LAKELAND FINANCIAL CORP 10-Q

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net income in the first six months of 2023 was $38.9 million, which decreased $10.4 million , or 21.1%, from $49.3 million for the comparable period of 2022 . Diluted income per common share was $1.51 in the first six months of 2023 , a decrease of 21.4% from $1.92 in the comparable period of 2022 . The decrease in net income for 2023 was primarily due to an increase in noninterest expense of $17.3 million, or 31.5%, and an increase in provision for credit losses expense of $4.7 million. Offsetting these items was an increase to net interest income of $6.5 million, or 6.9%, and an increase to noninterest income of $636,000, or 3.0%. Pretax pre-provision earnings in the first six months of 2023 were $49.7 million, a decrease of $10.2 million , or 17.0%, compared to $59.9 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 13.18% in the first six months of 2023 versus 15.72% in the comparable period of 2022 . Annualized return on average total assets was 1.22% in the first six months of 2023 versus 1.52% for the comparable period of 2022 . The Company's average equity to average assets ratio was 9.26% in the first six months of 2023 versus 9.65% 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). Net income in second quarter of 2023 was $14.6 million, down 43.1% from $25.7 million for the comparable period of 2022. Diluted earnings per common share was $0.57 in the second quarter of 2023, down 43.0% from $1.00 in the comparable period of 2022. The decrease was driven primarily by an increase in noninterest expense of $14.8 million, or 53.1%, partially offset by an increase in noninterest income of $1.0 million, or 9.6%. Pretax pre-provision earnings in the second quarter of 2023 were $17.3 million, a decrease of $14.0 million, or 44.7%, compared to $31.3 million for the comparable period of 2022. Annualized return on average total equity was 9.70% in the second quarter of 2023 versus 17.65% in the comparable period of 2022. Annualized return on average total assets was 0.91% in the second quarter of 2023 versus 1.59% in the comparable period of 2022. The average equity to average assets ratio was 9.39% in the second quarter of 2023 versus 9.03% the comparable period of 2022. On June 30, 2023, the Company discovered that it had been the victim of international wire fraud resulting in an estimated loss of $18.1 million, which is net of estimated insurance coverage of $4.1 million. The loss net of tax amounts to $13.6 million, or $0.53 diluted earnings per share for the three and six month periods ended June 30, 2023. As a result, the Company’s core operational profitability, which is a non‐GAAP measure that excludes the estimated effect of this one‐time loss, was $26.8 million for the quarter ended June 30, 2023, compared to $25.7 million for the three months ended June 30, 2022 and $24.3 million for the linked quarter ended March 31, 2023. Core profitability improved 10% on a linked quarter basis and 4% on an annual basis. The fraudulent wire activity resulted from a highly sophisticated business email compromise directed by a foreign threat actor that targeted a specific general ledger account at the Bank. To facilitate the fraud, the threat actor compromised a single employee email account outside the Company's network and used a forged wire transfer form. A third‐party forensic investigation determined that no client accounts were threatened by this activity, nor was there any attempt to access any client information or funds. Additionally, the investigation concluded that the Company's network was never penetrated and that the foreign threat actor made no attempt to penetrate the network. On June 30, 2023, the Company notified its insurance carriers about the fraudulent wire activity and engaged a forensic technology investigation firm to conduct a thorough investigation. The Company also notified the United States Secret Service, the FBI and the Financial Crimes Enforcement Network, or FinCEN. In addition, the Company has communicated actively with its primary regulators. The Company’s tangible common equity to tangible assets ratio, which is a non-GAAP financial measure, was 9.04% at June 30, 2023, compared to 8.92% at June 30, 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 as a result of the rising interest rate environment. These declines have 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 $202.0 million at June 30, 2023, compared to $175.6 million at June 30, 2022 and $215.3 million at December 31, 2022. When excluding the impact of investment securities market 34 Table of Contents 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 11.37% at June 30, 2023, compared to 11.08% at June 30, 2022 and 11.30% at December 31, 2022. Total assets were $6.510 billion as of June 30, 2023 versus $6.432 billion as of December 31, 2022, an increase of $77.2 million, or 1.2%. Balance sheet expansion was driven primarily by loan portfolio growth. Total loans, net of the allowance for credit losses, increased $152.4 million, or 3.3%, between June 30, 2023 and December 31, 2022. Contributing further to the increase in total assets was an increase in cash and cash equivalents of $42.9 million, or 32.9%. Offsetting these increases was a decrease in available-for-sale securities of $123.5 million, or 10.4%. To fund the balance sheet expansion, total borrowings increased $103.0 million, or 34.7%, and was offset by a decrease in total deposits of $37.6 million, or less than 1%. The deposit mix saw a shift from noninterest bearing deposits, which decreased $298.7 million, or 17.2%, to interest bearing deposits which increased $261.2 million, or 7.0%. Total equity increased $23.1 million, or 4.1%, from $568.9 million at December 31, 2022 to $592.0 million at June 30, 2023. Retained earnings increased $15.3 million, or 2.4%, as a result of net income of $38.9 million, offset by dividends declared and paid of $23.5 million. Accumulated other comprehensive income (loss), increased $11.3 million, or 6.0%, due primarily to an improvement in available-for-sale securities fair market values during the six months ended June 30, 2023. CRITICAL ACCOUNTING POLICIES The Company’s accounting policies are described in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2022. Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for credit losses. See “Note 4 – Allowance for Credit Losses and Credit Quality” for more information on this critical accounting policy. RESULTS OF OPERATIONS Overview Selected income statement information for the three and six months ended June 30, 2023 and 2022 is presented in the following table: Three Months Ended June 30, Six Months Ended June 30, (dollars in thousands) 2023 2022 2023 2022 Income Statement Summary: Net interest income $ 48,524 48,678 $ 100,043 $ 93,558 Provision for credit losses 800 0 5,150 417 Noninterest income 11,501 10,492 21,815 21,179 Noninterest expense 42,734 27,913 72,168 54,882 Other Data: Efficiency ratio (1) 71.19 % 47.17 % 59.22 % 47.83 % Diluted EPS $ 0.57 $ 1.00 $ 1.51 $ 1.92 Average Equity/Average Assets 9.39 % 9.03 % 9.26 % 9.65 % Tangible capital ratio (2) 9.04 8.92 9.04 8.92 Adjusted tangible capital ratio (3) 11.37 11.08 11.37 11.08 Net charge-offs to average loans 0.00 0.00 0.24 0.03 Net interest margin 3.28 3.26 3.41 3.09 Noninterest income to total revenue 19.16 17.73 17.90 18.46 Pretax pre-provision earnings (4) $ 17,291 $ 31,257 $ 49,690 $ 59,855 35 Table of Contents (1) Noninterest expense/net interest income plus noninterest income. (2) Non-GAAP financial measure. The Company believes that disclosing non-GAAP financial measures provides investors with information useful to understanding the Company’s financial performance. Additionally, these non-GAAP measures are used by management for planning and forecasting purposes, including measures based on “tangible common equity,” which is “total equity” excluding intangible assets, net of deferred tax, and “tangible assets,” which is “total assets” excluding intangible assets, net of deferred tax. The tangible capital ratio is calculated by excluding the balance of goodwill, net of deferred taxes. See reconciliation on the next page. (3) Non-GAAP financial measure. Calculated by removing the fair market value adjustment impact of the 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) Non-GAAP financial measure. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Management believes this is an important measure because it may enable investors to identify the trends in the Company's earnings exclusive of the effects of tax and provision expense, which may vary significantly from period to period. See reconciliation below. Reconciliations of non-GAAP measures are provided below (in thousands, except for per share data). As of and For The As of and For The Three Months Ended June 30, Six Months Ended June 30, (dollars in thousands) 2023 2022 2023 2022 Total Equity $ 591,995 $ 562,063 $ 591,995 $ 562,063 Less: Goodwill (4,970) (4,970) (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,167 1,167 1,167 Tangible Common Equity (A) 588,192 558,260 588,192 558,260 AOCI Market Value Adjustment 176,898 157,625 176,898 157,625 Adjusted Tangible Common Equity (C) 765,090 715,885 765,090 715,885 Total Assets $ 6,509,546 $ 6,265,087 $ 6,509,546 $ 6,265,087 Less: Goodwill (4,970) (4,970) (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,167 1,167 1,167 Tangible Assets (B) 6,505,743 6,261,284 6,505,743 6,261,284 Securities Market Value Adjustment 223,922 199,525 223,922 199,525 Adjusted Tangible Assets (D) 6,729,665 6,460,809 6,729,665 6,460,809 Ending Common Shares Issued (E) 25,607,663 25,527,896 25,607,663 25,527,896 Tangible Book Value per Common Share (A/E) $ 22.97 $ 21.87 $ 22.97 $ 21.87 Tangible Capital Ratio (A/B) 9.04 % 8.92 % 9.04 % 8.92 % Adjusted Tangible Capital Ratio (C/D) 11.37 11.08 11.37 11.08 Net Interest Income $ 48,524 $ 48,678 100,043 93,558 Noninterest Income 11,501 10,492 21,815 21,179 Noninterest Expense (42,734) (27,913) (72,168) (54,882) Pretax Pre-Provision Earnings $ 17,291 $ 31,257 $ 49,690 $ 59,855 36 Table of Contents Three Months Ended Six Months Ended Jun. 30, 2023 Jun. 30, 2023 Noninterest Expense $ 42,734 $ 72,168 Less: Wire Fraud Loss (18,058) (18,058) Plus: Salaries and Employee Benefits (5) 1,850 1,850 Adjusted Core Noninterest Expense $ 26,526 $ 55,960 Earnings Before Income Taxes $ 16,491 $ 44,540 Adjusted Core Noninterest Expense Impact 16,208 16,208 Adjusted Earnings Before Income Taxes 32,699 60,748 Tax Effect (5,873) (9,644) Core Operational Profitability $ 26,826 $ 51,104 Core Operational Diluted Earnings Per Common Share $ 1.05 $ 1.99 Adjusted Core Efficiency Ratio 44.19 % 45.92 % (5) Long-term, incentive-based compensation accruals were reduced as a result of the wire fraud loss. Adjusted core noninterest expense, adjusted earnings before income taxes, core operational profitability, core operational diluted earnings per common share and adjusted core efficiency ratio are non‐GAAP financial measures calculated using GAAP amounts. These adjusted amounts are calculated by excluding the impact of the wire fraud loss and corresponding reduction to salaries and employee benefits for the three‐ and six‐month periods ended June 30, 2023. Management considers these measures of financial performance to be meaningful to understanding the company’s core business performance for these periods. Net Income Net income was $38.9 million in the first six months of 2023, which decreased $10.4 million , or 21.1%, from $49.3 million for the comparable period of 2022 . The decrease in net income for the first six months of 2023 was primarily due to an increase in noninterest expense of $17.3 million, or 31.5%, and an increase in provision for credit losses expense of $4.7 million. Offsetting these items was an increase to net interest income of $6.5 million, or 6.9%, and an increase to noninterest income of $636,000, or 3.0%. Net income in second quarter of 2023 was $14.6 million, down 43.1% from $25.7 million for the comparable period of 2022. Diluted earnings per common share was $0.57 in the second quarter of 2023, down 43.0% from $1.00 in the comparable period of 2022. The decrease was driven primarily by an increase in noninterest expense of $14.8 million, or 53.1%, partially offset by an increase in noninterest income of $1.0 million, or 9.6%. On June 30, 2023, the Company discovered that it had been the victim of international wire fraud resulting in an estimated loss of $18.1 million. The loss net of tax amounts to $13.6 million, or $0.53 diluted earnings per share for the three and six month periods ended June 30, 2023. As a result, the Company’s core operational profitability, which is a non‐GAAP measure that excludes the estimated effect of this one‐time loss, was $26.8 million for the quarter ended June 30, 2023, compared to $25.7 million for the three months ended June 30, 2022 and $24.3 million for the linked quarter ended March 31, 2023. Core profitability improved 10% on a linked quarter basis and 4% on an annual basis. The fraudulent wire activity resulted from a highly sophisticated business email compromise directed by a foreign threat actor that targeted a specific general ledger account at the bank. To facilitate the fraud, the threat actor compromised a single employee email account outside the company's network and used a forged wire transfer form. 37 Table of Contents N et Interest Income The following tables set forth consolidated information regarding average balances and rates: Six Months Ended June 30, 2023 2022 (fully tax equivalent basis, dollars in thousands) Average Balance Interest Yield (1)/ Rate Average Balance Interest Yield (1)/ Rate Earning Assets Loans: Taxable (2)(3) $ 4,704,075 $ 144,589 6.20 % $ 4,337,938 $ 83,873 3.90 % Tax exempt (1) 57,709 2,322 8.11 25,726 566 4.44 Investments: Securities (1) 1,230,421 17,476 2.86 1,494,979 19,157 2.58 Short-term investments 2,275 48 4.25 2,223 3 0.27 Interest bearing deposits 87,529 1,951 4.49 413,048 726 0.35 Total earning assets $ 6,082,009 $ 166,386 5.52 % $ 6,273,914 $ 104,325 3.35 % Less: Allowance for credit losses (72,366) (67,787) Nonearning Assets Cash and due from banks 72,797 73,037 Premises and equipment 58,657 59,143 Other nonearning assets 281,465 217,581 Total assets $ 6,422,562 $ 6,555,888 Interest Bearing Liabilities Savings deposits $ 376,281 $ 137 0.07 % $ 416,755 $ 156 0.08 % Interest bearing checking accounts 2,844,181 48,627 3.45 2,676,528 5,646 0.43 Time deposits: In denominations under $100,000 189,734 1,789 1.90 193,873 653 0.68 In denominations over $100,000 553,472 7,976 2.91 617,824 1,516 0.49 Miscellaneous short-term borrowings 213,990 5,130 4.83 13 0 0.00 Long-term borrowings and subordinated debentures 0 0 0.00 64,641 127 0.40 Total interest bearing liabilities $ 4,177,658 $ 63,659 3.07 % $ 3,969,634 $ 8,098 0.41 % Noninterest Bearing Liabilities Demand deposits 1,555,877 1,895,333 Other liabilities 94,175 58,188 Stockholders' Equity 594,852 632,733 Total liabilities and stockholders' equity $ 6,422,562 $ 6,555,888 Interest Margin Recap Interest income/average earning assets 166,386 5.52 % 104,325 3.35 % Interest expense/average earning assets 63,659 2.11 8,098 0.26 Net interest income and margin $ 102,727 3.41 % $ 96,227 3.09 % (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 $2.7 million for both the six-month periods ended June 30, 2023 and June 30, 2022. (2) Loan fees, which are immaterial in relation to total taxable loan interest income for the six months ended June 30, 2023 and 2022 , are included as taxable loan interest income . (3) Nonaccrual loans are included in the average balance of taxable loans. 38 Table of Contents Three Months Ended June 30, 2023 2022 (fully tax equivalent basis, dollars in thousands) Average Balance Interest Yield (1)/ Rate Average Balance Interest Yield (1)/ Rate Earning Assets Loans: Taxable (2)(3) $ 4,739,885 $ 75,047 6.35 % $ 4,396,333 $ 44,138 4.03 % Tax exempt (1) 57,857 1,198 8.31 29,380 353 4.82 Investments: Securities (1) 1,210,870 8,520 2.82 1,476,144 10,049 2.73 Short-term investments 2,308 26 4.52 2,301 2 0.35 Interest bearing deposits 85,364 1,009 4.74 252,893 481 0.76 Total earning assets $ 6,096,284 $ 85,800 5.65 % $ 6,157,051 $ 55,023 3.58 % Less: Allowance for credit losses (71,477) (67,527) Nonearning Assets Cash and due from banks 69,057 74,158 Premises and equipment 58,992 58,978 Other nonearning assets 280,073 238,228 Total assets $ 6,432,929 $ 6,460,888 Interest Bearing Liabilities Savings deposits $ 360,173 $ 65 0.07 % $ 425,102 $ 81 0.08 % Interest bearing checking accounts 2,930,285 27,226 3.73 2,710,674 3,784 0.56 Time deposits: In denominations under $100,000 198,864 1,147 2.31 189,538 307 0.65 In denominations over $100,000 611,427 5,173 3.39 601,877 718 0.48 Miscellaneous short-term borrowings 186,418 2,347 5.05 0 0 0.00 Long-term borrowings and subordinated debentures 0 0 0.00 54,396 54 0.40 Total interest bearing liabilities $ 4,287,167 $ 35,958 3.36 % $ 3,981,587 $ 4,944 0.50 % Noninterest Bearing Liabilities Demand deposits 1,450,396 1,825,327 Other liabilities 91,367 70,650 Stockholders' Equity 603,999 583,324 Total liabilities and stockholders' equity $ 6,432,929 $ 6,460,888 Interest Margin Recap Interest income/average earning assets 85,800 5.65 % 55,023 3.58 % Interest expense/average earning assets 35,958 2.37 4,944 0.32 Net interest income and margin $ 49,842 3.28 % $ 50,079 3.26 % (1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $1.3 million and $1.4 million in the three-month periods ended June 30, 2023 and June 30, 2022, respectively. (2) Loan fees, which are immaterial in relation to total taxable loan interest income for the three months ended June 30, 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, on a fully tax equivalent basis, increased $6.5 million, or 6.8%, to $102.7 million for the six months ended June 30, 2023, compared to $96.2 million for the first six months of 2022 . Growth in average loans and an improvement in earning assets yields were the primary drivers behind the $62.1 million, or 59.5%. increase in tax equivalent interest income between the two periods. Offsetting these increases was a decrease in the average balance of investment securities. Interest expense, which partially offset the positive impact of the increase to tax equivalent interest income, increased by $55.6 million, or 686.1%. and was driven by increased funding costs from increased average interest bearing liabilities and decreased average noninterest bearing liabilities. 39 Table of Contents Total average earning assets were $6.082 billion for the six months ended June 30, 2023, a decrease of $191.9 million, or 3.1%, compared to $6.274 billion for the six months ended June 30, 2022. A decrease to average investment securities of $264.6 million, or 17.7%, from $1.495 billion for the six months ended June 30, 2022 to $1.230 billion for the six months ended June 30, 2023, and a decrease to interest bearing deposits of $325.5 million, or 78.8%, from $413.0 million for the six months ended June 30, 2022 to $87.5 million for the six months ended June 30, 2023, drove the contraction in average earning assets between the two periods. Offsetting these decreases was an increase in average loans outstanding, which increased $398.1 million, or 9.1%, to $4.762 billion during the six months ended June 30, 2023, compared to $4.364 billion during the same period of 2022 . Total average interest bearing liabilities were $4.178 billion for the six months ended June 30, 2023, an increase of $208.0 million, or 5.2%, from $3.970 billion for the six months ended June 30, 2022. This increase was driven by increased interest bearing deposits of $58.7 million, or 1.5%, from $3.905 billion for the six months ended June 30, 2022 to $3.964 billion for the six months ended June 30, 2023, and an increase in total average borrowings of $149.3 million, or 231.0%, from $64.6 million for the six months ended June 30, 2022 to $214.0 million for the six month ended June 30, 2023. Noninterest bearing demand deposits decreased $339.5 million, or 17.9%, from $1.895 billion for the six months ended June 30, 2022 to $1.556 billion for the six months ended June 30, 2023. The tax equivalent net interest margin was 3.41% for the six months ended June 30, 2023, compared to 3.09% during the first six months of 2022, representing a 32 basis point, or 10.4%, expansion between the two periods. The net interest margin expansion was driven