in the Statement of Financial Position (dollars in thousands) Financial Instruments Cash Collateral Position Net Amount Assets Interest Rate Swap Derivatives $ 36,920 $ 0 $ 36,920 $ 0 $ ( 34,185 ) $ 2,735 Total Assets $ 36,920 $ 0 $ 36,920 $ 0 $ ( 34,185 ) $ 2,735 Liabilities Interest Rate Swap Derivatives $ 36,921 $ 0 $ 36,921 $ 0 $ ( 90 ) $ 36,831 Total Liabilities $ 36,921 $ 0 $ 36,921 $ 0 $ ( 90 ) $ 36,831 2021 Gross Amounts of Recognized Assets/ Liabilities Gross Amounts Offset in the Statement of Financial Position Net Amounts presented in the Statement of Financial Position Gross Amounts Not Offset in the Statement of Financial Position (dollars in thousands) Financial Instruments Cash Collateral Position Net Amount Assets Interest Rate Swap Derivatives $ 14,309 $ 0 $ 14,309 $ 0 $ ( 2,255 ) $ 12,054 Total Assets $ 14,309 $ 0 $ 14,309 $ 0 $ ( 2,255 ) $ 12,054 Liabilities Interest Rate Swap Derivatives $ 14,329 $ 0 $ 14,329 $ 0 $ ( 7,995 ) $ 6,334 Total Liabilities $ 14,329 $ 0 $ 14,329 $ 0 $ ( 7,995 ) $ 6,334 If an event of default occurs causing an early termination of an interest rate swap derivative, any early termination amount payable to one party by the other party may be reduced by set-off against any other amount payable by the one party to the other party. If a default in performance of any obligation of a repurchase agreement occurs, each party will set-off property held in respect of transactions against obligations owing in respect of any other transactions. 113 Table of Contents NOTE 17 – COMMITMENTS, OFF-BALANCE SHEET RISKS AND CONTINGENCIES During the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk in order to meet the financing needs of its customers. These financial instruments include commitments to make loans and open-ended revolving lines of credit. Amounts as of the years ended December 31, 2022 and 2021, were as follows: 2022 2021 (dollars in thousands) Fixed Rate Variable Rate Fixed Rate Variable Rate Commercial loan lines of credit $ 140,022 $ 2,129,211 $ 79,792 $ 1,850,719 Standby letters of credit 0 48,406 0 55,336 Real estate mortgage loans 377 5,668 7,906 14,216 Real estate construction mortgage loans 2,212 9,043 2,402 3,213 Home equity mortgage open-ended revolving lines 0 341,622 0 306,124 Consumer loan open-ended revolving lines 0 25,916 0 23,287 Total $ 142,611 $ 2,559,866 $ 90,100 $ 2,252,895 The index on variable rate commercial loan commitments is principally the national prime rate. Interest rate ranges on commitments and open-ended revolving lines of credit for years ended December 31, 2022 and 2021, were as follows: 2022 2021 Fixed Rate Variable Rate Fixed Rate Variable Rate Commercial loan 1.99 - 14.50 % 1.63 - 13.00 % 1.99 - 14.50 % 1.11 - 10.00 % Real estate mortgage loan 0.00 - 7.00 % 3.13 - 12.50 % 2.50 - 3.75 % 3.00 - 8.25 % Consumer loan open-ended revolving line 15.00 % 7.00 - 15.00 % 15.00 % 3.25 - 15.00 % Commitments, excluding open-ended revolving lines, generally have fixed expiration dates of one year or less. Open-ended revolving lines are monitored for proper performance and compliance on a monthly basis. Since many commitments expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Company follows the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as it follows for those loans that are recorded in its financial statements. The Company’s exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments. 114 Table of Contents NOTE 18 – PARENT COMPANY STATEMENTS The Company operates primarily in the banking industry, which accounts for substantially all of its revenues, operating income and assets. Presented below are parent only financial statements: CONDENSED BALANCE SHEETS December 31, (dollars in thousands) 2022 2021 ASSETS Deposits with Lake City Bank $ 386 $ 834 Deposits with other depository institutions 1,954 2,459 Cash 2,340 3,293 Investments in banking subsidiary 549,031 686,487 Investments in other subsidiaries 3,845 3,468 Other assets 13,819 11,830 Total assets $ 569,035 $ 705,078 LIABILITIES Dividends payable and other liabilities $ 237 $ 261 STOCKHOLDERS’ EQUITY 568,798 704,817 Total liabilities and stockholders’ equity $ 569,035 $ 705,078 CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) Years Ended December 31, (dollars in thousands) 2022 2021 2020 Dividends from Lake City Bank $ 40,590 $ 47,355 $ 32,079 Dividends from non-bank subsidiaries 1,300 1,035 1,300 Other income 1 3 0 Interest expense 0 ( 7 ) 0 Miscellaneous expense ( 8,795 ) ( 8,133 ) ( 3,935 ) INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 33,096 40,253 29,444 Income tax benefit 2,770 