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Item 2. Management’s Discussion and Analysis

2023-04-26 compared with 2022-10-26 · 186 added, 316 removed, 272 unchanged (65% of the section changed)

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

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

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

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

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

Net income in the first three months of 2023 was $24.3 million, which increased $636,000, or 2.7%, from $23.6 million for the comparable period of 2022 .

Diluted income per common share was $0.94 in the first three months of 2023 , up 2.2% from $0.92 in the comparable period of 2022 .

The increase in net income for 2023 was primarily due to growth in net interest income of $6.6 million, offset by an increase to the provision for credit losses of $3.9 million, a decrease in noninterest income of $373,000 and an increase in noninterest expense of $2.5 million .

Pretax pre-provision earnings in the first three months of 2023 were $32.4 million, an increase of $3.8 million, or 13.3%, compared to $28.6 million for the comparable period of 2022.

Pretax pre-provision earnings is a non-GAAP measure calculated by adding net interest income to noninterest income and subtracting noninterest expense.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Annualized return on average total equity was 16.81% in the first three months of 2023 versus 14.04% in the comparable period of 2022 .

Annualized return on average total assets was 1.54% in the first three months of 2023 versus 1.44% for the comparable period of 2022 .

The Company's average equity to average assets ratio was 9.13% in the first three months of 2023 versus 10.26% in the comparable period of 2022 .

Equity has been negatively impacted by unrealized losses from the available-for-sale investment securities portfolio, which are reported as a component of accumulated other comprehensive income (loss).

The Company’s tangible common equity to tangible assets ratio, which is a non-GAAP financial measure, was 9.34% at March 31, 2023, compared to 9.22% at March 31, 2022 and 8.79% at December 31, 2022.

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

The market value decline is a result of rising interest rates caused by the tightening of monetary policy by the Federal Reserve beginning in March of 2022 to combat elevated levels of inflation affecting the U.S.

The rising interest rate environment has generated unrealized losses in the available-for-sale investment securities portfolio which are reflected in the company's reported accumulated other comprehensive income (loss).

Unrealized losses from available-for-sale investment securities were $188.5 million as of March 31, 2023, compared to unrealized losses of $117.4 million at March 31, 2022 and improved from unrealized losses of $215.3 million at December 31, 2022.

When excluding the impact of securities market value adjustments on tangible common equity and tangible assets, the Company's adjusted tangible common equity to adjusted tangible assets ratio, which is a non-GAAP financial measure, was 11.56% at March 31, 2023 compared to 10.44% at March 31, 2022 and 11.30% at December 31, 2022.

Total assets were $6.412 billion as of March 31, 2023 versus $6.432 billion as of December 31, 2022, a decrease of $20.8 million.

Balance sheet contraction was driven primarily by decreases in available-for-sale securities, noninterest bearing deposits and borrowings during the first three months of 2023.

Available-for-sale securities decreased $77.2 million, noninterest bearing deposits decreased $188.7 million and total borrowings decreased $97.0 million.

Offsetting these decreases were increases to short-term investments of $36.9 million, loans, net of the allowance for credit losses, of $45.9 million and interest bearing deposits of $245.8 million.

Tota l equity increased by $33.1 million, or 5.8%, due primarily to an increase to accumulated other comprehensive income (loss) of $21.6 million.

The increase in accumulated other comprehensive income (loss) was due to an improvement in available-for-sale securities fair market values during the first quarter of 2023 .

The change in total equity was also impacted by net income of $24.3 million and dividends declared and paid of $0.46 per share, totaling $11.7 million.

CRITICAL ACCOUNTING POLICIES

6 unchanged sentences

RESULTS OF OPERATIONS

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

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

Selected income statement information for the three months ended March 31, 2023 and 2022 is presented in the following table:

Three Months Ended March 31,

(dollars in thousands) 2023 2022

9 unchanged sentences

Adjusted tangible capital ratio (3) 11.56 % 10.44 %

Net charge offs (recoveries) to average loans 0.03 % 0.00 % 0.03 % (0.05) %

Net charge offs to average loans 0.49 % 0.06 %

Net interest margin 3.54 % 2.93 %

Net interest margin excluding PPP loans (4) 3.57 % 2.95 % 3.24 % 2.98 %

Noninterest income to total revenue 16.68 % 19.23 %

7 unchanged sentences

(3) Non-GAAP financial measure.

Adjusted tangible capital ratio excludes the market value impact of available-for-sale investment securities on tangible common equity and tangible assets.

See reconciliation on the next page.

(4) Non-GAAP financial measure.

Calculated by subtracting the impact PPP loans had on average earning assets, loan interest income, average interest bearing liabilities, and interest expense.

Management believes this is an important measure because it provides for better comparability to prior periods, given the low fixed interest rate of 1.0% applicable to PPP loans, and because the accretion of net loan fee income can be accelerated upon borrower forgiveness and repayment by the SBA.

Management is actively monitoring net interest margin on a fully tax equivalent basis with and without PPP loan impact for the duration of this program.

Calculated by removing the fair market value adjustment impact of the available-for-sale investment securities portfolio from tangible equity and tangible assets.