by a 500 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 5.00%-5.25% at June 30, 2023. The impact of the higher interest rate environment has increased earning asset yields by 217 basis points, or 64.8%, to 5.52% for the six months ended June 30, 2023, up from 3.35% for the comparable period of 2022. This increase was offset by an increase in the Company's funding costs, as excess customer liquidity in the form of deposits was utilized and the competition for deposits increased throughout the industry. Interest expense as a percentage of average earning assets increased to 2.11% for the six months ended June 30, 2023, up from 0.26% for the comparable period of 2022, an increase of 185 basis points, or 711.5%. The Company anticipates the c ost of funds may continue to rise throughout 2023 as a result of increased market competition for deposits, shifts from noninterest bearing deposits into interest bearing deposits, and increased utilization of FHLB borrowings. Net interest income, on a fully tax equivalent basis, decreased by $237,000, or less than 1%, for the three months ended June 30, 2023 as compared to the three months ended June 30, 2022. Tax equivalent net interest income benefited from increased average loan balances and yields between the two periods. Offsetting this benefit were increased interest bearing liabilities and an increased funding costs. Total average earning assets were $6.096 billion for the second quarter of 2023, a decrease of $60.8 million, or 1.0%, compared to $6.157 billion for the second quarter of 2022. The decrease in average earning assets was driven by a decrease in average in average interest bearing deposits, which decreased $167.5 million, or 66.2%, from $252.9 million for the second quarter of 2022 to $85.4 million for the second quarter of 2023, and a decrease in average investment securities, which decreased $265.3 million, or 18.0%, from $1.476 billion for the second quarter of 2022 to $1.211 billion for the second quarter of 2023. Offsetting these decreases was an increase in average loans of $372.0 million, or 8.4%, from $4.426 billion for the second quarter of 2022 to $4.798 billion for the second quarter of 2023. Total average interest bearing liabilities were $4.287 billion for the second quarter of 2023, an increase of $305.6 million, or 7.7%, from $3.982 billion for the second quarter of 2022. This increase was driven by increased interest bearing deposits of $173.6 million, or 4.4%, from $3.927 billion for the second quarter of 2022 to $4.101 billion for the second quarter of 2023 and increased total borrowings by $132.0 million, or 242.7%, from $54.4 million for the second quarter of 2022 to $186.4 million for the second quarter of 2023. Noninterest bearing demand deposits decreased $374.9 million, or 20.5%, from $1.825 billion for the second quarter of 2022 to $1.450 billion for the second quarter of 2023. The tax equivalent net interest margin expanded by 2 basis points, or less than 1%, to 3.28% for the second quarter of 2023, compared to 3.26% for the second quarter of 2022. Earning asset yields expanded 207 basis points, or 57.8%, from 3.58% for the second quarter of 2022 to 5.65% for the second quarter of 2023. This increase was offset by an increase in the Company's funding costs as interest expense as a percentage of average earning assets increased 205 basis points, or 640.6%, from 0.32% for the second quarter of 2022 to 2.37% for the second quarter of 2023. Increases to the Company's earning asset yields and interest expense as a percentage of average earning assets between the two periods were driven by the Federal Reserve's action to increase the target Federal Funds rate to 5.25% from 0.25%. The target Federal Funds rate was increased 350 basis points between June 30, 2022 and June 30, 2023, increasing the target Federal Funds rate range from 1.50%-1.75% to 5.00%-5.25%. While the rate increases have positively affected the Company's yields on earning assets, the Company has experienced a corresponding increase to funding costs as excess customer liquidity was utilized and the competition for deposits has increased throughout the industry. The Company anticipates the c ost of funds may continue to rise throughout 40 Table of Contents 2023 as a result of increased market competition for deposits, shifts from noninterest bearing deposits into interest bearing deposits, and increased utilization of FHLB borrowings. Provision for Credit Losses The Company recorded provision for credit losses expense of $5.2 million for the six months ended June 30, 2023, compared to provision expense of $417,000 during the comparable period of 2022, an increase of $4.7 million, or 1135.0%. The increase in provision during the six months ended June 30, 2023, compared to the comparable period in 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 six month period ended June 30, 2023, compared to net charge-offs of $667,000 during the comparable period of 2022, an increase of $5.0 million. The increase in charge-offs during the six months ended June 30, 2023, compared to the comparable period in 2022 was the result of a charge-off of $5.5 million attributable to a single commercial borrower during the first quarter of 2023. The Company recorded provision expense of $800,000 during the second quarter of 2023, compared to no provision expense recorded during the second quarter of 2022. Provision expense during the quarter was primarily driven by growth in the loan portfolio. Net charge-offs (recoveries) were ($43,000) during the second quarter of 2023, compared to $3,000 during the second quarter of 2022. 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. Noninterest Income Noninterest income categories for the six-month and three-month period ended June 30, 2023 and 2022 are shown in the following tables: Six Months Ended June 30, (dollars in thousands) 2023 2022 Dollar Change Percent Change Wealth advisory fees $ 4,471 $ 4,491 $ (20) (0.4) % Investment brokerage fees 962 1,060 (98) (9.2) Service charges on deposit accounts 5,356 5,691 (335) (5.9) Loan and service fees 5,848 6,084 (236) (3.9) Merchant card fee income 1,806 1,719 87 5.1 Bank owned life insurance income (loss) 1,384 (266) 1,650 (620.3) Interest rate swap fee income 794 404 390 96.5 Mortgage banking income (loss) (134) 860 (994) (115.6) Net securities gains 19 0 19 100.0 Other income 1,309 1,136 173 15.2 Total noninterest income $ 21,815 $ 21,179 $ 636 3.0 % Noninterest income to total revenue 17.90 % 18.46 % 41 Table of Contents Three Months Ended June 30, (dollars in thousands) 2023 2022 Dollar Change Percent Change Wealth advisory fees $ 2,271 $ 2,204 $ 67 3.0 % Investment brokerage fees 428 541 (113) (20.9) Service charges on deposit accounts 2,726 2,882 (156) (5.4) Loan and service fees 3,002 3,195 (193) (6.0) Merchant card fee income 929 904 25 