2,360 1,065 INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 35,866 42,613 30,509 Equity in undistributed income of subsidiaries 67,951 53,120 53,828 NET INCOME $ 103,817 $ 95,733 $ 84,337 COMPREHENSIVE INCOME (LOSS) $ ( 101,199 ) $ 84,082 $ 100,022 115 Table of Contents NOTE 18 – PARENT COMPANY STATEMENTS (continued) CONDENSED STATEMENTS OF CASH FLOWS Years Ended December 31, (dollars in thousands) 2022 2021 2020 Cash flows from operating activities: Net income $ 103,817 $ 95,733 $ 84,337 Adjustments to net cash from operating activities: Equity in undistributed income of subsidiaries ( 67,951 ) ( 53,120 ) ( 53,828 ) Other changes 6,157 5,177 1,257 Net cash from operating activities 42,023 47,790 31,766 Cash flows from financing activities Proceeds from (payments on) short-term borrowings 0 ( 10,500 ) 10,500 Payments related to equity incentive plans ( 1,780 ) ( 1,914 ) ( 2,137 ) Purchase of treasury stock ( 579 ) ( 559 ) ( 10,547 ) Sales of treasury stock 221 115 119 Dividends paid ( 40,838 ) ( 34,640 ) ( 30,566 ) Cash flows from financing activities ( 42,976 ) ( 47,498 ) ( 32,631 ) Net increase (decrease) in cash and cash equivalents ( 953 ) 292 ( 865 ) Cash and cash equivalents at beginning of the year 3,293 3,001 3,866 Cash and cash equivalents at end of the year $ 2,340 $ 3,293 $ 3,001 NOTE 19 – EARNINGS PER SHARE Following are the factors used in the earnings per share computations: (dollars in thousand except share and per share data) 2022 2021 2020 Basic earnings per common share: Net income $ 103,817 $ 95,733 $ 84,337 Weighted-average common shares outstanding 25,528,328 25,475,994 25,469,242 Basic earnings per common share $ 4.07 $ 3.76 $ 3.31 Diluted earnings per common share: Net income $ 103,817 $ 95,733 $ 84,337 Weighted-average common shares outstanding for basic earnings per common share 25,528,328 25,475,994 25,469,242 Add: Dilutive effect of assumed exercises of stock options and awards 184,210 144,111 104,699 Average shares and dilutive potential common shares 25,712,538 25,620,105 25,573,941 Diluted earnings per common share $ 4.04 $ 3.74 $ 3.30 There were no antidilutive stock options for 2022, 2021 and 2020. 116 Table of Contents NOTE 20 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following tables summarize the changes within each classification of accumulated other comprehensive income (loss) for December 31, 2022 and 2021, all shown net of tax: (dollars in thousands) Unrealized Gains and (Losses) on Available-for-Sales Securities Defined Benefit Pension Items Total Balance at January 1, 2022 $ 17,056 $ ( 963 ) $ 16,093 Other comprehensive income (loss) before reclassification ( 206,392 ) 86 ( 206,306 ) Amounts reclassified from accumulated other comprehensive income (loss) 1,182 108 1,290 Net current period other comprehensive income (loss) ( 205,210 ) 194 ( 205,016 ) Balance at December 31, 2022 $ ( 188,154 ) $ ( 769 ) $ ( 188,923 ) (dollars in thousands) Unrealized Gains and (Losses) on Available-for-Sales Securities Defined Benefit Pension Items Total Balance at January 1, 2021 $ 29,182 $ ( 1,438 ) $ 27,744 Other comprehensive income (loss) before reclassification ( 11,496 ) 293 ( 11,203 ) Amounts reclassified from accumulated other comprehensive income (loss) ( 630 ) 182 ( 448 ) Net current period other comprehensive income (loss) ( 12,126 ) 475 ( 11,651 ) Balance at December 31, 2021 $ 17,056 $ ( 963 ) $ 16,093 117 Table of Contents NOTE 20 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (continued) Reclassifications out of accumulated other comprehensive income for the years ended December 31, 2022, 2021 and 2020 are as follows: Details about Accumulated Other Comprehensive Income Components Amount Reclassified From Accumulated Other Comprehensive Income (Loss) Affected Line Item in the Statement Where Net Income is Presented 2022 (dollars in thousands) Amortization of unrealized losses on held-to-maturity securities $ ( 1,518 ) Interest income Realized gains and (losses) on available-for-sale securities 21 Net securities gains Tax effect 315 Income tax expense Subtotal ( 1,182 ) Net of tax Amortization of defined benefit pension items (1) ( 144 ) Salaries and employee benefits Tax effect 36 Income tax expense Subtotal ( 108 ) Net of tax Total reclassifications for the period $ ( 1,290 ) Net income 2021 (dollars in thousands) Realized gains and (losses) on available-for-sale securities $ 797 Net securities gains Tax effect ( 167 ) Income tax expense Subtotal 630 Net of tax Amortization of defined benefit pension items (1) ( 242 ) Salaries and employee benefits Tax effect 60 Income tax expense Subtotal ( 182 ) Net of tax Total reclassifications for the period $ 448 Net income 2020 (dollars in thousands) Realized gains and (losses) on available-for-sale securities $ 433 Net securities gains Tax effect ( 91 ) Income tax expense Subtotal 342 Net of tax Amortization of defined benefit pension items (1) ( 251 ) Salaries and employee benefits Tax effect 63 Income tax expense Subtotal ( 188 ) Net of tax Total reclassifications for the period $ 154 Net income (1) Included in the computation of net pension plan expense as more fully discussed in Note 10 – Pension and Other Postretirement Plans. 