Management believes this is an important measure because it provides better comparability to prior periods.

See reconciliation on the next page.

4 unchanged sentences

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

As of and for the As of and for the

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

As of and For The

Three Months Ended March 31,

(dollars in thousands) 2023 2022

11 unchanged sentences

Adjusted Tangible Assets (D) 6,618,627 6,685,862

Ending Common Shares Issued (E) 25,607,663 25,527,896

Tangible Book Value per Common Share (A/E) $ 23.36 $ 23.71

Tangible Capital Ratio (A/B) 9.34 % 9.22 %

4 unchanged sentences

Pretax Pre-Provision Earnings $ 32,399 $ 28,598

Impact of Paycheck Protection Program on Net Interest Margin FTE.

As of and for the As of and for the

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

2022 2021 2022 2021

Total Average Earnings Assets $ 5,991,630 $ 5,909,834 $ 6,178,787 $ 5,825,275

Average Balance of PPP Loans (3,232) (142,917) (10,098) (296,938)

Total Adjusted Earning Assets 5,988,398 5,766,917 6,168,689 5,528,337

Total Interest Income FTE $ 64,011 $ 50,271 $ 168,335 $ 147,351

PPP Loan Income (58) (3,946) (767) (12,764)

Total Adjusted Interest Income FTE 63,953 46,325 167,568 134,587

Adjusted Earning Asset Yield, net of PPP Impact 4.24 % 3.19 % 3.63 % 3.25 %

Total Average Interest Bearing Liabilities $ 3,821,699 $ 3,737,707 $ 3,919,779 $ 3,728,339

Average Balance of PPP Loans (3,232) (142,917) (10,098) (296,938)

Total Adjusted Interest Bearing Liabilities 3,818,467 3,594,790 3,909,681 3,431,401

Total Interest Expense FTE $ 10,066 $ 3,554 $ 18,164 $ 11,816

PPP Cost of Funds (2) (90) (19) (555)

Total Adjusted Interest Expense FTE 10,064 3,464 18,145 11,261

Adjusted Cost of Funds, net of PPP Impact 0.67 % 0.24 % 0.39 % 0.27 %

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

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

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

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

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

Net Interest Income

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

Nine Months Ended September 30,

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

Rate Average Balance Interest Yield (1)/

Earning Assets

Taxable (2)(3) $ 4,351,009 $ 136,580 4.20 % $ 4,455,488 $ 128,828 3.87 %

Tax exempt (1) 30,275 1,149 5.07 13,403 410 4.09

Securities (1) 1,472,807 29,105 2.64 977,955 17,765 2.43

Short-term investments 2,251 12 0.71 2,273 2 0.12

Interest bearing deposits 322,445 1,489 0.62 376,156 346 0.12

Total earning assets $ 6,178,787 $ 168,335 3.64 % $ 5,825,275 $ 147,351 3.38 %

Allowance for credit losses (67,684) (71,783)

Nonearning Assets

Cash and due from banks 72,240 69,066

Premises and equipment 59,026 59,652

Other nonearning assets 226,732 189,472

Total assets $ 6,469,101 $ 6,071,682

Interest Bearing Liabilities

Savings deposits $ 421,363 $ 241 0.08 % $ 353,058 $ 204 0.08 %

Interest bearing checking accounts 2,658,739 14,456 0.73 2,334,480 4,905 0.28

Time deposits:

In denominations under $100,000 189,459 951 0.67 223,486 1,650 0.99

In denominations over $100,000 607,352 2,389 0.53 741,815 4,828 0.87

Miscellaneous short-term borrowings 9 0 0.00 500 7 1.87

Long-term borrowings and subordinated debentures 42,857 127 0.40 75,000 222 0.40

Total interest bearing liabilities $ 3,919,779 $ 18,164 0.62 % $ 3,728,339 $ 11,816 0.42 %

Noninterest Bearing Liabilities

Demand deposits 1,868,858 1,627,522

Other liabilities 64,262 47,169

Stockholders' Equity 616,202 668,652

Total liabilities and stockholders' equity $ 6,469,101 $ 6,071,682

Interest Margin Recap

Interest income/average earning assets 168,335 3.64 147,351 3.38 %

Interest expense/average earning assets 18,164 0.39 11,816 0.27 %

Net interest income and margin $ 150,171 3.25 % $ 135,535 3.11 %

(1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate.

The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses.

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

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

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

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

(3) Nonaccrual loans are included in the average balance of taxable loans.

Net income was $24.3 million in the first three months of 2023 , an increase of $636,000, or 2.7%, versus net income of $23.6 million in the first three months of 2022 .

The increase in net income for 2023 was primarily due to growth in net interest income of $6.6 million, or 14.8%, offset by a decrease to the provision for credit losses of $3.9 million, a decrease to noninterest income of $373,000, or 3.5%, and an increase to noninterest expense of $2.5 million, or 9.1%.

N et Interest Income

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

Three Months Ended September 30,

Three Months Ended March 31,

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

33 unchanged sentences

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

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

Net loan fees attributable to PPP loans were $50,000 and $3.57 million for the three months ended September 30, 2022 and September 30, 2021, respectively.