2.8 Bank owned life insurance income (loss) 693 (183) 876 (478.7) Interest rate swap fee income 794 354 440 124.3 Mortgage banking income (loss) (35) 351 (386) (110.0) Net securities gains 3 0 3 100.0 Other income 690 244 446 182.8 Total noninterest income $ 11,501 $ 10,492 $ 1,009 9.6 % Noninterest income to total revenue 19.16 % 17.73 % Noninterest income increased by $636,000, or 3.0%, to $21.8 million for the six months ended June 30, 2023, compared to $21.2 million for the prior year six month period. The increase was driven by increases to bank owned life insurance income of $1.7 million, or 620.3%, interest rate swap fee income of $390,000, or 96.5%, and other income of $173,000, or 15.2%. Bank owned life insurance income benefited from improved market performance of the Company's variable life insurance policies which track to the overall performance of the equity markets, and from the purchase of general life insurance policies during the fourth quarter of 2022. Interest rate swap fee income increased due to increased demand for fixed rate loan arrangements among certain commercial borrowers and the Bank's utilization of back-to-back swaps to convert the fixed rate exposure to a floating rate. Other income increased due to increased dividends from the the Company's Federal Home Loan Bank stock and activity from the Company's low income housing tax credit investment holdings. These increases were offset by decreases to mortgage banking income of $994,000, or 115.6%, due to a decrease in mortgage volume, service charges on deposit accounts of $335,000, or 5.9%, and loan and service fees of $236,000, or 3.9%. The Company’s noninterest income increased $1.0 million, or 9.6%, to $11.5 million for the second quarter of 2023, compared to $10.5 million for the second quarter of 2022. The increase in noninterest income was primarily driven by an increase in bank owned life insurance income of $876,000, or 478.7%, an increase in other income of $446,000, or 182.8%, and an increase in interest rate swap fee income of $440,000, or 124.3%. Offsetting these increases was a decrease to mortgage banking income of $386,000, or 110.0%, a decrease to loan and service fees of $193,000, or 6.0%, a decrease to service charges on deposit accounts of $156,000, or 5.4%, and a decrease to investment brokerage income of $113,000, or 20.9%. These decreases were primarily volume driven. Noninterest Expense Noninterest expense categories for the six-month and three-month period ended June 30, 2023 and 2022 are shown in the following tables: Six Months Ended June 30, (dollars in thousands) 2023 2022 Dollar Change Percent Change Salaries and employee benefits $ 27,437 $ 29,190 $ (1,753) (6.0) % Net occupancy expense 3,253 3,317 (64) (1.9) Equipment costs 2,864 2,870 (6) (0.2) Data processing fees and supplies 6,926 6,284 642 10.2 Corporate and business development 2,729 2,652 77 2.9 FDIC insurance and other regulatory fees 1,598 1,058 540 51.0 Professional fees 4,170 2,973 1,197 40.3 Wire fraud loss 18,058 0 18,058 100.0 Other expense 5,133 6,538 (1,405) (21.5) Total noninterest expense $ 72,168 $ 54,882 $ 17,286 31.5 % Efficiency ratio 59.22 % 47.8 % 42 Table of Contents Three Months Ended June 30, (dollars in thousands) 2023 2022 Dollar Change Percent Change Salaries and employee benefits $ 11,374 $ 14,798 $ (3,424) (23.1) % Net occupancy expense 1,681 1,688 (7) (0.4) Equipment costs 1,426 1,459 (33) (2.3) Data processing fees and supplies 3,474 3,203 271 8.5 Corporate and business development 1,298 1,433 (135) (9.4) FDIC insurance and other regulatory fees 803 619 184 29.7 Professional fees 2,049 1,414 635 44.9 Wire fraud loss 18,058 0 18,058 100.0 Other expense 2,571 3,299 (728) (22.1) Total noninterest expense $ 42,734 $ 27,913 $ 14,821 53.1 % Efficiency ratio 71.19 % 47.2 % Noninterest expense increased by $17.3 million, or 31.5%, for the six months ended June 30, 2023, from $54.9 million to $72.2 million. The increase to noninterest expense during the year was driven primarily by the previously described wire fraud loss recorded as a component of noninterest expense in the amount of $18.1 million in June 2023. Adjusted core noninterest expense, which is a non-GAAP financial measure, declined by $1.1 million, or 2.0%, as compared to the prior six months ended June 30, 2022, excluding the impact of the wire fraud loss on recurring operating expense, and the related reduction of performance-based, long-term incentive compensation The primary driver of the decline in noninterest expense was a decline in other expense which included settlement accruals in 2022 offset by increase of $1.2 million, or 40.3%, an increase of $642,000, or 10.2%, in data processing fees and supplies and an increase of $540,000, or 51.0%, in FDIC insurance and other regulatory fees. Noninterest expense increased $14.8 million, or 53.1%, to $42.7 million for the second quarter of 2023, compared to $27.9 million during the second quarter of 2022. The increase to noninterest expense during the quarter was driven primarily by the previously described wire fraud loss recorded as a component of noninterest expense in the amount of $18.1 million. Adjusted core noninterest expense, which is a non-GAAP financial measure, declined by $1.4 million, or 5.0%, as compared to the prior year quarter ended June 30, 2022, excluding the impact of the wire fraud loss and the related reduction of performance-based, long-term incentive compensation. Salaries and benefits decreased by 23.1%, or $3.4 million as compared to the prior year quarter due primarily to reduced performance-based accruals, offset partially by higher salary expense. Other expense decreased $728,000, or 22.1%, driven by a decrease in accruals pertaining to ongoing legal matters. Noninterest expense increases during the second quarter of 2023 compared to the prior year quarter included professional fees of $635,000, or 44.9%, data processing fees and supplies of $271,000, or 8.5%, and FDIC insurance and other regulatory fees of $184,000, or 29.7%. The Company's income tax expense decreased $4.5 million, or 44.2%, in the six months ended June 30, 2023, compared to the same period in 2022. The effective tax rate was 12.7% in the six months ended June 30, 2023, compared to 17.0% for the comparable period of 2022. The year-to-date effective tax rate is reduced by the wire fraud loss, 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 Overview Total assets were $6.510 billion as of June 30, 2023 versus $6.432 billion as of December 31, 2022, an increase of $77.2 million, or 1.2%. Balance sheet expansion was driven primarily by increases to loans net of the allowance for credit losses of $152.4 million, or 3.3%, and an increase in cash and cash equivalents of $42.9 million, or 32.9%. These increases were offset by a decrease in available-for-sale securities of $123.5 million, or 10.4%. To fund the balance sheet expansion, total borrowings increased $103.0 million, or 34.7%. Total deposits decreased $37.6 million, or less than 1%, with a shift in the deposit mix from noninterest bearing deposits, which decreased $298.7 million, or 17.2%, to interest bearing deposits, which increased $261.2 million, or 7.0%. Total equity increased $23.1 million, or 4.1%, from $568.9 million at December 31, 2022 to $592.0 million at June 30, 2023. Retained earnings increased $15.3 million, or 2.4%, as a result of net income of $38.9 million, offset by dividends declared and paid of $23.5 million. Accumulated other comprehensive income (loss), increased $11.3 million, or 6.0%, due primarily to an improvement in available-for-sale securities fair market values during the six months ended June 30, 2023. 