118 Table of Contents NOTE 21 – SELECTED QUARTERLY DATA (UNAUDITED) (in thousands except per share data) 2022 4th Quarter 3rd Quarter 2nd Quarter 1st Quarter Interest income $ 75,353 $ 62,558 $ 53,622 $ 48,034 Interest expense 18,516 10,066 4,944 3,154 Net interest income 56,837 52,492 48,678 44,880 Provision for credit losses 8,958 0 0 417 Net interest income after provision 47,879 52,492 48,678 44,463 Noninterest income 10,519 10,164 10,492 10,687 Noninterest expense 27,434 27,894 27,913 26,969 Income tax expense 4,987 6,237 5,584 4,539 Net income $ 25,977 $ 28,525 $ 25,673 $ 23,642 Basic earnings per common share $ 1.02 $ 1.12 $ 1.00 $ 0.93 Diluted earnings per common share $ 1.01 $ 1.11 $ 1.00 $ 0.92 2021 4th Quarter 3rd Quarter 2nd Quarter 1st Quarter Interest income $ 48,322 $ 49,295 $ 47,625 $ 47,977 Interest expense 3,315 3,554 3,964 4,298 Net interest income 45,007 45,741 43,661 43,679 Provision for credit losses 0 1,300 ( 1,700 ) 1,477 Net interest income after provision 45,007 44,441 45,361 42,202 Noninterest income 9,709 11,114 11,340 12,557 Noninterest expense 24,926 25,967 26,648 26,746 Income tax expense 5,507 5,469 5,705 5,030 Net income $ 24,283 $ 24,119 $ 24,348 $ 22,983 Basic earnings per common share $ 0.95 $ 0.95 $ 0.96 $ 0.90 Diluted earnings per common share $ 0.95 $ 0.94 $ 0.95 $ 0.90 NOTE 22 – LEASES The Company leases certain office facilities under long-term operating lease agreements. The leases expire at various dates through 2037 and some include renewal options. Many of these leases require the payment of property taxes, insurance premiums, maintenance, utilities and other costs. In many cases, rentals are subject to increase in relation to a cost-of-living index. The Company accounts for lease and non-lease components together as a single lease component. The Company determines if an arrangement is a lease at inception. Operating leases are recorded as a right-of-use (“ROU”) lease assets and are included in other assets on the consolidated balance sheet. The Company’s corresponding lease obligations are included in other liabilities on the consolidated balance sheet. ROU lease assets represent the Company’s right to use an underlying asset for the lease term and lease obligations represent the Company’s obligation to make lease payments arising from the lease. Operating ROU lease assets and obligations are recognized at the commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The ROU lease asset also includes any lease payments made and excludes lease incentives. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. 119 Table of Contents NOTE 22 - LEASES (continued) Lease expense for lease payments is recognized on a straight-line basis over the lease term. Short-term leases are leases having a term of twelve months or less. The Company recognizes short-term leases on a straight-line basis and does not record a related lease asset or liability for such leases, as allowed as practical expedient of the lease standard. The following is a maturity analysis of the operating lease liabilities as of December 31, 2022: Years ending December 31, (in thousands) Operating Lease Obligation 2023 $ 727 2024 744 2025 756 2026 731 2027 753 2028 and thereafter 2,185 Total undiscounted lease payments 5,896 Less imputed interest ( 600 ) Lease liability $ 5,296 Right-of-use asset $ 5,296 Year Ended Year Ended Year Ended December 31, 2022 December 31, 2021 December 31, 2020 Lease cost Operating lease cost $ 667 $ 536 $ 536 Short-term lease cost 22 24 24 Total lease cost $ 689 $ 560 $ 560 Other information Operating cash outflows from operating leases $ 667 $ 536 $ 536 Weighted-average remaining lease term - operating leases 7.3 7.9 8.8 Weighted average discount rate - operating leases 2.5 % 2.8 % 2.8 % 120 Table of Contents ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Within the prior two years of the date of the most recent financial statement, there have been no changes in or disagreements with the Company’s accountants.