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

Taxable equivalent basis adjustments were $1.37 million and $1.27 million in the three-month periods ended March 31, 2023 and March 31, 2022, respectively.

(2) Loan fees, which are immaterial in relation to total taxable loan interest income for the three months ended March 31, 2023 and 2022, are included as taxable loan interest income .

(3) Nonaccrual loans are included in the average balance of taxable loans.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Net interest income increased $6.6 million, or 14.8%, to $51.5 million for the three months ended March 31, 2023, compared with $44.9 million for the first three months of 2022 .

Growth in average loans and an improvement in loan yields were the primary drivers behind the $31.3 million increase in tax-equivalent interest income between the two quarters.

An improvement in yields in securities and cash and cash equivalents also contributed to the increase in net interest income.

Interest expense, which increased by $24.5 million, partially offset the positive impact of increased loan and securities interest income, driven by increased funding costs from deposits and borrowings.

Average earning assets declined by $324.5 million, due primarily to a reduction in investment securities of $263.8 million and a decrease in demand deposits of $303.6 million.

Offsetting the contraction in average deposits was an increase in average short-term borrowings of $241.8 million, offset by a decrease in average long-term borrowings of $75.0 million.

Average loans outstanding increased $424.5 million to $4.725 billion during the three months ended March 31, 2023, compared to $4.301 billion during the same period of 2022 .

The earning asset contraction was offset by a decrease in deposits.

Average total deposits decreased $361.0 million to $5.488 billion during the three months ended March 31, 2023, compared to $5.849 billion for the same period of 2022 .

The decrease in average deposits was driven by a decrease in average noninterest bearing deposits, which decreased $303.6 million, or 15.4%, from $1.967 billion for the three months ended March 31, 2022, to $1.663 billion for the same period of 2023.

Offsetting the contraction in average deposits was an increase in average short-term borrowings of $241.8 million, offset by a decrease in average long-term borrowings of $75.0 million.

The tax equivalent net interest margin was 3.54 % for the three months ended March 31, 2023, compared to 2.93% during the first three months of 2022, representing a 61 basis point expansion between the two quarters.

The net interest margin expansion was driven by a 475 basis point increase to the target Federal Funds rate implemented by the Federal Reserve through a series of rate increases beginning in March of 2022.

The target Federal Funds rate increased from a zero-bound range of 0.00%-0.25% in March 2022 to a range of 4.75%-5.00% at March 31, 2023.

The impact of the higher interest rate increased earning asset yields by 226 basis points to 5.39% for the first quarter of 2023, up from 3.13% for the first quarter of 2022.

However, this increase was offset by an increase in the company's funding costs as excess customer liquidity was utilized and the competition for deposits increased throughout the industry.

Interest expense as a percentage of average earning assets increased to 1.85% for the first quarter of 2023 from a historical low of 0.20% for the first quarter of 2022, an increase of 165 basis points .

Cost of funds may continue to rise throughout 2023 as a result of market competition for deposits.

Provision for Credit Losses

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

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

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

Net charge offs were $284,000 during the three month period ended September 30, 2022 compared to net recoveries of $35,000 during the comparable period of 2021 .

The Company recorded provision for credit losses expense of $4.4 million for the three months ended March 31, 2023 compared to provision expense of $417,000 during the comparable period of 2022 .

The increase in provision during the first quarter of 2023 compared to the first quarter of 2022 was primarily attributable to increases in the qualitative and environmental risk factors for certain segments of the Company's loan portfolio that could be impacted by higher borrowing costs and the potential economic weakness in the Company's markets.

Net charge-offs were $5.7 million during the three month period ended March 31, 2023 compared to net recoveries of $664,000 during the comparable period of 2022 .

The increase in charge offs in the first quarter of 2023 compared to the first quarter of 2022 was the result of a further charge off of $5.5 million attributable to a single commercial customer.

The $10.7 million credit was downgraded in late December 2022, and a partial charge off of $3.7 million was recognized at that time.

The remaining $7.0 million was placed on nonaccrual status pending additional due diligence and financial analysis related to the borrower's debt service capacity.

During the first quarter of 2023, the outlook for repayment of the loan weakened significantly and resulted in the additional charge off of $5.5 million.

The charge off amount was fully allocated in the allowance for credit losses.

Additional factors considered by management included key loan quality metrics, including reserve coverage of nonperforming loans and economic conditions in the Company’s markets, and changes in the facts and circumstances of watch list credits, which includes the security position of the borrower.

Management’s overall view on current credit quality was also a factor in the determination of the provision for credit losses.

The Company’s management continues to monitor the adequacy

of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.

The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.