43 Table of Contents Uses of Funds Total Cash and Cash Equivalents Total cash and cash equivalents increased by $42.9 million, or 32.9%, to $173.1 million at June 30, 2023, from $130.3 million at December 31, 2022. Cash and cash equivalents include short-term investments. The increase in cash and cash equivalents at June 30, 2023 was driven by an increase in interest bearing short-term investment accounts of $48.8 million, or 98.9%, offset by a decrease in cash and due from banks of $5.9 million, or 7.3%. 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, loan growth in 2023 and utilization of excess cash balances by deposit customers. Investment Portfolio The amortized cost and the fair value of securities as of June 30, 2023 and December 31, 2022 were as follows: June 30, 2023 December 31, 2022 (dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Available-for-Sale U.S Treasury securities $ 3,251 $ 3,232 $ 3,057 $ 3,034 U.S government sponsored agencies 151,029 122,086 156,184 126,961 Mortgage-backed securities: residential 545,616 462,033 578,175 492,308 State and municipal securities 564,165 474,718 663,367 563,225 Total available-for-sale $ 1,264,061 $ 1,062,069 $ 1,400,783 $ 1,185,528 Held-to-Maturity State and municipal securities $ 129,070 $ 114,264 $ 128,242 $ 111,029 Total Investment Portfolio $ 1,393,131 $ 1,176,333 $ 1,529,025 $ 1,296,557 At June 30, 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. Management is aware that, as interest rates rise, any unrealized loss in the available-for-sale investment securities portfolio will increase, and as interest rates fall the unrealized gain in the investment portfolio will rise. Since the majority of the bonds in the investment portfolio are fixed-rate, with only a few adjustable-rate bonds, we would expect our investment portfolio to follow this market value pattern. This is taken into consideration when evaluating the gain or loss of investment securities in the portfolio and the potential for an allowance for credit losses. Purchases of securities available-for-sale totaled $4.3 million in the first six months of 2023. The purchases consisted of U.S. Treasury securities and mortgage-backed securities issued by government sponsored entities for CRA purposes. Investment securities represented 18.3% of total assets on June 30, 2023, compared to 20.4% of total assets on December 31, 2022. Effective duration for the investment portfolio was 6.6 years at June 30, 2023, compared to 4.0 years at December 31, 2019 before the pandemic, and 6.5 years at December 31, 2022. Duration of the portfolio extended following the deployment of excess liquidity to the portfolio and the dramatic rise in interest rates during 2022 and into 2023. The ratio of investment securities as a percentage of total assets remains elevated over historical levels of approximately 12-14% during 2014 to 2020. 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 for excess balance sheet liquidity stemming from increased levels of core deposits from government stimulus programs. The Company expects the investment securities portfolio as a percentage of assets to decrease over time as the 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 $28.9 million were received in the first six months of 2023, and the amortization of premiums, net of the accretion of discounts, was $2.4 million. Maturities and calls of securities totaled $10.0 million in the first six months of 2023. Sales of available-for-sale investment securities totaled $100.0 million in the first six months of 2023 and resulted in net gains of $19,000. No allowance for credit losses was recognized for available-for-sale or held-to-maturity securities as of June 30, 2023 and December 31, 2022. The fair value of the available-for-sale investment securities portfolio as of June 30, 2023 included net unrealized losses of $202.0 million, compared to net unrealized losses of $215.3 million as of December 31, 2022. Unrealized losses in the 44 Table of Contents 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. economy. 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. The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds under what is commonly referred to as the “Volcker Rule” of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Real Estate Mortgage Loans Held-for-Sale Real estate mortgage loans held-for-sale increased by $941,000, or 263.6%, to $1.3 million at June 30, 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 factors, 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 $3.4 million in the first six months of 2023, compared to $28.4 million in the first six months of 2022. Management expects the volume of loans originated for sale in the secondary market to remain at reduced levels due to elevated mortgage rates, limited inventory, and existing homeowners being locked in at historically low 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 $348.4 million and $364.3 million, as of June 30, 2023 and December 31, 2022, respectively. Loan Portfolio The loan portfolio by portfolio segment as of June 30, 2023 and December 31, 2022 is summarized as follows: (dollars in thousands) June 30, 2023 December 31, 2022 Current Period Change Commercial and industrial loans $ 1,469,887 30.2 % $ 1,493,049 31.7 % $ (23,162) Commercial real estate and multi-family residential loans 2,376,393 48.8 2,179,094 46.2 197,299 Agri-business and agricultural loans 374,962 7.7 432,088 9.2 (57,126) Other commercial loans 120,958 2.5 113,593 2.4 7,365 Consumer 1-4 family mortgage loans 431,385 8.9 407,566 8.6 23,819 Other consumer loans 92,139 1.9 88,075 1.9 4,064 Subtotal, gross loans 4,865,724 100.0 % 4,713,465 100.0 % 152,259 Less: Allowance for credit losses (72,058) (72,606) 548 Net deferred loan fees (3,464) (3,069) (395) Loans, net $ 4,790,202 $ 4,637,790 $ 152,412 Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, increased by $152.4 million, or 3.2%, to $4.866 billion at June 30, 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. 