Noninterest Income

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

Nine Months Ended

September 30,

(dollars in thousands) 2022 2021 Dollar Change Percent Change

Wealth advisory fees $ 6,550 $ 6,433 $ 117 1.8 %

Investment brokerage fees 1,711 1,560 151 9.7

Service charges on deposit accounts 8,681 7,768 913 11.8

Loan and service fees 9,131 8,823 308 3.5

Merchant card fee income 2,660 2,226 434 19.5

Bank owned life insurance income (loss) (212) 2,101 (2,313) (110.1)

Interest rate swap fee income 492 934 (442) (47.3)

Mortgage banking income 771 1,756 (985) (56.1)

Net securities gains 0 797 (797) (100.0)

Other income 1,559 2,613 (1,054) (40.3)

Total noninterest income $ 31,343 $ 35,011 $ (3,668) (10.5) %

Noninterest income to total revenue 17.7 % 20.8 %

Noninterest income categories for the three-month period ended March 31, 2023 and 2022 are shown in the following table:

Three Months Ended

September 30,

(dollars in thousands) 2023 2022 Dollar Change Percent Change

4 unchanged sentences

Merchant card fee income 877 815 62 7.6

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

Bank owned life insurance income (loss) 691 (83) 774 (932.5)

Interest rate swap fee income 0 50 (50) (100.0)

Mortgage banking income (loss) (99) 509 (608) (119.4)

Net securities gains 16 0 16 100.0

Other income 619 892 (273) (30.6)

1 unchanged sentence

Noninterest income to total revenue 16.7 % 19.2 %

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

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

Market value declines impacted the overall decrease in noninterest income.

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

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

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

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

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

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

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

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

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

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

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

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

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

The Company's noninterest income decreased $373,000, or 3.5%, to $10.3 million for the three months ended March 31, 2023 compared to $10.7 million in the prior year period.

The decrease in noninterest income was primarily driven by a decline in mortgage banking income of $608,000, from reduced levels of mortgage financing activity because of the increased rate environment.

Additionally, a decrease in other income of $273,000, or 30.6%, and decreased service charges on deposit accounts of $179,000, or 6.4%, contributed to the decrease in noninterest income.

The decrease in other income was the result of less income from partnership investments during the comparable quarters and the decrease in service charges on deposit accounts was primarily the result of increased earning credit rating for commercial depositors related to commercial treasury management fees.

Offsetting these decreases was an increase in bank owned life insurance income of $774,000.

Bank owned life insurance income benefited by improved market performance of the company's variable life insurance policies, which track to the overall performance of the equity markets.

In addition, increased general account bank owned life insurance income resulted from the purchase of insurance policies during the fourth quarter of 2022.

Noninterest Expense

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

Nine Months Ended

September 30, 2022

(dollars in thousands) 2022 2021 Dollar Change Percent Change

Salaries and employee benefits $ 43,840 $ 44,377 $ (537) (1.2) %

Net occupancy expense 4,793 4,343 450 10.4

Equipment costs 4,250 4,134 116 2.8

Data processing fees and supplies 9,510 9,692 (182) (1.9)

Corporate and business development 4,078 3,208 870 27.1

FDIC insurance and other regulatory fees 1,516 1,707 (191) (11.2)

Professional fees 4,527 5,058 (531) (10.5)

Other expense 10,262 6,842 3,420 50.0

Total noninterest expense $ 82,776 $ 79,361 $ 3,415 4.3 %

Efficiency ratio 46.7 % 47.2 %

(dollars in thousands)

Noninterest expense categories for the three-month period ended March 31, 2023 and 2022 are shown in the following tables:

Three Months Ended

September 30, 2022

March 31, 2023

(dollars in thousands) 2023 2022 Dollar Change Percent Change

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Efficiency ratio 47.6 % 48.5 %

The Company's noninterest expense increased by $3.4 million, or 4.3%, to $82.8 million for the nine months ended September 30, 2022, from $79.4 million for the nine months ended September 30, 2021.

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

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

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

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

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

Operating expenses excluding the

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

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

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

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

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

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

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

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

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

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

As previously disclosed, in the third quarter of 2019, the Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks.

The former client subsequently filed several related bankruptcy cases, captioned In re Interlogic Outsourcing, Inc., et al ., which are pending in the United States Bankruptcy Court for the Western District of Michigan.

On April 27, 2021, the bankruptcy court entered an order approving an amended plan of liquidation, which was filed by the former client, other debtors and bankruptcy plan proponents, and approving the consolidation of the assets in the aforementioned cases under the Khan IOI Consolidated Estate Trust.

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

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

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

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

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

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

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

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

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

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

The Company's noninterest expense increased by $2.5 million, or 9.1%, to $29.4 million for the three months ended March 31, 2023, from $27.0 million for the three months ended March 31, 2022.

Salaries and employee benefits expense contributed $1.7 million, or 11.6%, of the increase in noninterest expense primarily as a result of increased salaries and wages and health insurance expense.

Variable compensation expense, which is tied to market performance of the company's variable bank owned life insurance policies, increased due to improved market performance and also contributed to the increase in salaries and employee benefits expense.

Additionally, professional fees increased $562,000, or 36.0%, data processing fees and supplies increased $371,000, or 12.0%, FDIC insurance and other regulatory fees increased $356,000, or 81.1%, and corporate and business development expense increased $212,000, or 17.4%.

The increase in professional fees was a result of increased interest charges associated with the bank's swap collateral positions as well as continued investment in technology solutions for our retail and commercial digital applications.

This increased investment in technology was also primarily responsible for the increase in data processing fees and supplies expense.

The increase to FDIC insurance and other regulatory fees was caused by a blanket increase to the assessment rate used by the FDIC to calculate insurance premiums, effective during the first quarter of 2023.

Corporate and business development expense was impacted by increased spending for advertising and other corporate and business development activities.

These increases were offset by a decrease to other expense of $677,000, or 20.9%, driven by a decrease in accruals pertaining to ongoing legal matters between the two periods.

See "Note 11 – Loss Contingencies" for additional details.

The Company's efficiency ratio was 47.6% for the three months ended March 31, 2023 compared to 48.5% for the first three months of 2021.

The Company's income tax expense decreased $768,000, or 16.9%, in the three months ended March 31, 2023 compared to the same period in 2022.

The effective tax rate was 13.4% in the three months ended March 31, 2023, compared to 16.1% for the comparable period of 2022.

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

FINANCIAL CONDITION

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

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

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

Total deposits decreased $71.3 million, or 1.2%.

The decrease in deposits was primarily driven by contraction in retail and commercial deposits, which declined $121.9 million and $145.8 million, respectively.

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

Core deposits were $5.654 billion as of September 30, 2022, a decrease of $71.3 million, compared to $5.725 billion as of December 31, 2021 .

Total assets were $6.412 billion as of March 31, 2023 versus $6.432 billion as of December 31, 2022, a decrease of $20.8 million.

Balance sheet contraction was driven primarily by decreases in available-for-sale securities, noninterest bearing deposits and borrowings during the first three months of 2023.

Available-for-sale securities decreased $77.2 million, noninterest bearing deposits decreased $188.7 million and total borrowings decreased $97.0 million.

Offsetting these decreases were increases to short-term investments of $36.9 million, loans, net of the allowance for credit losses, of $45.9 million and interest bearing deposits of $245.8 million.

Uses of Funds

Total Cash and Cash Equivalents

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

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

Total cash and cash equivalents increased by $23.2 million, or 17.8%, to $153.5 million at March 31, 2023, from $130.3 million at December 31, 2022.

Cash and cash equivalents include short-term investments.

Short-term investments include cash on deposit that earns interest such as excess liquidity maintained at the Federal Reserve Bank.

Cash and cash equivalents balances will vary depending on the cyclical nature of the bank’s liquidity position.

The increase in cash and cash equivalents at March 31, 2023 was driven by an increase in interest bearing short-term investment accounts of $36.9 million, or 74.8%, offset by a decrease in cash and due from banks of $13.7 million, or 16.9%.

These fluctuations are reflective of a normalization of activity as excess levels of liquidity experienced throughout 2021 and 2022 have decreased through deployments of cash to the investment securities portfolio and utilization of excess cash balances by deposit customers.

Investment Portfolio

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

September 30, 2022 December 31, 2021

The amortized cost and the fair value of securities as of March 31, 2023 and December 31, 2022 were as follows:

March 31, 2023 December 31, 2022

(dollars in thousands) Amortized

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residential 561,865 484,462 578,175 492,308

Mortgage-backed securities:

commercial 0 0 522 523

State and municipal securities 577,603 492,472 663,367 563,225

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State and municipal securities $ 128,651 $ 115,533 $ 128,242 $ 111,029

Total Held-to-Maturity $ 127,820 $ 103,326 $ 0 $ 0

Total Investment Portfolio $ 1,425,410 $ 1,223,814 $ 1,529,025 $ 1,296,557

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

The fair value of securities transferred was $127.0 million.

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

At March 31, 2023 and December 31, 2022, there were no holdings of securities of any one issuer, other than the U.S.

government agencies and government sponsored entities, in an amount greater than 10% of stockholders’ equity.

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This is taken into consideration when evaluating the gain or loss of investment securities in the portfolio and the potential for an allowance for credit losses.

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

Purchases of securities available-for-sale totaled $4.0 million in the first three months of 2023.

The purchases consisted of U.S.

Treasury securities, securities issued by government sponsored entities, mortgage-backed securities issued by government sponsored entities and state and municipal securities.

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

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

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

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

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

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

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

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

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

Treasury securities and mortgage-backed securities issued by government sponsored entities.

Investment securities represented 19.3% of total assets on March 31, 2023, compared to 20.4% of total assets on December 31, 2022.

The ratio of investment securities as a percentage of total assets remains elevated over historical levels of approximately 14%.

The increase in this ratio resulted from the deployment of excess liquidity during 2021 and 2022 to the investment securities portfolio as an earning asset alternative of excess balance sheet liquidity stemming from increased levels of core deposits from government stimulus programs.

The Company expects the investment securities portfolio to represent a lower percentage of total assets over time as proceeds from pay downs, sales and maturities of these investment securities are used to fund loan portfolio growth and for other general liquidity purposes.

Paydowns from prepayments and scheduled payments of $13.0 million were received in the first three months of 2023, and the amortization of premiums, net of the accretion of discounts, was $1.2 million.

Maturities and calls of securities totaled $6.1 million in the first three months of 2023.

Sales of available-for-sale investment securities totaled $87.5 million in the first three months of 2023 and resulted in net gains of $16,000.

No allowance for credit losses was recognized for available-for-sale or held-to-maturity securities as of March 31, 2023 and December 31, 2022.