45 Table of Contents The following table summarizes the Company’s non-performing assets as of June 30, 2023 and December 31, 2022: (dollars in thousands) June 30, 2023 December 31, 2022 Nonaccrual loans $ 18,004 $ 16,964 Loans past due over 90 days and still accruing 8 123 Total nonperforming loans 18,012 17,087 Other real estate owned 384 100 Repossessions 20 37 Total nonperforming assets $ 18,416 $ 17,224 Individually analyzed loans $ 18,465 $ 31,327 Nonperforming loans to total loans 0.37 % 0.36 % Nonperforming assets to total assets 0.28 % 0.27 % Total nonperforming assets increased by $1.2 million, or 6.9%, to $18.4 million during the six month period ended June 30, 2023. The ratio of nonperforming assets to total assets increased from 0.27% at December 31, 2022 to 0.28% at June 30, 2023. A loan is individually analyzed when full payment under the original loan terms is not expected. The analysis for smaller loans that are similar in nature and which are not in nonaccrual or modified status, such as residential mortgage, consumer, and credit card loans, is determined based on the class of loans. If a loan is individually analyzed, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows or at the fair value of collateral if repayment is expected solely from the collateral. Total individually analyzed loans decreased by $12.9 million, or 41.1%, to $18.5 million at June 30, 2023 from $31.3 million at December 31, 2022, due primarily to a charge off of a single commercial credit during the first quarter of 2023. Loans are charged against the allowance for credit losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb current expected credit losses relating to specifically identified loans based on an evaluation of the loans by management, as well as other current expected losses in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. General allowance is determined after considering the following factors: application of loss percentages using a probability of default/loss given default approach subject to a floor, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans: Substandard, Doubtful and Loss. The regulations also contain a Special Mention category. Special Mention applies to loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as Substandard, Doubtful or Loss but do possess credit deficiencies or potential weaknesses deserving management’s close attention. The Company’s policy is to establish a specific allowance for credit losses for any assets where management has identified conditions or circumstances that indicate an asset is nonperforming. If an asset or portion, thereof is classified as a loss, the Company’s policy is to either establish specified allowances for credit losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount. At June 30, 2023, the allowance for credit losses was 1.48% of total loans outstanding, versus 1.54% of total loans outstanding at December 31, 2022. At June 30, 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. The Company has a relatively high percentage of commercial and commercial real estate loans, which are extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing 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. The Company has limited exposure to commercial 46 Table of Contents office space borrowers, all of which are located in the Bank's Indiana markets. Loans totaling $68.8 million for this sector represented only 1.4% of total loans at June 30, 2023. As of June 30, 2023, based on management’s review of the loan portfolio, the Company had 59 credit relationships totaling $186.0 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 six 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 June 30, 2023, the Company had $163.7 million of assets classified as Special Mention, $21.5 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 3.83% as of June 30, 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. The Company has annual discussions regarding this methodology with regulatory authorities. Allowance estimates are considered a prudent measurement of the risk in the Company’s loan portfolio based upon loan segment. In accordance with applicable accounting guidance, the allowance is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. For a more thorough discussion of the allowance for credit losses methodology see the ("Critical Accounting Policies") section of this Item 2. The allowance for credit losses decreased $548,000, or less than 1%, from $72.6 million at December 31, 2022 to $72.1 million at June 30, 2023. The decrease was a result of net charge-offs recorded during the period of $5.7 million, offset by provision expense of $5.2 million. Of the $5.7 million in net charge-offs, $5.5 million was attributable to a single deteriorated commercial relationship which was reserved for in the allowance for credit losses. The increased provision expense recorded during the six months ended June 30, 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 well as portfolio loan growth. 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 Company's sources of funds include a diversified deposit base gathered throughout the Company's footprint and includes a stable mix of 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 June 30, 2023, the Company had access to $2.89 billion in unused liquidity available from these aggregate sources, compared to $2.99 billion at December 31, 2022. 47 Table of Contents The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the six months ended June 30, 2023 and 2022 are summarized in the following table: Six months ended June 30, 2023 2022 (dollars in thousands) Balance Rate Balance Rate Noninterest bearing demand deposits $ 1,555,877 0.00 % $ 1,895,333 0.00 % Savings and transaction accounts: Savings deposits 376,281 0.07 416,755 0.08 Interest bearing demand deposits 2,844,181 3.45 2,676,528 0.43 Time deposits: . Deposits of $100,000 or more 553,472 1.90 617,824 0.49 Other time deposits 189,734 2.91 193,873 0.68 Total deposits $ 5,519,545 2.14 % $ 5,800,313 0.28 % FHLB advances and other borrowings 213,990 4.83 64,654 0.40 Total funding sources $ 5,733,535 2.24 % $ 5,864,967 0.28 % Average total deposits were $5.520 billion for the six months ended June 30, 2023, a decrease of $280.8 million, or 4.8%, from the comparable period in 2022. Average total borrowings were $214.0 million for the six months ended June 30, 2023, an increase of $149.3 million, or 231.0%, from the comparable period in 2022. Total average deposit costs increased 186 basis points from 0.28% for the six months ended June 30, 2022, compared to 2.14% for the six months ended June 30, 2023. Total average borrowing costs increased 443 basis points from 0.40% for the six months ended June 302, 2022 to 4.83% for the six months ended June 30, 2023. In aggregate, these increases raised total funding costs from these sources by 196 basis points from 0.28% for the six months ended June 30, 2022, to 2.24% for the six months ended June 30, 2023. Deposits and Borrowings As of June 30, 2023, total deposits decreased by $37.6 million, or less than 1%, from December 31, 2022. Core deposits, which excludes brokered deposits, decreased by $95.9 million, or 1.8%, to $5.355 billion as of June 30, 2023 from $5.451 billion as of December 31, 2022. Total brokered deposits were $68.4 million at June 30, 2023, compared to $10.0 million at December 31, 2022. The following table summarizes deposit composition at June 30, 2023 and December 31, 2022: (dollars in thousands) June 30, 2023 Percentage of Total December 31, 2022 Percentage of Total Current Period Change Retail $ 1,821,607 33.6 % $ 1,934,787 35.4 % $ (113,180) Commercial 2,082,564 38.4 2,085,934 38.2 (3,370) Public funds 1,450,527 26.7 1,429,872 26.2 20,655 Core deposits $ 5,354,698 98.7 % $ 5,450,593 99.8 % $ (95,895) Brokered deposits 68,361 1.3 10,027 0.2 58,334 Total deposits $ 5,423,059 100.0 % $ 5,460,620 100.0 % $ (37,561) Commercial, retail and public funds deposit composition remained stable between June 30, 2023 and December 31, 2022. On June 30, 2023 and December 31, 2022, commercial deposits represented 38% of total deposits. Retail deposits represented 34% at June 30, 2023 versus 35% at December 31, 2022. Public Funds deposits represented 27% at June 30, 2023 versus 26% at December 31, 2022. Commercial deposits contracted $3.4 million, or less than 1%, from $2.086 billion at December 31, 2022 to $2.083 billion at June 30, 2023; retail deposits contracted $113.2 million, or 5.8%, from $1.935 billion at December 31, 2022 to $1.822 billion at June 30, 2023; and public funds deposits grew $20.7 million, or 1.4%, from $1.430 billion at December 31, 2022 to $1.451 billion at June 30, 2023. Uninsured deposits, not covered by FDIC deposit insurance or the Indiana Public Deposit Insurance Fund (PDIF), were 28% of total deposits as of June 30, 2023, versus 30% as of December 31, 2022. Deposits not insured by FDIC Insurance coverage (including those public fund deposits that are covered by the PDIF) were 54% as of June 30, 2023, versus 56% at 48 Table of Contents December 31, 2022. As of June 30, 2023 and December 31, 2022, 98% of deposit accounts had deposit balances less than $250,000 and 2% of deposit accounts had deposit balances greater than $250,000. Capital As of June 30, 2023, total stockholders’ equity was $592.0 million, an increase of $23.1 million, or 4.1%, from $568.9 million at December 31, 2022. Net income of $38.9 million increased equity. In addition, an increase of $11.3 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 $0.92 per share, or $23.5 million, offset the increase to total stockholders' equity. The impact on equity for other comprehensive income (loss) is not included in regulatory capital. The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1, or core capital, as a percentage of average assets, to measure the soundness of a financial institution. In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations. As of June 30, 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 June 30, 2023 and December 31, 2022, are presented in the table below. Capital ratios for June 30, 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 June 30, 2023: Total Capital (to Risk Weighted Assets) Consolidated $ 834,541 14.94 % $ 447,004 8.00 % $ 586,602 N/A N/A N/A Bank $ 814,283 14.58 % $ 446,819 8.00 % $ 586,450 10.50 % $ 558,524 10.00 % Tier I Capital (to Risk Weighted Assets) Consolidated $ 764,580 13.68 % $ 335,253 6.00 % $ 474,942 N/A N/A N/A Bank $ 744,351 13.33 % $ 335,114 6.00 % $ 474,745 8.50 % $ 446,819 8.00 % Common Equity Tier 1 (CET1) Consolidated $ 764,580 13.68 % $ 251,440 4.50 % $ 391,128 N/A N/A N/A Bank $ 744,351 13.33 % $ 251,336 4.50 % $ 390,967 7.00 % $ 363,041 6.50 % Tier I Capital (to Average Assets) Consolidated $ 764,580 11.54 % $ 264,931 4.00 % $ 264,931 N/A N/A N/A Bank $ 744,351 11.27 % $ 264,263 4.00 % $ 264,263 4.00 % $ 330,328 5.00 % 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 % 49 Table of Contents FORWARD-LOOKING STATEMENTS This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the federal securities law. Forward-looking statements are not historical facts and are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “project,” “possible,” “continue,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain and, accordingly, the reader is cautioned not to place undue reliance on any forward-looking statement made by the Company. Actual results could differ materially from those addressed in the forward-looking statements as a result of numerous factors, including, without limitation: • the effects of future economic, business and market conditions and changes, including prevailing interest rates and the rate of inflation; • governmental monetary and fiscal policies and the impact the current economic environment will have on these; • the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities and other interest sensitive assets and liabilities; • changes in borrowers’ credit risks and payment behaviors; • the failure of assumptions and estimates used in our reviews of our loan portfolio, underlying the establishment of reserves for possible credit losses, our analysis of our capital position and other estimates; • the effects of disruption and volatility in capital markets on the value of our investment portfolio; • the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services; • 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; • the risks related to the recent failures of First Republic Bank, 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; • the outcome of pending litigation and other claims we may be subject to from time to time; • the phase out of most LIBOR tenors by mid-2023 and establishment of a new reference rate or rates; • changes in technology or products that may be more difficult or costly, or less effective than anticipated; • the effects of fraud by or affecting employees, customers or third parties; • the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions; • changes in accounting policies, rules and practices; • the effects of war or other conflicts, acts of terrorism or other catastrophic events, including storms, droughts, tornados and flooding, that may affect general economic conditions, including agricultural production and 50 Table of Contents demand and prices for agricultural goods and land used for agricultural purposes, generally and in our markets; and • the risks noted in the Risk Factors discussed under Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2022, as well as other risks and uncertainties set forth from time to time in the Company’s other filings with the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.