The fair value of the available-for-sale investment securities portfolio as of March 31, 2023 included net unrealized losses of $188.5 million compared to net unrealized losses of $215.3 million as of December 31, 2022.

Unrealized losses in the available-for-sale investment securities portfolio resulted from the declines in market values of the investment securities.

These declines were driven by the rising interest rate environment as a result of the Federal Reserve's monetary tightening policy to combat elevated levels of inflation affecting the U.S.

The investment portfolio is managed by a third-party firm to provide for an appropriate balance between liquidity, credit risk, interest rate risk management and investment return and to limit the Company’s exposure to credit risk in the investment securities portfolio.

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Real Estate Mortgage Loans Held-for-Sale

Real estate mortgage loans held-for-sale decreased by $6.4 million, or 85.3%, to $1.1 million at September 30, 2022, from $7.5 million at December 31, 2021.

Real estate mortgage loans held-for-sale increased by $151,000, or 42.3%, to $508,000 at March 31, 2023, from $357,000 at December 31, 2022.

The balance of this asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market.

The Company generally sells conforming qualifying mortgage loans it originates on the secondary market.

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

Management expects the volume of loans originated for sale in the secondary market to decline as compared to volumes originated in 2021 due to the rise in mortgage interest rates that have occurred during 2022.

Proceeds from sales of residential mortgages totaled $672,000 in the first three months of 2023 compared to $18.1 million in the first three months of 2022.

Management expects the volume of loans originated for sale in the secondary market to remain at reduced levels due to the rise in mortgage rates.

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

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

The unpaid principal balances of loans serviced for others were $355.9 million and $364.3 million as of March 31, 2023 and December 31, 2022, respectively.

Loan Portfolio

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

(dollars in thousands) September 30,

The loan portfolio by portfolio segment as of March 31, 2023 and December 31, 2022 is summarized as follows:

(dollars in thousands) March 31,

2023 December 31,

10 unchanged sentences

Loans, net $ 4,683,713 $ 4,637,790 $ 45,923

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

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

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

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

(dollars in thousands) September 30,

Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, increased by $44.8 million to $4.758 billion at March 31, 2023 from $4.713 billion at December 31, 2022.

The increase was primarily driven by originations of loans concentrated in the commercial real estate and multi-famly residential, other commercial, and consumer 1-4 family mortgage loans categories and was offset by paydowns in commercial and industrial loans and the agri-business and agricultural loans segments, the latter of which traditionally experiences seasonal fluctuations in activity.

The following table summarizes the Company’s non-performing assets as of March 31, 2023 and December 31, 2022:

(dollars in thousands) March 31,

2023 December 31,

Nonaccrual loans including nonaccrual troubled debt restructured loans (1) $ 9,892 $ 14,973

Nonaccrual loans $ 17,715 $ 16,964

Loans past due over 90 days and still accruing 25 123

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Total nonperforming assets $ 17,922 $ 17,224

Individually analyzed loans including troubled debt restructurings (1) $ 17,313 $ 25,581

Individually analyzed loans $ 18,188 $ 31,327

Nonperforming loans to total loans 0.37 % 0.36 %

Nonperforming assets to total assets 0.28 % 0.27 %

Performing troubled debt restructured loans (1) $ 0 $ 5,121

Nonperforming troubled debt restructured loans (included in nonaccrual loans) (1) 0 6,218

Total troubled debt restructured loans (1) $ 0 $ 11,339

(1) On April 1, 2022, the Company adopted certain aspects of ASU 2022-02, whereby the Company no longer recognizes or accounts for TDRs.

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

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

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

Total nonperforming assets increased by $698,000, or 4.1%, to $17.9 million during the three month period ended March 31, 2023.

The ratio of nonperforming assets to total assets increased from 0.27% at December 31, 2022 to 0.28% at March 31, 2023.

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

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If a loan is individually analyzed, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows or at the fair value of collateral if repayment is expected solely from the collateral.

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

Total individually analyzed loans decreased by $13.1 million, or 41.9%, to $18.2 million at March 31, 2023 from $31.3 million at December 31, 2022.

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

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If an asset or portion, thereof is classified as a loss, the Company’s policy is to either establish specified allowances for credit losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount.

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

At September 30, 2022, management believed the allowance for credit losses was at a level commensurate with the overall risk exposure of the loan portfolio.

However, if economic conditions deteriorate, certain

borrowers may experience difficulty and the level of nonperforming loans, charge offs and delinquencies could rise and require increases in the allowance for credit losses.

At March 31, 2023, the allowance for credit losses was 1.50% of total loans outstanding, versus 1.54% of total loans outstanding at December 31, 2022.

At March 31, 2023, management believed the allowance for credit losses was at a level commensurate with the overall risk exposure of the loan portfolio.

However, if economic conditions deteriorate, certain borrowers may experience difficulty and the level of nonperforming loans, charge offs and delinquencies could rise and require increases in the allowance for credit losses.

The process of identifying credit losses is a subjective process.

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The Company manages this risk by utilizing relatively conservative credit structures, by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and market area.

As of September 30, 2022, based on management’s review of the loan portfolio, the Company had 55 credit relationships totaling $163.2 million on the classified loan list versus 81 credit relationships totaling $234.5 million on December 31, 2021.

The decrease in classified loans for the first nine months of 2022 resulted primarily from paydowns and borrower risk rating upgrades to previously classified loans on the non-individually analyzed portion of the watchlist.

As of September 30, 2022, the Company had $121.0 million of assets classified as Special Mention, $42.1 million classified as Substandard, $0 classified as Doubtful and $0 classified as Loss as compared to $176.6 million, $57.9 million, $0 and $0, respectively, at December 31, 2021.

Watch list loans as a percentage of total loans, excluding PPP loans, decreased to a historical low of 3.64% as of September 30, 2022, compared to 5.50% as of December 31, 2021.

The Company has limited exposure to commercial office space borrowers.

Loans totaling $33.6 million for this sector represent 0.71% of total loans at March 31, 2023.

As of March 31, 2023, based on management’s review of the loan portfolio, the Company had 59 credit relationships totaling $174.9 million on the classified loan list versus 58 credit relationships totaling $161.0 million as of December 31, 2022.

The increase in classified loans for the first three months of 2023 resulted primarily from borrower risk rating downgrades of pass rated loans to the non-individually analyzed portion of the watch list.

As of March 31, 2023, the Company had $142.6 million of assets classified as Special Mention, $32.3 million classified as Substandard, $0 classified as Doubtful and $0 classified as Loss as compared to $115.7 million, $45.3 million, $0 and $0, respectively, at December 31, 2022.

Watch list loans as a percentage of total loans increased to 3.68% as of March 31, 2023, up from a historical low at 3.42% as of December 31, 2022.

Allowance estimates are developed by management after taking into account actual loss experience adjusted for current economic conditions and a reasonably supportable forecast period.

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For a more thorough discussion of the allowance for credit losses methodology see the ("Critical Accounting Policies") section of this Item 2.

The allowance for credit losses decreased $534,000, from $67.8 million at December 31, 2021 to $67.2 million at September 30, 2022.

Most of the Company’s recent loan growth has been concentrated in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits.

Management has historically considered growth and portfolio composition when determining credit loss allocations.

The allowance for credit losses decreased $1.4 million, from $72.6 million at December 31, 2022 to $71.2 million at March 31, 2023.

The decrease was a result of net charge offs recorded during the quarter of $5.7 million, offset by provision expense of $4.4 million.

Of the $5.7 million in net charge offs, $5.5 million was attributable to the previously described deteriorated commercial relationship which was reserved for in the allowance for credit losses.

The increased provision expense recorded during the first quarter of 2023 was primarily attributable to increases in the qualitative and environmental risk factors for certain segments of the Company's loan portfolio that could be impacted by higher borrowing costs and the potential economic weakness in the Company's markets.

As the bulk of the Company’s lending activity is concentrated in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits, management has historically considered growth and portfolio composition when determining credit loss allocations.

Sources of Funds

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

Nine months ended September 30,

The Company's sources of funds include a diversified deposit base gathered throughout the Company's footprint and includes approximately 130,000 commercial, retail and public funds deposit accounts.

While the traditional base of core deposits represents the primary source of funding for the Company, the Company has access to a robust array of other liquidity sources, including secured borrowings available from the Federal Home Loan Bank, the Federal Reserve Bank Discount Window and the Federal Reserve Bank Term Funding Program.

In addition, the Company has access to unsecured borrowing capacity through long established relationships within the brokered deposit markets, Federal Funds lines from correspondent bank partners and Insured Cash Sweep (ICS) one-way buy funds available from the Intrafi network.

As of March 31, 2023, the Company had access to $3.03 billion in unused liquidity available from these aggregate sources compared to $2.99 billion at December 31, 2022.

The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the three months ended March 31, 2023 and 2022 are summarized in the following table:

Three months ended March 31,

(dollars in thousands) Balance Rate Balance Rate

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Total funding sources $ 5,729,462 1.96 % $ 5,923,664 0.22 %

Average total deposits were $5.488 billion for the first quarter of 2023, a decrease of $361.0 million, or 6.2%, from the first quarter of 2022.

Average total borrowings were $241.9 million for the first quarter of 2023, an increase of $166.8 million from the first quarter of 2023.

Deposits and Borrowings

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

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

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

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

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

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

(dollars in thousands) September 30,

2022 December 31,

As of March 31, 2023, total deposits increased by $57.1 million, or 1.0%, from December 31, 2022.

Core deposits, which excludes brokered deposits, decreased by $93.5 million, or 1.7%, to $5.357 billion as of March 31, 2023 from $5.451 billion as of December 31, 2022.

Total brokered deposits were $160.7 million at March 31, 2023 compared to $10.0 million at December 31, 2022.

The following table summarizes deposit composition at March 31, 2023 and December 31, 2022:

(dollars in thousands) March 31,

2023 Percentage of Total December 31,

2022 Percentage of Total Current

Retail $ 1,894,707 34.3 % $ 1,934,787 35.4 % $ (40,080)

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Total deposits $ 5,517,728 100.0 % $ 5,460,620 100.0 % $ 57,108

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

The Company utilizes wholesale funding, including brokered deposits and Federal Home Loan Bank advances, to supplement funding of assets, which is primarily used for loan and investment securities growth.

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

Commercial, retail and public funds deposit composition remained stable between March 31, 2023 and December 31, 2022.

On March 31, 2023 and December 31, 2022, commercial deposits represented 38% of total deposits.

Retail deposits represented 34% at March 31, 2023 versus 35% at December 31, 2022.

Public Funds deposits represented 25% at March 31, 2023 versus 26% at December 31, 2022.

Commercial deposits grew $19.6 million, or 0.9%, from $2.086 billion at December 31, 2022;

retail deposits contracted $40.1 million, or 2.1%, from $1.935 billion at December 31, 2022;

and public funds deposits contracted $73.0 million, or 5.1%, from $1.430 billion at December 31, 2022.

Commercial checking accounts increased in number of accounts and balances since year end and average balances per account remain elevated above pre-pandemic levels.

Retail checking accounts have increased, but balances have declined.

Average retail checking account balances per account have declined modestly but remain elevated above pre-pandemic levels.

Public Fund accounts are unchanged, but balances have decreased.

Average public fund checking account balances are lower on a linked quarter basis but remain elevated as compared to pre-pandemic levels.

Uninsured deposits, not covered by FDIC deposit insurance or the Indiana Public Deposit Insurance Fund (PDIF), were 29% of total deposits as of March 31, 2023, versus 30% as of December 31, 2022.

Deposits not insured by FDIC Insurance coverage (including the public fund deposits that are covered by the PDIF) were 54% as of March 31, 2023, versus 56% at December 31, 2022.

As of March 31, 2023, and December 31, 2022, 98% of deposit accounts have deposit balances less than $250,000 and 2% of accounts have deposit balances greater than $250,000.

Utilization of other sources of liquidity totaled $360.7 million at March 31, 2023, compared to $307.0 million at December 31, 2022, an increase of $53.7 million, or 17.5%.

Brokered deposits of $160.7 million at March 31, 2023 drove the increase up $150.6 million from $10.0 million at December 31, 2022.

Total borrowings decreased $97.0 million, or 32.7%, from $297.0 million at December 31, 2022 to $200.0 million at March 31, 2023, driven by a decrease in Federal Funds purchased of $22.0 million, and a decrease in FHLB advances of $75.0 million, or 27.3%.

As of March 31, 2023, total stockholders’ equity was $602.0 million, an increase of $33.1 million, or 5.8%, from $568.9 million at December 31, 2022.

Net income of $24.3 million increased equity.

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

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

In addition, an increase of $21.6 million in accumulated other comprehensive income (loss), primarily driven by a net increase in the fair value of available-for-sale securities, contributed to the increase.

Dividends declared and paid of $0.46 per share, or $11.7 million, offset the increase to total stockholders' equity.

The impact on equity for other comprehensive income (loss) is not included in regulatory capital.

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banking organizations.

As of September 30, 2022, the Company's capital levels remained characterized as “well-capitalized”.

The actual capital amounts and ratios of the Company and the Bank as of September 30, 2022 and December 31, 2021, are presented in the table below.

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

As of March 31, 2023, the Company's capital levels remained characterized as “well-capitalized”.

The actual capital amounts and ratios of the Company and the Bank as of March 31, 2023 and December 31, 2022, are presented in the table below.

Capital ratios for March 31, 2023 are preliminary until the Call Report and FR Y-9C are filed.

Actual Minimum Required For Capital Adequacy Purposes For Capital Adequacy Purposes Plus Capital Conservation Buffer Minimum Required to Be Well Capitalized Under Prompt Corrective Action Regulations

(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio

As of September 30, 2022:

As of March 31, 2023:

Total Capital (to Risk Weighted Assets)

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Actual results could differ materially from those addressed in the forward-looking statements as a result of numerous factors, including, without limitation:

• the effects of future economic, business and market conditions and changes, including prevailing interest rates, the rate of inflation and the effects of the COVID-19 pandemic;

• the effects of future economic, business and market conditions and changes, including prevailing interest rates and the rate of inflation;

• governmental monetary and fiscal policies and the impact the current economic environment will have on these;

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• the effects of disruption and volatility in capital markets on the value of our investment portfolio;

• the risk of labor availability, trade policy and tariffs, as well as supply chain constraints could impact loan demand from the manufacturing sector;

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

• the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

• the risks related to the recent failures of Silicon Valley Bank and Signature Bank, including the effects on FDIC premiums, increased regulation, and increased deposit volatility;

• the timing and scope of any legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators;

• changes in the scope and cost of FDIC insurance, the state of Indiana’s Public Deposit Insurance Fund and other coverages;

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

• the risk of labor availability, trade policy and tariffs, as well as supply chain constraints could impact loan demand from the manufacturing sector;

• changes in the availability and cost of credit and capital in the financial markets;

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

• the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

• the timing and scope of any legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators;

• risk of cyber-security attacks that could result in damage to the Company's or third-party service providers' networks or data of the Company;

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis