LAKELAND FINANCIAL CORP 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net income in 2023 was $93.8 million, down 9.7%, from $103.8 million in 2022. Net income for 2022 was 8.4% higher than $95.7 million in 2021. Diluted net income per common share was $3.65 in 2023, $4.04 in 2022 and $3.74 in 2021. Return on average total assets was 1.45% in 2023, versus 1.62% in 2022 and 1.56% in 2021. Return on average total equity was 15.93% in 2023, versus 17.40% in 2022 and 14.19% in 2021. The dividend payout ratio, with respect to diluted earnings per share, was 50.41% in 2023, versus 39.60% in 2022 and 36.36% in 2021. The average equity to average assets ratio was 9.11% in 2023, compared to 9.28% in 2022 and 10.96% in 2021. Net income in 2023 was negatively impacted by a $20.5 million increase in noninterest expense and a $5.9 million decrease in net interest income. Offsetting these decreases were an $8.0 million increase in noninterest income and a $3.5 million decrease in provision for credit losses. On June 30, 2023, the Company discovered that it had been the victim of an international wire fraud resulting in a loss of $18.1 million. During the fourth quarter of 2023, the Company recognized $6.3 million in insurance and loss recoveries associated with the wire fraud loss. During 2023, the total impact of the wire fraud loss to income before income tax expense was $10.4 million, net of recoveries and adjustments to salaries and benefits expense, or $7.8 million net of tax, and $0.30 diluted earnings per common share. Core operational profitability, a non-GAAP financial measure that excludes the impact of the wire fraud loss and related insurance and loss recoveries as well as adjustments to the Company's salaries and employee benefits expense, was $101.6 million for the twelve months ended December 31, 2023, a decrease of $2.2 million, or 2.2%, from the full year 2022. Core operational diluted earnings per common share, a non-GAAP financial measure, for the twelve months ended December 31, 2023, was $3.95, also a decrease of 2.2%, from the full year 2022. Net income in 2022 was positively impacted by a $24.8 million increase in net interest income. Offsetting the positive impact of net interest income were an $8.3 million increase in provision for credit losses, a $5.9 million increase in noninterest expense and a $2.9 million decrease in noninterest income. Total assets were $6.524 billion as of December 31, 2023 versus $6.432 billion as of December 31, 2022, an increase of $91.7 million or 1.4%. Balance sheet expansion in 2023 was driven by loan growth of $206.1 million, or 4.4%. Offsetting the increase in loan growth was a decrease in investments securities of $132.1 million, or 10.1%. Balance sheet expansion in 2023 was funded by an increase in deposits of $259.9 million, or 4.8%, and was offset by a decrease in borrowings of $247.0 million. CRITICAL ACCOUNTING POLICIES 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. Allowance for Credit Losses The Company maintains an allowance for credit losses to provide for expected credit losses. Losses are charged against the allowance when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management’s judgment, should be charged against the allowance. A provision for credit losses is taken based on management’s ongoing evaluation of the appropriate allowance balance. A formal evaluation of the adequacy of the credit loss allowance is conducted monthly. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control. The level of credit loss provision is influenced by growth in the overall loan portfolio, emerging market risk, emerging concentration risk, commercial loan focus and large credit concentration, new industry lending activity, general economic 32 Table of Contents conditions and historical loss analysis. In addition, management gives consideration to changes in the facts and circumstances of watch list credits, which includes the security position of the borrower, in determining the appropriate level of the credit loss provision. Furthermore, management’s overall view on credit quality is a factor in the determination of the provision. The determination of the appropriate allowance is inherently subjective, as it requires significant estimates by management. The Company has an established process to determine the adequacy of the allowance for credit losses that generally includes consideration of changes in the nature and volume of the loan portfolio and overall portfolio quality, along with current and forecasted economic conditions that may affect borrowers’ ability to repay. Consideration is not limited to these factors although they represent the most commonly cited factors. To determine the specific allocation levels for individual credits, management considers the current valuation of collateral and the amounts and timing of expected future cash flows as the primary measures. Management also considers trends in adversely classified loans based upon an ongoing review of those credits. With respect to pools of similar loans, an appropriate level of general allowance is determined by portfolio segment using a probability of default-loss given default (“PD/LGD”) model, subject to a floor. A default can be triggered by one of several different asset quality factors, including past due status, nonaccrual status, material modification to a borrower experiencing financial difficulty or if the loan has had a charge off. This PD is then combined with a LGD derived from historical charge off data to construct a default rate. This loss rate is then supplemented with adjustments for reasonable and supportable forecasts of relevant economic indicators, particularly the unemployment rate forecast from the Federal Open Market Committee’s Summary of Economic Projections, and other environmental factors based on the risks present for each portfolio segment. These environmental factors include consideration of the following: levels of, and trends in, delinquencies and nonperforming loans; trends in volume and terms of loans; changes in collateral strength; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedure, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. It is also possible that these factors could include social, political, economic, and terrorist events or activities. All of these factors are subject to change, which may be significant. As a result of this detailed process, the allowance results in two forms of allocations, specific and general. These two components represent the total allowance for credit losses deemed adequate to cover expected losses inherent in the loan portfolio. Commercial loans are subject to a dual standardized grading process administered by the credit administration function. These grade assignments are performed independent of each other and a consensus is reached by credit administration and the loan officer. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that indicate it should be evaluated on an individual basis. Considerations with respect to specific allocations for these individual credits include, but are not limited to, the following: (a) the sufficiency of the customer’s cash flow or net worth to repay the loan; (b) the adequacy of the discounted value of collateral relative to the loan balance; (c) whether the loan has been criticized in a regulatory examination; (d) whether the loan is nonperforming; (e) any other reasons the ultimate collectability of the loan may be in question; or (f) any unique loan characteristics that require special monitoring. Allocations are also applied to categories of loans considered not to be individually analyzed, but for which the rate of loss is expected to be consistent with or greater than historical averages. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. These general pooled loan allocations are performed for portfolio segments of commercial and industrial; commercial real estate, multi-family, and construction; agri-business and agricultural; other commercial loans; and consumer 1-4 family mortgage and other consumer loans. General allocations of the allowance are determined by a historical loss rate based on the calculation of each pool’s probability of default-loss given default, subject to a floor. The length of the historical period for each pool is based on the average life of the pool. The historical loss rates are supplemented with consideration of economic conditions and portfolio trends. Due to the imprecise nature of estimating the allowance for credit losses, the Company’s allowance for credit losses includes an unallocated component. The unallocated component of the allowance for credit losses incorporates the Company’s judgmental determination of potential expected losses that may not be fully reflected in other allocations. As a practical expedient, the Company has elected to state accrued interest separately from loan principal balances on the consolidated balance sheet. Additionally, when a loan is placed on non-accrual, interest payments are reversed through interest income. For off balance sheet credit exposures outlined in the ASU at 326-20-30-11, it is the Company’s position that nearly all of the unfunded amounts on lines of credit are unconditionally cancellable, and therefore not subject to having a liability recorded. The allowance is inherently uncertain as it represents the Company’s expectation of the future collectability of loans in its portfolio; actual collections may be greater than or less than expectations. Actual collections may be impacted by wider economic conditions such as changes in the competitive environment or in the levels of business investment or consumer 33 Table of Contents spending, or by the quality of borrowers’ management teams and the success of their strategy execution. Borrowers’ ability to repay may also change due to the effects of government monetary or fiscal policy, which could affect the level of demand for borrowers’ products or services. The Company’s allowance for credit losses is subject to changes in the inputs to the model, including the following: the number of delinquent loans, nonaccrual loans, material modification due to a borrower experiencing financial difficulty, or charge offs; the levels of charge offs and recoveries; projected unemployment rates and other economic indicators; the Company’s collateral position on adversely classified loans; or management’s qualitative judgment of the implication of trends in its loan portfolio or in the broader economy. RESULTS OF OPERATIONS Overview The Company's net income in 2023 decreased $10.1 million, or 9.7%, as a result of an increase in noninterest expense of $20.5 million, or 18.6%, and a decrease in net interest income of $5.9 million, or 2.9%. Noninterest income increased $8.0 million, or 19.1%. Provision for credit losses decreased $3.5 million, or 37.6%. The increases to noninterest expense and noninterest income were primarily driven by the wire fraud loss that occurred during the second quarter of 2023 and related insurance and loss recoveries and adjustments to salaries and benefits expense recorded by the Company as a result of the loss. The wire fraud loss of $18.1 million was the primary driver of the increase to noninterest expense. Insurance and loss recoveries associated with the event of $6.3 million were recorded as noninterest income during the fourth quarter of 2023. Salaries and employee benefits expense was reduced by $1.4 million as a result of adjustments to the Company's long term incentive accrual due to the negative impact of the loss on the Company's net income for the year. Core operational profitability, a non-GAAP financial measure which excludes the impact of the wire fraud loss and related insurance and loss recoveries and adjustments to the Company's salaries and employee benefits expense, was $101.6 million for the twelve months ended December 31, 2023, a decrease of $2.2 million, or 2.2%, from the full year 2022. Core operational diluted earnings per common share, a non-GAAP financial measure, for the twelve months ended December 31, 2023, was $3.95, also a decrease of 2.2%, from the full year 2022. The Company's net interest income was negatively impacted in 2023 by increased funding costs, primarily driven by deposit repricing as deposit rates adjusted to the higher interest rate environment as a result of tightened monetary policy by the Federal Reserve. The rise in deposit costs combined with a shift in deposit mix from noninterest bearing deposits to interest bearing deposits were the primary drivers behind the 2.9% decrease in net interest income during 2023. Asset quality metrics remained stable with watch list loans as a percentage of total loans remaining near historic lows at 3.72% at December 31, 2023, as compared to 3.42% at December 31, 2022. The provision for credit losses decreased $3.5 million, or 37.6%. The near-term outlook includes plans for continued loan growth, disciplined credit philosophy, continued investments in human capital and technological innovations and enhancements, and targeted expansion of our branch network in the Indianapolis market with two new offices planned in the next 24 months. 34 Table of Contents Selecte d income statement information for the years ended December 31, 2023, 2022 and 2021 is presented in the following table. (dollars in thousands, except per share data) 2023 2022 2021 Income Statement Summary: Net interest income (a) $ 197,035 $ 202,887 $ 178,088 Provision for credit losses 5,850 9,375 1,077 Noninterest income (b) 49,858 41,862 44,720 Adjusted Core Noninterest Income (1) 43,558 41,862 44,720 Noninterest expense (c) 130,710 110,210 104,287 Adjusted Core Noninterest Expense (1) 114,049 110,210 104,287 Other Data: Efficiency ratio (2) 52.94 % 45.03 % 46.81 % Adjusted Core Efficiency Ratio (1) 47.40 45.03 46.81 Dilutive EPS $ 3.65 $ 4.04 $ 3.74 Total equity 649,793 568,887 704,906 Tangible capital ratio (3) 9.91 % 8.79 % 10.70 % Adjusted tangible capital ratio (4) 11.99 11.38 10.47 Net charge offs to average loans 0.13 0.10 0.09 Net interest margin 3.31 3.40 3.07 Net interest margin excluding Paycheck Protection Program ("PPP") loans (5) 3.31 3.40 2.95 Noninterest income to total revenue 20.19 17.10 20.07 Pretax Pre-Provision Earnings (6) $ 116,183 $ 134,539 $ 118,521 (1) Non-GAAP financial measure. Calculated by excluding the wire fraud loss and related insurance and loss recoveries and adjustments to salary and benefits. Management believes this is an important measure because meaningful to understanding the company’s core business performance for these periods. See reconciliation on the following pages. (2) Noninterest expense (c)/(Net interest income (a) plus Noninterest income (b)). (3) Non-GAAP financial measure. Calculated by subtracting intangible assets, net of deferred tax, from total assets and total equity. Management believes this is an important measure because it is useful for planning and forecasting purposes. See reconciliation on the following pages. (4) Non-GAAP financial measure. Calculated by removing the fair market value adjustment impact of the available-for-sale investment securities portfolio included in accumulated other comprehensive income ("AOCI") from tangible equity and tangible assets. Management believes this is an important measure because it provides better comparability to periods preceding the recent significant rise in prevailing interest rates. See reconciliation on the following pages. (5) Non-GAAP financial measure. Calculated by subtracting the impact PPP loans had on average earnings assets, loan interest income, average interest bearing liabilities, and interest expense. Management believes this is an important measure because it provides for better comparability to subsequent periods, given the expectation that PPP represented a limited governmental intervention in the lending market, designed to support small businesses through the pandemic, its low fixed interest rate of 1.0% and because the accretion of net loan fee income can be accelerated upon borrower forgiveness and repayment by the SBA. See reconciliation on the following pages. (6) Non-GAAP financial measure. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Management believes this is an important measure because it may enable investors to identify the trends in the Company's earnings exclusive of the effects of tax and provision expense, which may vary significantly from period to period. See reconciliation on the following pages. 35 Table of Contents The Company believes that providing non-GAAP financial measures provides investors with information useful to understanding the company's financial performance. Reconciliations of these non-GAAP financial measures is provided below. The impact of the wire fraud loss, insurance and loss recoveries and adjustments to salaries and benefits is presented below. Management considers these measures of core financial performance to be meaningful to understanding the Company’s business performance for these periods. Year Ended Dec. 31, 2023 Dec. 31, 2022 Dec. 31, 2021 Noninterest Income $ 49,858 $ 41,862 $ 44,720 Less: Recoveries (6,300) 0 0 Adjusted Core Noninterest Income $ 43,558 $ 41,862 $ 44,720 Noninterest Expense $ 130,710 $ 110,210 $ 104,287 Less: Wire Fraud Loss (18,058) 0 0 Plus: Salaries and Employee Benefits 1,397 0 0 Adjusted Core Noninterest Expense $ 114,049 $ 110,210 $ 104,287 Earnings Before Income Taxes $ 110,333 $ 125,164 $ 117,444 Adjusted Core Impact: Noninterest Income (6,300) 0 0 Noninterest Expense 16,661 0 0 Total Adjusted Core Impact 10,361 0 0 Adjusted Earnings Before Income Taxes 120,694 125,164 117,444 Tax Effect (19,119) (21,347) (21,711) Core Operational Profitability $ 101,575 $ 103,817 $ 95,733 Diluted Earnings Per Share $ 3.65 $ 4.04 $ 3.74 Impact of Wire Fraud Loss, Net of Recoveries 0.30 0.00 0.00 Core Operational Diluted Earnings Per Common Share $ 3.95 $ 4.04 $ 3.74 Adjusted Core Efficiency Ratio 47.40 % 45.03 % 46.81 % 36 Table of Contents Year Ended (dollars in thousands, except per share data) Dec. 31, 2023 Dec. 31, 2022 Dec. 31, 2021 Total Equity $ 649,793 $ 568,887 $ 704,906 Less: Goodwill (4,970) (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,167 1,176 Tangible Common Equity 645,990 565,084 701,112 Market Value Adjustment in AOCI 154,460 188,154 (17,056) Adjusted Tangible Common Equity 800,450 753,238 684,056 Assets $ 6,524,029 $ 6,432,371 $ 6,557,323 Less: Goodwill (4,970) (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,167 1,176 Tangible Assets 6,520,226 6,428,568 6,553,529 Market Value Adjustment in AOCI 154,460 188,154 (17,056) Adjusted Tangible Assets 6,674,686 6,616,722 6,536,473 Ending Common Shares Issued 25,614,585 25,536,026 25,488,508 Tangible Book Value Per Common Share $ 25.22 $ 22.13 $ 27.50 Tangible Common Equity/Tangible Assets 9.91 % 8.79 % 10.70 % Adjusted Tangible Common Equity/Adjusted Tangible Assets 11.99 11.38 10.47 Net Interest Income $ 197,035 $ 202,887 $ 178,088 Plus: Noninterest Income 49,858 41,862 44,720 Minus: Noninterest Expense (130,710) (110,210) (104,287) Pretax Pre-Provision Earnings $ 116,183 $ 134,539 $ 118,521 37 Table of Contents The impact of the Paycheck Protection Program on Net Interest Margin FTE for the years ended December 31, 2022 and 2021 is presented below (dollars in thousands). The impact of the Paycheck Protection Program on Net Interest Margin FTE for the year ended December 31, 2023 is excluded as the Program had an immaterial impact on average earning assets, interest income and cost of funds during the period. Year Ended Dec. 31, 2022 Dec. 31, 2021 Total Average Earnings Assets $ 6,123,163 $ 5,906,640 Less: Average Balance of PPP Loans (7,942) (237,951) Total Adjusted Earning Assets 6,115,221 5,668,689 Total Interest Income FTE $ 245,194 $ 196,806 Less: PPP Loan Income (772) (14,945) Total Adjusted Interest Income FTE 244,422 181,861 Adjusted Earning Asset Yield, net of PPP Impact 4.00 % 3.21 % Total Average Interest Bearing Liabilities $ 3,913,195 $ 3,761,520 Less: Average Balance of PPP Loans (7,942) (237,951) Total Adjusted Interest Bearing Liabilities 3,905,253 3,523,569 Total Interest Expense FTE $ 36,680 $ 15,131 Less: PPP Cost of Funds (20) (595) Total Adjusted Interest Expense FTE 36,660 14,536 Adjusted Cost of Funds, net of PPP Impact 0.60 % 0.26 % Net Interest Margin FTE, net of PPP Impact 3.40 % 2.95 % Net Income Net income was $93.8 million in 2023, a decrease of $10.1 million, or 9.7%, versus net income of $103.8 million in 2022. The decrease in net income from 2022 to 2023 was driven by an increase in noninterest expense of $20.5 million, or 18.6% and a decrease in net interest income of $5.9 million, or 2.9%. Offsetting these decreases was an increase in noninterest expense of $8.0 million, or 19.1%, and a decrease in the provision for credit losses of $3.5 million, or 37.6%. The increases to noninterest expense and noninterest income were a result of the wire fraud loss and related insurance and loss recoveries and adjustments to salaries and employee benefits expense recorded by the Company during 2023. The wire fraud loss, which occurred during the second quarter of 2023, was $18.1 million and was the primary driver of the increase to noninterest expense. Insurance and loss recoveries associated with the event of $6.3 million were recorded as noninterest income during the fourth quarter of 2023. Salaries and employee benefits expense was reduced by $1.4 million as a result of adjustments to the Company's long term incentive accrual due to the negative impact of the loss on the Company's net income for the year. Core operational profitability, a non-GAAP financial measure which excludes the impact of the wire fraud loss and related insurance and loss recoveries as well as adjustments to the Company's salaries and employee benefits expense, was $101.6 million for the twelve months ended December 31, 2023, a decrease of $2.2 million, or 2.2%, from the comparable period of 2022. Core operational diluted earnings per common share, a non-GAAP financial measure, for the twelve months ended December 31, 2023, was $3.95, also a decrease of 2.2%, from the comparable period of 2022. 38 Table of Contents Net income was $103.8 million in 2022, an increase of $8.1 million, or 8.4%, versus net income of $95.7 million in 2021. The increase in net income from 2021 to 2022 was primarily due to an increase in net interest income of $24.8 million, or 13.9%, and an increase in the provision for credit losses of $8.3 million, or 770.5%. Noninterest expense increased $5.9 million, or 5.7%, and noninterest income decreased $2.9 million, or 6.4%. Net interest income for 2022 included $772,000 in PPP interest and fee income, compared to $14.9 million for 2021. The increase in provision expense for 2022 was driven primarily by the downgrade of a single commercial relationship, with the remaining increase attributable to loan growth. Net Interest Income The following table presents a three-year average balance sheet and, for each major asset and liability category, its related interest income and yield or its expense and rate for the years ended December 31, 2023, 2022 and 2021. 39 Table of Contents THREE YEAR AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS 2023 2022 2021 (fully tax equivalent basis, dollars in thousands) Average Balance Interest Income Yield (1)/ Rate Average Balance Interest Income Yield (1)/ Rate Average Balance Interest Income Yield (1)/ Rate Earning Assets Loans: Taxable (1)(2) $ 4,755,341 $ 304,130 6.40 % $ 4,391,590 $ 202,004 4.60 % $ 4,406,456 $ 170,081 3.86 % Tax exempt (3) 58,337 4,839 8.29 35,576 2,094 5.89 14,638 594 4.06 Investments: (3) Securities 1,184,659 33,907 2.86 1,432,287 38,882 2.71 1,068,325 25,582 2.39 Short-term investments 2,425 109 4.49 2,266 30 1.32 2,254 2 0.09 Interest bearing deposits 113,463 5,594 4.93 261,444 2,184 0.84 414,967 547 0.13 Total earning assets $ 6,114,225 $ 348,579 5.70 % $ 6,123,163 $ 245,194 4.00 % $ 5,906,640 $ 196,806 3.33 % Less: Allowance for credit losses (72,222) (67,717) (72,083) Nonearning Assets Cash and due from banks 70,941 72,302 70,035 Premises and equipment 58,633 58,894 59,667 Other nonearning assets 293,403 240,937 189,521 Total assets $ 6,464,980 $ 6,427,579 $ 6,153,780 Interest Bearing Liabilities Savings deposits $ 347,009 $ 246 0.07 % $ 419,997 $ 327 0.08 % $ 360,915 $ 278 0.08 % Interest bearing checking accounts 2,909,464 107,471 3.69 2,689,572 31,182 1.16 2,392,220 6,759 0.28 Time deposits: In denominations under $100,000 202,904 5,106 2.52 185,215 1,289 0.70 218,624 2,038 0.93 In denominations over $100,000 669,545 24,968 3.73 579,797 3,483 0.60 714,353 5,752 0.81 Miscellaneous short-term borrowings 166,821 8,441 5.06 6,559 272 4.15 408 7 1.72 Long-term borrowings 0 0 0.00 32,055 127 0.40 75,000 297 0.40 Total interest bearing liabilities $ 4,295,743 $ 146,232 3.40 % $ 3,913,195 $ 36,680 0.94 % $ 3,761,520 $ 15,131 0.40 % Noninterest Bearing Liabilities Demand deposits 1,475,306 1,842,777 1,671,172 Other liabilities 105,264 75,120 46,451 Stockholders' Equity 588,667 596,487 674,637 Total liabilities and stockholders' equity $ 6,464,980 $ 6,427,579 $ 6,153,780 Interest Margin Recap Interest income/average earning assets 348,579 5.70 % 245,194 4.00 % 196,806 3.33 % Interest expense/average earning assets 146,232 2.39 36,680 0.60 15,131 0.26 Net interest income and margin $ 202,347 3.31 % $ 208,514 3.40 % $ 181,675 3.07 % (1) Loan fees are included as taxable loan interest income. Net loan fees attributable to PPP loans were $10,000 , $692,000 and $12.5 million for the years ended December 31, 2023, 2022 and 2021, respectively. (2) Nonaccrual loans are included in the average balance of taxable loans. (3) 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 $5.3 million, $5.6 million and $3.6 million for the years ended December 31, 2023, 2022 and 2021, respectively. 40 Table of Contents The following table shows fluctuations in net interest income attributable to changes in the average balances of assets and liabilities and the yields earned or rates paid for the years ended December 31. NET INTEREST INCOME – RATE/VOLUME ANALYSIS (fully tax equivalent basis, dollars in thousands) 2023 Over (Under) 2022 (1) 2022 Over (Under) 2021 (1) Attributable to Total Change Attributable to Total Change Volume Rate Volume Rate Interest Income (2) Loans: Taxable $ 17,875 $ 84,251 $ 102,126 $ (576) $ 32,499 $ 31,923 Tax exempt 1,674 1,071 2,745 1,141 359 1,500 Investments: Securities (7,000) 2,025 (4,975) 9,552 3,748 13,300 Short-term investments 2 77 79 0 28 28 Interest bearing deposits (1,863) 5,273 3,410 (272) 1,909 1,637 Total interest income 10,688 92,697 103,385 9,845 38,543 48,388 Interest Expense Savings deposits (53) (28) (81) 46 3 49 Interest bearing checking accounts 2,750 73,539 76,289 941 23,482 24,423 Time deposits: In denominations under $100,000 134 3,683 3,817 (282) (467) (749) In denominations over $100,000 620 20,865 21,485 (966) (1,303) (2,269) Miscellaneous short-term borrowings 8,096 73 8,169 242 23 265 Long-term borrowings and subordinated debentures (127) 0 (127) (170) 0 (170) Total interest expense 11,420 98,132 109,552 (189) 21,738 21,549 Net Interest Income (tax equivalent) $ (732) $ (5,435) $ (6,167) $ 10,034 $ 16,805 $ 26,839 (1) The earning assets and interest bearing liabilities used to calculate interest differentials are based on average daily balances for 2023, 2022 and 2021. The changes in net interest income are created by changes in interest rates and changes in the volumes of loans, investments, deposits and borrowings. In the table above, changes attributable to volume are computed using the change in volume from the prior year multiplied by the previous year’s rate, and changes attributable to rate are computed using the change in rate from the prior year multiplied by the previous year’s volume. The change in interest or expense due to both rate and volume has been allocated between factors in proportion to the relationship of the absolute dollar amounts of the change in each. (2) 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 TEFRA adjustment applicable to nondeductible interest expense. Net interest income decreased by $5.9 million to $197.0 million in 2023 compared to $202.9 million in 2022, primarily as a result of increased funding costs. Total interest expense increased $109.6 million, or 298.7%. Of this increase, deposit interest expense increased $101.5 million, or 279.8%, as a result of increased rates paid for customer deposits and a shift in deposit mix from noninterest bearing deposits to interest bearing deposits. Funding costs for deposits increased 183 basis points to 2.46% during 2023, a 290.5% increase compared to 0.63% during 2022. Average noninterest bearing deposits decreased $367.5 million, or 19.9%, to $1.48 billion for 2023 as compared to $1.84 billion for 2022. Average interest bearing deposits increased $254.3 million, or 6.6%, to $4.13 billion for 2023 as compared to $3.87 billion for 2022. Contributing further to the increased funding costs was an increase in borrowings expense of $8.0 million, as a result of increased average short-term borrowings to meet the Company's funding needs. Average wholesale funding reliance remained low at 2.90% as of December 31, 2023 compared to 0.70% at December 31, 2022. Investment securities interest income decreased $4.1 million, or 12.3%, and contributed to the decline in net interest income during 2023. The decrease in investment securities income was driven by a decrease in average securities balances of $247.6 million, or 17.3%, during 2023 as a result of available-for-sale investment securities sales of $105.2 million, maturities, calls and paydowns of $71.8 million, and offset by purchases of CRA securities of $7.2 million. Realized losses of $25,000 41 Table of Contents were recognized on the securities sales during 2023. The yield on average investment securities increased 15 basis points to 2.86% for 2023, as compared to 2.71% for 2022, partially offsetting the impact of the decrease in securities average balances. An increase in loans interest income offset the negative impacts to net interest income, increasing $104.3 million, or 51.2%, to $308.0 million during 2023 compared to $203.7 million during 2022. The increase in average loans was driven by loan growth during the period as average loan balances increased $386.5 million, or 8.7%, from $4.43 billion during 2022 to $4.81 billion during 2023. An increase in loan yields of 181 basis points, or 39.3%, from 4.61% for 2022 to 6.42% for 2023 as a result of continued Federal Reserve tightening during 2023 and loan repricing opportunities. As a result of these effects, net interest margin decreased 9 basis points to 3.31% in 2023 versus 3.40% in 2022. Net interest margin increased to 3.40% in 2022 from 3.07% in 2021, driven by the dramatic tightening of monetary policy by the Federal Reserve during 2022 and 2023 and deposit repricing to reflect the increased rate environment that lagged into 2023. Additionally, net interest margin during the year ended December 31, 2022 was positively impacted by the recognition of nonaccrual interest resulting from the interest recovery of two nonaccrual commercial borrowers during the fourth quarter of 2022. The interest recovery was from two loans placed on nonaccrual status in 2009 and 2021. The $1.9 million of nonaccrual interest income was recognized into loan interest income and contributed 3 basis points to the Company's net interest margin during 2022. The utilization of commercial and retail lines of credit decreased to 39% at December 31, 2023, down from 42% at December 31, 2022 and 2021. However, available lines of credit have increased by $124.0 million to $4.786 billion at December 31, 2023 compared to $4.662 billion at December 31, 2022, or 2.7% growth. The decrease in line usage is attributable to the conservative approach commercial and industrial borrowers continue to take since the pandemic, due to continued elevated levels of average commercial demand deposits relative to pre-pandemic levels. Provision for Credit Losses The Company recorded a provision for credit losses of $5.9 million in 2023 compared to $9.4 million in 2022 and $1.1 million in 2021. Provision expense during 2023 was driven primarily by 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 potential economic weakness in the Company's markets. The remainder of expense was driven by growth in the loan portfolio during the year. The Company’s allowance for credit losses as of December 31, 2023 was $72.0 million compared to $72.6 million as of December 31, 2022 and $67.8 million as of December 31, 2021. The allowance for credit losses represented 1.46% of total loans as of December 31, 2023 versus 1.54% at December 31, 2022 and 1.58% at December 31, 2021. The company’s credit loss reserve to total loans, excluding PPP loans, which are guaranteed by the United States SBA and have not been allocated for within the allowance for credit losses, was 1.59% at December 31, 2021. The impact of PPP loans had an immaterial impact on the allowance coverage ratio at December 31, 2023 and 2022. Net charge offs of $6.5 million, or 0.13%, and $4.5 million, or 0.10% of average loans, were recorded in 2023 and 2022, respectively. The charge offs for 2023 and 2022 resulted primarily from the deterioration of a single commercial credit. Management believes the charge offs related to this credit were an isolated instance as a result of negative impacts caused by unique circumstances from the pandemic and are not reflective of deteriorating trends in the loan portfolio. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions including the impact of the increased interest rate environment, inflation levels, and other factors that may influence the assessment of the collectability of loans. The Company adopted CECL on January 1, 2021. Adoption of the standard resulted in a day one impact to the allowance for credit losses of $9.1 million, with an offset, net of taxes, to stockholders' equity. 42 Table of Contents Noninterest Income The following table presents changes in the components of noninterest income for the years ended December 31, 2023, 2022 and 2021. % Change From Prior Year (dollars in thousands) 2023 2022 2021 2023 2022 Wealth advisory fees $ 9,080 $ 8,636 $ 8,750 5.1 % (1.3) % Investment brokerage fees 1,815 2,318 1,975 (21.7) 17.4 Service charges on deposit accounts 10,773 11,595 10,608 (7.1) 9.3 Loan and service fees 11,750 12,214 11,922 (3.8) 2.4 Merchant and interchange fee income 3,651 3,560 3,023 2.6 17.8 Bank owned life insurance income 3,133 432 2,467 625.2 (82.5) Interest rate swap fee income 794 579 1,035 37.1 (44.1) Mortgage banking income (loss) (254) 633 1,418 (140.1) (55.4) Net securities gains (losses) (25) 21 797 (219.0) (97.4) Other income 9,141 1,874 2,725 387.8 (31.2) Total noninterest income $ 49,858 $ 41,862 $ 44,720 19.1 % (6.4) % Noninterest income to total revenue 20.2 % 17.1 % 20.1 % Noninterest income was $49.9 million in 2023 versus $41.9 million in 2022, an increase of $8.0 million, or 19.1%. Adjusted core noninterest income, which excludes the net wire fraud loss, was $43.6 million in 2023, an increase of $1.7 million, or 4.1% compared to 2022. Wealth advisory fees increased by 5.1%, or $444,000, during 2023, from $8.6 million to $9.1 million reflecting continued growth in the business and improving equity market valuations. Service charges on deposit accounts decreased by 7.1%, or $822,000, during 2023 from $11.6 million to $10.8 million due primarily to an increase to earnings allowances on business checking accounts and reduced overdraft and other deposit fees. Loan and service fees declined by 3.8%, or $464,000, during 2023 primarily due to a decline in interchange revenue due to reduced volume and spend per debit card as compared to higher trends during the pandemic. Merchant fee income improved by 2.6%, or $91,000, during 2023. Other income increased $7.3 million, or 387.8%, due primarily to insurance and loss recoveries of $6.3 million that were recognized during the fourth quarter of 2023. Bank owned life insurance increased $2.7 million, or 625.2%, from improved performance for the Company's variable life insurance policies, which track with the performance of the equity markets. The purchase of traditional bank owned life policies in December 2022 contributed further to the increase in bank owned life insurance income. These increases were offset by decreases to mortgage banking income of $887,000, or 140.1%, and a decrease in investment brokerage fees of $503,000, or 21.7%. Noninterest income was $41.9 million in 2022 versus $44.7 million in 2021, a decrease of $2.9 million, or 6.4%. Market value declines impacted the overall decrease in noninterest income. Bank owned life insurance income for the year ended December 31, 2022 decreased by $2.0 million, primarily due to declines in the market value of variable life insurance policies that are tied to the equity markets. A reduction of market value of $950,000 was recorded during 2022 compared to market value gains of $1.1 million for 2021. The valuation changes to the variable life insurance policies are offset by similar changes to the deferred compensation expense that is recognized in salary and employee benefits. Excluding the impact of the variable life insurance policy market value changes, noninterest income was $42.8 million for the year ended December 31, 2022, compared to $43.7 million for the year ended December 31, 2021, a decline of $840,000, or 2.1%. In addition, other income decreased $851,000, mortgage banking income decreased by $785,000, gains on securities sales decreased by $776,000 and interest rate swap fee income decreased by $456,000. Notably, fee-based noninterest income increased by a cumulative $2.0 million primarily due to volume, including improvements in service charges on deposit accounts of $987,000, or 9.3%, merchant and interchange fee income of $537,000, or 17.8%, investment brokerage fees of $343,000, or 17.4%, and loan and service fees of $292,000, or 2.4%. Wealth advisory fees declined by $114,000, or 1.3%, and were negatively impacted by market value declines of 8.0% in trust assets from $2.5 billion at December 31, 2021 to $2.3 billion at December 31, 2022. 43 Table of Contents Noninterest Expense The following table presents changes in the components of noninterest expense for the years ended December 31, 2023, 2022 and 2021. % Change From Prior Year (dollars in thousands) 2023 2022 2021 2023 2022 Salaries and employee benefits $ 59,147 $ 58,530 $ 57,882 1.1 % 1.1 % Net occupancy expense 6,360 6,287 5,728 1.2 9.8 Equipment costs 5,632 5,763 5,530 (2.3) 4.2 Data processing fees and supplies 14,003 12,826 12,674 9.2 1.2 Corporate and business development 4,807 5,198 4,262 (7.5) 22.0 FDIC insurance and other regulatory fees 3,363 1,999 2,242 68.2 (10.8) Professional fees 8,583 6,483 7,064 32.4 (8.2) Wire fraud loss 18,058 0 0 100.0 — Other expense 10,757 13,124 8,905 (18.0) 47.4 Total noninterest expense $ 130,710 $ 110,210 $ 104,287 18.6 % 5.7 % Noninterest expense increased by $20.5 million, or 18.6%, for 2023 from $110.2 million to $130.7 million. The increase to noninterest expense during the year was driven by an $18.1 million wire fraud loss that occurred during the second quarter of 2023. Contributing to the increase in noninterest expense during 2023 was an increase to professional fees expense of $2.1 million, or 32.4%, an increase to FDIC insurance and other regulatory fees of $1.4 million, or 68.2%, from increased assessments due to a blanket increase to the assessment rate used by the FDIC to calculate premiums. Data processing fees and supplies expense increased $1.2 million, or 9.2%. Offsetting these increases was a decrease in other expense of $2.4 million, or 18.0%, driven by reduced accruals related to ongoing litigation matters. Adjusted core noninterest expense, a non-GAAP measure, which excludes the impact of the wire fraud loss and corresponding adjustments to salaries and employee benefits, was $114.0 million during 2023, an increase of $3.8 million, or 3.5%, compared to 2022. Noninterest expense increased by $5.9 million, or 5.7%, for 2022, to $110.2 million compared to $104.3 million for 2021. The increase was due primarily to an increase of $4.2 million in other expense caused by accruals for ongoing legal matters of $3.5 million. See "Note 1 – Summary of Significant Accounting Policies" for additional details regarding loss contingencies. Corporate and business development expense increased $936,000, or 22.0%, driven by increased corporate development spending, advertising expense and charitable and foundation contributions, including contributions associated with the Company's sesquicentennial celebration. Salaries and benefits expense increased $648,000, or 1.1%. Offsetting these increases was a decrease in professional fees of $581,000, or 8.2%, due to a decrease in legal expense incurred during the year. FDIC insurance and other regulatory fee expense decreased by $243,000, or 10.8%, due to declining deposits and reduced total assets of the Company. Income Taxes The Company recognized income tax expense in 2023 of $16.6 million, compared to $21.3 million in 2022 and $21.7 million in 2021. The effective tax rate was 15.0% in 2023, compared to 17.1% in 2022 and 18.5% in 2021. The effective tax rate declined due to negative impact of the wire fraud loss and related effects on net income, which lowered income tax expense by $2.6 million for 2023. Additionally, changes to the Indiana Financial Institution Tax rate to 4.9% in 2023, 5.0% in 2022 and 5.5% in 2021, as well as tax-free interest income from municipal securities and loans during 2023 contributed to the decreased effective tax rate. For a detailed analysis of the Company’s income taxes see "Note 12 – Income Taxes". 44 Table of Contents CERTAIN STATISTICAL DISCLOSURES BY BANK HOLDING COMPANIES We are required to provide certain statistical disclosures as a bank holding company under the SEC's Industry Guide 3. The following table provides certain of those disclosures. Year ended December 31, 2023 2022 2021 Return on average assets 1.45 % 1.62 % 1.56 % Return on equity 15.93 17.40 14.19 Average equity to average assets 9.11 9.28 10.96 Dividend payout ratio 50.41 39.60 36.36 Return on average assets is computed by dividing net income by average assets for each indicated fiscal year. Average assets is computed by adding total assets as of each date during the indicated fiscal year and dividing by the number of days in the fiscal year. Return on average total equity is computed by dividing net income by average equity for each indicated fiscal year. Average equity is computed by adding the total equity attributable to the Company as of each date during the indicated fiscal year and dividing by the number of days in the fiscal year. Average equity to average assets is computed by dividing average equity by average assets for each indicated fiscal year, as calculated in accordance with the previous explanation. Dividend payout ratio is computed by dividing dividends declared per common share by earnings per diluted common share for each indicated fiscal year. The dividend payout ratio increased to 50.4% for 2023 as compared to prior periods due to the wire fraud loss and its negative impact to net income. Refer to the "Financial Condition - Loan Portfolio", "Financial Condition - Sources of Funds" and "Risk Management - Loan Portfolio" sections of this MD&A and to the Notes to Consolidated Financial Statements of this Form 10-K for the other required statistical disclosures. FINANCIAL CONDITION Overview Total assets of the Company were $6.524 billion as of December 31, 2023, an increase of $91.7 million, or 1.4%, when compared to $6.432 billion as of December 31, 2022. Total loans outstanding increased by $206.1 million, or 4.4%, to $4.917 billion at December 31, 2023 from $4.710 billion at December 31, 2022. Total deposits increased $259.9 million, from $5.461 billion at December 31, 2022, to $5.721 billion at December 31, 2023, driven by increased commercial and public funds deposits and offset by net retail outflows. Total cash and equivalents increased $21.5 million, to $151.8 million at December 31, 2023 from $130.3 million at December 31, 2022. Total investment securities decreased by $132.1 million, to $1.182 billion at December 31, 2023 from $1.314 billion at December 31, 2022. The decrease was attributable to a decrease in available-for-sale securities, which decreased by $133.8 million, primarily as a result of investment sales of $105.2 million and maturities, calls and paydowns of $71.8 million, and offset by purchases of $7.2 million and improvement in fair market valuations of $40.7 million. Losses of $25,000 were realized from the sale of available-for-sale securities in 2023. Total borrowings decreased at December 31, 2023, as a result of the liquidity provided by increased levels of deposits at period end and cash inflows from the investment securities portfolio. Total borrowings decreased by $247.0 million to $50.0 million at December 31, 2023 compared to $297.0 million at December 31, 2022. 45 Table of Contents Uses of Funds Investment Portfolio At year end 2023, 2022 and 2021, there were no holdings of securities of any one issuer, other than the U.S. government, government agencies and government sponsored agencies, in an amount greater than 10% of stockholders’ equity. See "Note 2 – Securities" for more information on these investments. Purchases of securities available-for-sale totaled $7.2 million in 2023, $315.3 million in 2022 and $835.0 million in 2021. Growth of the investment portfolio during 2021 and 2022 served to provide an earning asset alternative for excess balance sheet liquidity stemming from increased levels of liquidity provided by government stimulus programs in response to the COVID-19 pandemic. Prior to the recent Federal Reserve monetary tightening cycle starting in March of 2022, the Company deployed $250 million of excess liquidity to the investment securities portfolio during 2022 and $652 million in 2021 to preserve net interest margin. Investment securities represented 18.1% of total assets on December 31, 2023 compared to 20.4% on December 31, 2022 and 21.3% on December 31, 2021. Management expects the investment securities portfolio as a percentage of assets to decrease over time and return to historical levels of approximately 12%-14% during 2014 to 2020 as the proceeds from paydowns and maturities of these investment securities provide liquidity to fund future loan growth. On April 1, 2022, 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 as an overall balance sheet management strategy. The fair value of these securities transferred was $127.0 million. Securities sales totaled $105.2 million in 2023, $25.3 million in 2022 and $14.0 million in 2021. Paydowns from prepayments and scheduled payments of $56.2 million, $98.8 million and $113.1 million were received in 2023, 2022 and 2021, and the amortization of premiums, net of the accretion of discounts, was $4.9 million, $6.3 million and $5.0 million, respectively. Maturities and calls of securities totaled $13.6 million , $9.3 million and $24.7 million in 2023, 2022 and 2021, respectively. No provision for allowance for credit loss was recorded in connection with the investment securities portfolio in 2023, 2022 or 2021 . The investment portfolio is managed to provide for an appropriate balance between liquidit y, credit risk and investment return and to limit the Company’s exposure to risk to an acceptable level. The longer duration of the investment security portfolio serves to balance the shorter duration of the loan portfolio. The weighted average yields and maturity distribution for the securities portfolio at December 31, 2023, were as follows: Within One Year After One Within Five Years After Five Years Within Ten years After Ten Years (fully tax equivalent basis, dollars in thousands) Fair Value Yield Fair Value Yield Fair Value Yield Fair Value Yield U.S. government sponsor agency $ 0 0.00 % $ 4,376 1.00 % $ 0 0.00 % $ 115,103 1.57 % Mortgage-backed securities: residential 7 5.00 10,671 2.56 31,632 2.59 405,532 2.11 State and municipal securities 1,191 4.90 3,045 3.95 38,730 2.99 560,656 5.63 Total Securities $ 1,198 4.90 $ 18,092 2.42 $ 70,362 2.81 $ 1,081,291 4.99 The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds in the Volcker Rule. Real Estate Mortgage Loans Held-For-Sale Real estate mortgages held-for-sale increased by $801,000 to $1.2 million at December 31, 2023 from $357,000 at December 31, 2022 as a result of fluctuations in secondary market sales activity. This asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the quantity and timing of loan sales into the secondary market. The Company generally sells almost all of the conforming mortgage loans it originates in the secondary market. Proceeds from sales totaled $8.0 million in 2023, $36.5 million in 2022 and $126.4 million in 2021. 46 Table of Contents Loan Portfolio The loan portfolio by class as of December 31, 2023, 2022 and 2021 was as follows: (dollars in thousands) 2023 2022 2021 Commercial and industrial loans: Working capital lines of credit loans $ 604,893 $ 650,948 $ 652,861 Non-working capital loans 815,871 842,101 736,608 Total commercial and industrial loans 1,420,764 1,493,049 1,389,469 Commercial real estate and multi-family residential loans: Construction and land development loans 634,435 517,664 379,813 Owner occupied loans 825,464 758,091 739,371 Nonowner occupied loans 724,101 706,107 588,458 Multi-family loans 253,534 197,232 247,204 Total commercial real estate and multi-family residential loans 2,437,534 2,179,094 1,954,846 Agri-business and agricultural loans: Loans secured by farmland 162,890 201,200 206,331 Loans for agricultural production 225,874 230,888 239,494 Total agri-business and agricultural loans 388,764 432,088 445,825 Other commercial loans 120,726 113,593 73,490 Total commercial loans 4,367,788 4,217,824 3,863,630 Consumer 1-4 family mortgage loans: Closed end first mortgage loans 258,103 212,742 176,561 Open end and junior lien loans 189,663 175,575 156,238 Residential construction and land development loans 8,421 19,249 11,921 Total consumer 1-4 family mortgage loans 456,187 407,566 344,720 Other consumer loans 96,022 88,075 82,755 Total consumer loans 552,209 495,641 427,475 Gross loans 4,919,997 4,713,465 4,291,105 Less: Allowance for credit losses (71,972) (72,606) (67,773) Net deferred loan fees (3,463) (3,069) (3,264) Loans, net $ 4,844,562 $ 4,637,790 $ 4,220,068 The ratio of loans to total loans by portfolio segment as of December 31, 2023, 2022 and 2021 was as follows: 2023 2022 2021 Commercial and industrial loans 28.89 % 31.68 % 32.38 % Commercial real estate and multi-family residential loans 49.54 46.23 45.56 Agri-business and agricultural loans 7.90 9.17 10.39 Other commercial loans 2.45 2.41 1.71 Consumer 1-4 family mortgage loans 9.27 8.64 8.03 Other consumer loans 1.95 1.87 1.93 Total Loans 100.00 % 100.00 % 100.00 % 47 Table of Contents In 2023, net loan balances increased by $206.8 million to $4.845 billion, and excludes approximately $8.6 million in loans originated for sale. In 2022, net loan balances increased by $417.7 million to $4.638 billion, and excluded approximately $28.7 million in loans originated for sale. In 2021, net loan balances decreased by $367.7 million to $4.220 billion, and excluded approximately $119.4 million in loans originated for sale. The mix of The Company's loan portfolio consists primarily of commercial loans, and the Bank's lending focus is on the commercial sector of the Lake City Bank footprint. Owner occupied commercial real estate loans represent in many instances the buildings and factories of our commercial and industrial borrowers. Commercial and industrial loans together with owner occupied commercial real estate loans represented 45.7% and 47.8% of total loans as of December 31, 2023 and 2022, respectively. The Company has limited exposure to commercial office space borrowers, all of which are located in the Bank's Indiana markets. Loans totaling $71.2 million for this sector represented 1.5% of total loans at December 31, 2023. Loans to the agriculture and agri-business sector of our Indiana footprint represent a significant loan segment of the overall loan portfolio. This loan segment is well diversified with loans to corn, soybean, poultry, dairy, swine, beef and egg growers. The residential construction and land development loans class included construction loans totaling $1.0 million and $12.0 million as of December 31, 2023 and 2022. Increases in consumer loans during 2023 resulted from an increased focus on indirect lending to consumers and the introduction of a new adjustable rate mortgage product. The Bank generally sells conforming mortgage loans, which it originates locally, into the secondary market. These loans generally represent mortgage loans that are made to clients with long-term or substantial relationships with the Bank on terms consistent with secondary market requirements. The loan classifications are based on the nature of the loans as of the loan origination date. There were no foreign loans included in the loan portfolio for the periods presented. Repricing opportunities of the loan portfolio occur either according to predetermined float rate indices, adjustable rate schedules included in the related loan agreements or upon maturity of each principal payment. The following table indicates the scheduled maturities of the loan portfolio as of December 31, 2023: (dollars in thousands) Commercial and Industrial Commercial Real Estate and Multi-family Residential Agri-business and Agricultural Other Commercial Consumer 1-4 Family Mortgage Other Consumer Total Percent Within one year $ 614,306 $ 601,153 $ 132,955 $ 49,766 $ 13,823 $ 13,778 $ 1,425,781 28.98 % After one year, within five years 572,286 1,180,447 126,227 27,946 68,673 35,120 2,010,699 40.87 Over five years 222,777 652,687 129,482 43,014 372,860 47,012 1,467,832 29.83 Nonaccrual loans 11,395 3,247 100 0 831 112 15,685 0.32 Total loans $ 1,420,764 $ 2,437,534 $ 388,764 $ 120,726 $ 456,187 $ 96,022 $ 4,919,997 100.00 % At maturity, credits are reviewed and, if renewed, are renewed at rates and conditions that prevail at the time of maturity. Based upon the table above, all loans due after one year which have a predetermined interest rate and loans due after one year which have floating or adjustable interest rates as of December 31, 2023 amounted to $2.290 billion and $1.188 billion, respectively. Bank Owned Life Insurance Bank owned life insurance increased by $707,000 to $109.1 million at December 31, 2023 and by $10.8 million to $108.4 million at December 31, 2022 from $97.7 million at December 31, 2021. The increase during 2023 was primarily due to increased income from traditional policies purchased in December 2022 and from improved market performance of the Bank's variable bank owned life insurance policies which track with the performance of the equity markets. The increase during 2022 was primarily due to the purchase of life insurance policies on officers of the Bank. Bank owned life insurance investment income is used as an offset to the cost of life insurance purchased by the Bank as a benefit for bank officers. 48 Table of Contents Sources of Funds The average daily deposits and borrowings together with the average rates paid on those deposits and borrowings for the years ended December 31, 2023, 2022 and 2021 are summarized in the following table: 2023 2022 2021 % Balance Change From Prior Year (dollars in thousands) Balance Rate Balance Rate Balance Rate 2023 2022 Noninterest bearing demand deposits $ 1,475,306 0.00 % $ 1,842,777 0.00 % $ 1,671,172 0.00 % (19.94) % 10.27 % Savings and transaction accounts: Savings deposits 347,009 0.07 419,997 0.08 360,915 0.08 (17.38) 16.37 Interest bearing demand deposits 2,909,464 3.69 2,689,572 1.16 2,392,220 0.28 8.18 12.43 Time deposits: Deposits of $100,000 or more 669,545 3.73 579,797 0.60 714,353 0.81 15.48 (18.84) Other time deposits 202,904 2.52 185,215 0.70 218,624 0.93 9.55 (15.28) Total deposits $ 5,604,228 2.46 % $ 5,717,358 0.63 % $ 5,357,284 0.28 % (1.98) % 6.72 % FHLB advances and other borrowings 166,821 5.06 38,614 1.03 75,408 0.40 332.02 (48.79) Total funding sources $ 5,771,049 2.53 % $ 5,755,972 0.64 % $ 5,432,692 0.28 % 0.26 % 5.95 % Time deposits as of December 31, 2023 will mature as follows: (dollars in thousands) $100,000 or more $100,000 or less Total % of Total Within three months $ 347,896 $ 92,698 $ 440,594 43.33 % Over three months, within six months 153,827 53,543 207,370 20.39 Over six months, within twelve months 190,803 40,536 231,339 22.75 Over twelve months 100,212 37,306 137,518 13.53 Total time certificates of deposit $ 792,738 $ 224,083 $ 1,016,821 100.00 % Deposits Deposits by portfolio segment for December 31, 2023, 2022 and 2021 are presented below: December 31, 2023 December 31, 2022 December 31, 2021 Commercial $ 2,227,147 38.9 % $ 2,085,934 38.2 % $ 2,262,229 39.4 % Retail 1,794,958 31.4 1,934,787 35.4 2,178,534 38.0 Public fund 1,563,015 27.3 1,429,872 26.1 1,284,641 22.3 Core deposits 5,585,120 97.6 5,450,593 99.7 $ 5,725,404 99.7 % Brokered deposits 135,405 2.4 10,027 0.3 10,003 0.3 Total $ 5,720,525 100.0 % $ 5,460,620 100.0 % $ 5,735,407 100.0 % Total deposits increased by $259.9 million to $5.721 billion, at December 31, 2023 compared to $5.461 billion at December 31, 2022. The increase in deposits was attributable to increases in commercial and public fund deposits. Commercial deposits increased $141.2 million, or 6.8% and represented 38.9% and 38.2% of total deposits at December 31, 2023 and 2022, respectively. Public fund deposits increased $133.1 million, or 9.3% and represented 27.3% and 26.1% of total deposits at December 31, 2023 and 2022, respectively. Additionally, brokered deposits increased $125.4 million, and represented 2.4% and 0.3% of total deposits at December 31, 2023 and 2022, respectively. Retail deposits decreased $139.8 million, or 7.2%, and represented 31.4% and 35.4% of deposits at December 31, 2023 and 2022, respectively. The decline in retail deposits represents a continued utilization of retail deposits from peak savings levels during 2021. Total deposits decreased by $274.8 million to $5.461 billion, at December 31, 2022 compared to December 31, 2021. The decrease in deposits was attributable to a decrease in core deposits. Total deposit contraction was led by a decrease of $243.7 million, or 11.2%, in retail deposits. In addition, commercial deposits decreased $176.3 million, or 7.8%, while public funds deposits increased by $145.2 million, or 11.3%. The decrease in deposits during 2022 reflects the normalization of excess 49 Table of Contents liquidity in our customer's deposit accounts and occurred primarily during the fourth quarter of 2022. Rising inflation is considered a contributor to the decline in deposits during 2022 after the surge in deposits experienced during 2020 and 2021 from PPP funding and COVID-related stimulus programs. As previously noted, 27.3% of the Company’s deposit base is attributable to public fund entities which consist primarily of customers in the Company’s geographic footprint. A majority of public fund balances represent customers with operating accounts at the Bank. The public fund segment is a stable source of deposit funding and a focus in the treasury management area due to their business needs. A shift in funding away from public fund deposits could require the Company to execute alternative funding plans under the Contingency Funding Plan discussed in further detail under “Liquidity Risk”. FHLB Advances and Other Borrowings During 2023, average total short-term borrowings increased by $160.3 million to $166.8 million. Ending balances of short-term and miscellaneous borrowings decreased to $50.0 million at December 31, 2023 compared to $297.0 million at December 31, 2022. Average total long-term borrowings decreased by $32.1 million to zero, as no long-term FHLB advances were outstanding during 2023. During 2022, average total short-term borrowings increased by $6.2 million to $6.6 million, as the Company's excess liquidity position normalized after experiencing a reduction in cash and short-term investments. Ending balances of short-term and miscellaneous borrowings increased to $297.0 million at December 31, 2022, from zero at December 31, 2021. Average total long-term borrowings decreased by $42.9 million to $32.1 million, due to the repayment of an outstanding long-term advance during the second quarter of 2022. Capital The Company believes that a strong, appropriately managed capital position is critical to support continued growth of loans and earnings. Capital is used primarily to fund continued organic loan growth and to support dividends to shareholders. The Company had a total risk-based capital ratio of 15.47%, a Tier I risk-based capital ratio of 14.21% and a common Tier 1 risk-based capital ratio of 14.21% as of December 31, 2023. These ratios met or exceeded the Federal Reserve Bank’s “well-capitalized” minimums of 10.0%, 8.0% and 6.5%, respectively. The Company also had a Tier 1 leverage ratio of 11.82% and a tangible equity ratio of 9.91%. When excluding the impact of accumulated other comprehensive income (loss) on tangible common equity, the Company's adjusted tangible common equity to adjusted tangible assets was 11.99%. See "Note 15 – Capital Requirements and Restrictions on Retained Earnings" for more information. The ability to maintain these ratios is a function of the balance between net income and a prudent dividend policy. Total stockholders’ equity increased by 14.2% to $649.8 million as of December 31, 2023 from $568.9 million as of December 31, 2022. The Company earned $93.8 million in 2023 and $103.8 million in 2022. The Company declared cash dividends of $1.84 per share in 2023, which decreased equity by $47.1 million. The Company declared cash dividends of $1.60 per share in 2022, which decreased equity by $40.9 million. Total stockholder's equity has been impacted by declines in the market value of the Company's available-for-sale investment securities portfolio. The market value decline, resulting from higher interest rate environment, has generated unrealized losses in the available-for-sale portfolio. Unrealized losses from the available-for-sale investment securities portfolio are recorded, net of tax, in accumulated other comprehensive income (loss) in the statement of stockholders' equity. Improvements in the fair value of available-for-sale securities and net defined pension plan gains positively impacted equity by $33.7 million in 2023 compared to a decrease of $205.0 million in 2022. The impact to equity due to other comprehensive income (loss) is not included in regulatory capital. RISK MANAGEMENT Overview The Company, with the oversight of the Corporate Risk Committee of the board of directors, has developed a company-wide risk management program intended to help identify, manage and mitigate the various business risks it faces. Following is a discussion addressing the risks identified as most significant to the Company – Credit, Liquidity, Interest Rate and Market Risk. Item 7A. includes additional discussion about market risk. Credit Risk Credit risk represents the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms. Our primary credit risks result from lending and to a lesser extent, investment activities. 50 Table of Contents Investment Portfolio The Company’s investment portfolio consists of U.S. treasuries, government agencies and municipal bonds subject to an investment security policy that is approved annually by the board of directors. As of December 31, 2023, the Company’s investment in U.S government sponsored mortgage-backed securities represented approximately 38% of total investment securities fair value consisting of mortgage pools issued by Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae, Fannie Mae and Freddie Mac securities are each guaranteed by their respective agencies as to principal and interest. All mortgage securities purchased by the Company in 2023 were within risk tolerances for price, prepayment, extension and original life risk characteristics contained in the Company’s investment policy. As of December 31, 2023, all mortgage-backed securities were performing in a manner consistent with management’s expectations at time of purchase. Municipal securities represent 52% of total investment securities fair value as of December 31, 2023 and were rated investment grade at the time of purchase and continue to be rated investment grade. The Company uses analytics provided by its third party portfolio advisor to evaluate and monitor credit risk for all investments on a quarterly basis. Based upon these analytics as of December 31, 2023, the securities in the combined available-for-sale and held-to-maturity portfolios had an effective duration of approximately 6.5 years. The analysis indicated a negative 18.1% change in market value in the event of a 300 basis point upward, instantaneous rate shock and an approximate positive 6.5% change in market value in the event of a 100 basis point downward, instantaneous rate shock. Loan Portfolio The Company has a high percentage of commercial and commercial real estate loans extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing conservative credit structures, adjusting its pricing to the perceived risk of each individual credit, diversifying the portfolio by customer, product, industry and market area and by obtaining personal loan guarantees. There were no loan concentrations within industries, which exceeded ten percent of total loans, except commercial real estate. Commercial real estate was $2.438 billion, or 49.5% , of total loans at December 31, 2023. The owner occupied commercial real estate portfolio generally represents the financing of factories and operational facilities for the Bank's commercial and industrial borrowers. The Company’s in-house lending limit is $40.0 million. M anufacturing loans are included in the commercial and industrial loans total and are well diversified by industry. Agri-business and agricultural loans represent 7.9% of total loans as of December 31, 2023 and are not concentrated to any agricultural sector. Substantially all of the Bank’s commercial, industrial, agricultural real estate mortgage, real estate construction mortgage and consumer loans are made within its geographic market areas and to diverse industries. When segmenting the Bank's loan portfolio by North American Industry Classification System code as of December 31, 2023, the largest segments are multifamily housing, agriculture, industrial warehouses and the recreational vehicle industry which represented 11%, 9%, 4% and 4% of total loans, respectively. 51 Table of Contents The following is a summary of nonperforming loans on an amortized cost basis as of December 31, 2023 and 2022. (dollars in thousands) 2023 2022 Amount of loans outstanding, net of deferred fees, December 31, $ 4,916,534 $ 4,710,396 Commercial and industrial loans Past due accruing loans (90 days or more) 0 1 Nonaccrual loans 11,395 13,064 Subtotal nonperforming loans 11,395 13,065 Commercial real estate and multi-family residential loans Past due accruing loans (90 days or more) 0 0 Nonaccrual loans 3,247 3,065 Subtotal nonperforming loans 3,247 3,065 Agri-business and agricultural loans Past due accruing loans (90 days or more) 0 0 Nonaccrual loans 100 145 Subtotal nonperforming loans 100 145 Other commercial loans Past due accruing loans (90 days or more) 0 0 Nonaccrual loans 0 0 Subtotal nonperforming loans 0 0 Consumer 1-4 family mortgage loans Past due accruing loans (90 days or more) 27 122 Nonaccrual loans 831 481 Subtotal nonperforming loans 858 603 Other consumer loans Past due accruing loans (90 days or more) 0 0 Nonaccrual loans 112 209 Subtotal nonperforming loans 112 209 Total nonperforming loans $ 15,712 $ 17,087 Ratio: Nonperforming loans to total loans 0.32 % 0.36 % Nonperforming assets of the Company include nonperforming loans (as indicated above), nonaccrual investments, other real estate owned and repossessions, the total of which amounted to $16.1 million and $17.2 million at December 31, 2023 and 2022, respectively. Nonperforming loans remained stable at 0.3% of total loans at December 31, 2023 compared to 0.4% at December 31, 2022. Nonperforming loans decreased by $1.4 million during 2023, due to the net activity of charge offs, paydowns and upgrades. One commercial relationship placed on nonaccrual during 2023 subsequently received a modification to loan terms due to financial difficulty experienced by the borrower. Loans for which the borrower appears to be unable or unwilling to repay its debt in full or on time, and the collateral is insufficient to cover all principal and accrued interest, will be reclassified as nonperforming to the extent they are unsecured, on or before the date when the loan becomes 90 days delinquent, with the exception of small dollar other consumer loans which are not placed on nonaccrual status since these loans are charged-off when they have been delinquent from 90 to 180 days, and when the related collateral, if any, is not sufficient to offset the indebtedness. When a loan is classified as a nonaccrual loan, interest on the loan is no longer accrued, all unpaid accrued interest is reversed and interest income is subsequently recorded only to the extent cash payments are received. Accrual status is resumed when all contractually due payments are brought current and future payments are reasonably assured. 52 Table of Contents A loan is individually analyzed when full payment under the original loan terms is not expected. Reserves are evaluated in total for smaller-balance loans of similar nature not in nonaccrual status such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans including material modifications made to borrowers experiencing financial difficulty. 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 flow or at the fair value of collateral if repayment is expected solely from the collateral. Total nonperforming loans were $15.7 million, or 0.32% of total loans, at December 31, 2023 versus $17.1 million, or 0.36% of total loans, at December 31, 2022. There were 33 relationships totaling $16.1 million classified as individually analyzed as of December 31, 2023 versus 39 relationships totaling $31.3 million at the end of 2022. The decrease in individually analyzed loans during 2023 resulted primarily from the payoff of two large commercial relationships and the partial charge off of another commercial relationship. Paydowns and upgrades of other individually analyzed loans further contributed to the decrease for individually analyzed loans for the year ended December 31, 2023. Loans renegotiated as modifications to borrowers experiencing financial difficulty are those loans for which the Company modifies the terms of loans for borrowers experiencing financial distress by providing the following forms of relief: forgiveness of loan principal, extension of repayment terms, reduction of interest rate or an other than insignificant payment delay. For the twelve months ended December 31, 2023, there were three loans to three financially distressed commercial borrowers with balances totaling $4.4 million at December 31, 2023 that received such modifications. The Company has no material commitments to lend additional funds to these borrowers. For the twelve months ended December 31, 2022, no loan modifications were made to borrowers experiencing financial difficulty. 53 Table of Contents The following is a summary of the credit loss experience for the years ended December 31, 2023, 2022 and 2021. (dollars in thousands) 2023 2022 2021 Amount of loans outstanding, net of deferred fees, December 31, $ 4,916,534 $ 4,710,396 $ 4,287,841 Average daily loans outstanding during the year ended December 31, $ 4,813,678 $ 4,427,166 $ 4,421,094 Allowance for credit losses, January 1, $ 72,606 $ 67,773 $ 61,408 Impact of adopting ASC 326 0 0 9,050 Loans charged-off: Commercial and industrial loans 6,341 4,022 5,575 Commercial real estate and multi-family residential loans 0 597 70 Agri-business and agricultural loans 0 0 0 Other commercial loans 0 0 0 Consumer 1-4 family mortgage loans 163 42 51 Other consumer loans 828 473 287 Total loans charged-off 7,332 5,134 5,983 Recoveries of loans previously charged-off: Commercial and industrial loans 180 71 1,559 Commercial real estate and multi-family residential loans 322 277 14 Agri-business and agricultural loans 0 0 320 Other commercial loans 0 0 0 Consumer 1-4 family mortgage loans 38 52 122 Other consumer loans 308 192 206 Total recoveries 848 592 2,221 Net loans charged-off 6,484 4,542 3,762 Provision for credit loss charged to expense 5,850 9,375 1,077 Balance, December 31, $ 71,972 $ 72,606 $ 67,773 Ratios: Net charge offs (recoveries) to average daily loans outstanding: Commercial and industrial loans 0.13 % 0.09 % 0.09 % Commercial real estate and multi-family residential loans (0.01) 0.01 0.00 Agri-business and agricultural loans 0.00 0.00 0.00 Other commercial loans 0.00 0.00 0.00 Consumer 1-4 family mortgage loans 0.00 0.00 0.00 Other consumer loans 0.01 0.00 0.00 Total ratio of net charge offs (recoveries) 0.13 % 0.10 % 0.09 % Allowance for credit losses on loans to: Total loans 1.46 % 1.54 % 1.58 % Ratio of allowance for credit losses to nonperforming loans 458.01 % 424.91 % 449.13 % 54 Table of Contents The following is a summary of the allocation for credit losses as of December 31, 2023 and 2022. (dollars in thousands) 2023 2022 Allocated allowance for credit losses: Commercial and industrial loans $ 30,338 $ 35,290 Commercial real estate and multi-family residential loans 31,335 27,394 Agri-business and agricultural loans 4,150 4,429 Other commercial loans 1,129 917 Consumer 1-4 family mortgage loans 3,474 3,001 Other consumer loans 1,174 1,021 Total allocated allowance for credit losses 71,600 72,052 Unallocated allowance for credit losses 372 554 Total allowance for credit losses $ 71,972 $ 72,606 At December 31, 2023, the allowance for credit losses was 1.46% of total loans outstanding, versus 1.54% of total loans outstanding at December 31, 2022. Management believes the allowance for credit losses is at a level commensurate with the overall risk exposure of the loan portfolio. The process of identifying expected credit losses is a subjective process. Therefore, the Company maintains a general allowance to cover expected credit losses within the entire portfolio. The methodology management uses to determine the adequacy of the credit loss reserve includes the considerations below. 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 for expected credit losses relating to specifically identified loans based on an evaluation of the loans by management, as well as other expected credit losses inherent 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 and forecasted 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. An appropriate level of qualitative and environmental allowance is determined after considering the following factors: changes in the nature and volume of the loan portfolio, overall portfolio quality, changes in collateral strength and current economic conditions that may affect the borrowers’ ability to repay. Consideration is not limited to these factors although they represent the most commonly cited factors. 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 is defined as 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 loss, the Company’s policy is to either establish specific allocations for credit losses in the amount of 100% of the portion of the asset classified loss or charge off such amount. At December 31, 2023, on the basis of management’s review of the loan portfolio, the Company had 68 credits totaling $183.1 million on the classified loan list versus 58 credits totaling $161.0 million on December 31, 2022. These amounts represent outstanding balances, excluding deferred fees and costs. While the increase in classified loans during 2023 raises concern for the potential for an economic slowdown in the Company's Indiana footprint, it has not translated to broader loan quality issues in the portfolio as the ratio of watch list loans as a percentage of total loans remains near historic lows and was accompanied by a reduction in nonperforming loans during 2023. As of December 31, 2023, the Company had $143.6 million of assets classified as Special Mention , $39.4 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. The balances reported in "Note 4 – Allowance for Credit Losses and Credit Quality" include deferred fees and costs. Included in the classified loan amounts above for December 31, 2023 were loans receiving modifications due to financial difficulty experienced by the borrower during the twelve months ended December 31, 2023 for three commercial loans to three commercial borrowers totaling $4.4 million million with total allocations of $2.3 million. There were no loan modifications made to borrowers experiencing financial difficulty during the twelve months ended December 31, 2022. 55 Table of Contents Allowance estimates are developed by management taking into account actual loss experience, subject to a floor, adjusted for current economic conditions and a reasonably supportable forecast period. The Company has regular discussions regarding this methodology with regulatory authorities. Allowance estimates are considered a prudent measurement of the risk in the Company's loan portfolio based upon loan segment. In accordance with accounting guidance, the allowance is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility 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 0.9%, or $634,000, from $72.6 million at December 31, 2022 to $72.0 million at December 31, 2023 due primarily to net charge offs of $6.5 million and offset by provision expense of $5.9 million recorded during 2023. Pooled loan allocations increased $5.6 million from $58.2 million at December 31, 2022 to $63.8 million at December 31, 2023. The unallocated component of the allowance for credit losses was $372,000 at December 31, 2023, which decreased from $554,000 reported at December 31, 2022 . The unallocated component of the allowance for credit losses incorporates the Company’s judgmental determination of expected losses that may not be fully reflected in other allocations. The Company has experienced organic growth in total loans over the last several years with an increase in gross loans of $206.5 million, or 4.4%, from December 31, 2022 to December 31, 2023. This growth is primarily 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. Management believes that it is prudent to continue to provide for credit losses in a manner consistent with its historical approach due to the loan growth described above and current economic conditions. Watch list loans increased $22.1 million to $183.1 million as of December 31, 2023, compared to $161.0 million at December 31, 2022, or an increase of 13.7%. Watch list loans represent 3.7 % of total loans at December 31, 2023 compared to a historical low of 3.4% at December 31, 2022. PPP loans outstanding of $1.3 million and $1.5 million at December 31, 2023 and 2022, respectively, had an immaterial impact on these asset quality ratios. The increase in watch list loans resulted primarily from downgraded credits of approximately $112.4 million and offset by upgrades of approximately $55.8 million in addition to paydowns to watch list credits . The Company's continued growth strategy promotes diversification among industries as well as continued focus on the enforcement of a disciplined credit culture and a conservative posture in loan work-out situations. Liquidity Risk Liquidity risk arises from the possibility that the Company may not be able to satisfy current or future financial commitments or may become unduly reliant on alternative funding sources. Liquidity is monitored and closely managed by the ALCO Committee. Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. The liquidity structure is expressly detailed in the Company’s Contingency Funding Plan, which is discussed below. The Company relies on a number of different sources in order to meet these potential liquidity demands. The primary sources are increases in deposit accounts and cash flows from loan payments and the securities portfolio. The cash flow from the securities portfolio is expected to provide approximately $103.9 million of potential contingent funding in 2024. The Bank had total available sources of liquidity totaling $3.4 billion at December 31, 2023 compared to $3.0 billion at December 31, 2022. The Company has approval of $3.593 billion in secondary funding sources available as of December 31, 2023, of which $185.4 million was utilized. The Company had $325.0 million of availability in federal funds lines with eleven correspondent banks, of which none was drawn on as of December 31, 2023. The Company has board of directors approval to borrow up to $800.0 million at the FHLB, but given the Company’s current collateral structure and outstanding borrowings as of December 31, 2023, the Company could have only borrowed up to $574.9 million under this authority. The Company has additional collateral that could be pledged to the FHLB of $8.4 million as of December 31, 2023 to generate additional liquidity. Further, the Company had available capacity at the Federal Reserve Bank of Chicago of up to $1.259 billion given its current collateral structure at the Federal Reserve Bank discount window program and the terms of that facility at December 31, 2023, with no balances outstanding at December 31, 2023. During 2023 the Company also became eligible to borrow funds under the Federal Reserve Bank's Bank Term Funding Program (BTFP); available capacity secured by pledged eligible investment securities was $150.5 million with no outstanding balance at December 31, 2023. The BTFP is scheduled to expire in March 2024. The Company also has established relationships in the brokered time deposit and brokered money market sectors, as well as the IntraFi Network CDARS One-Way Buy program, to access these funds when desired with settlement of funds in one to two weeks’ time. Additionally, the Bank has entered agreements with IntraFi Network relative to their Insured 56 Table of Contents Cash Sweep One-Way Buy program. As of December 31, 2023, the total amount available to the Bank via this program was $100.0 million, of which $10.0 million was drawn. The Bank is also a member of the American Financial Exchange (AFX) where overnight fed funds purchased can be obtained from other banks on the exchange that have approved the Bank for an unsecured, overnight line. These funds are only available if the approving banks have an ‘offer’ out to sell that day. As of December 31, 2023, the total amount approved for the Bank via AFX banks was $319.0 million and none was outstanding at year end. The Company had 90% of its securities in the available-for-sale portfolio at December 31, 2023, allowing the Company extensive flexibility to sell securities to meet funding demands. The remaining portion of investments securities were designated as held-to-maturity. Management believes the majority of the securities in investment portfolio are of high quality and marketable. Approximately 48% of this portfolio is comprised of U.S. government agency securities or mortgage-backed securities directly or indirectly backed by the U.S. government. At December 31, 2023, 92% of municipal securities owned by the Company were AAA or AA rated with a diversified geography of state issuer. In addition, the Company has historically sold the majority of its originated mortgage loans on the secondary market to reduce interest rate risk and to create an additional source of funding. The Company has a formalized Contingency Funding Plan (“CFP”). The Board and management recognize the importance of liquidity during times of normal operations and in times of stress. The CFP was developed to ensure that the multiple liquidity sources available to the Company are readily available. All liquidity sources are tested annually. The CFP specifically considers liquidity at the Bank and the Company level. The CFP identifies the potential funding sources at the Bank level, which includes the FHLB, the Federal Reserve Bank, brokered deposits, one-way buy products via the IntraFi Network (CDARS and ICS) and Federal Funds. The CFP also addresses the Bank’s ability to liquidate its securities portfolio or other liquid assets. The CFP funding sources at the holding company level include a holding company committed line of credit, as well as the ability to transfer securities from the investment subsidiary of the Bank to the Company. The Company’s committed line of credit has availability up to $30.0 million, of which $0 was drawn upon as of December 31, 2023. Further, the CFP identifies CFP team members and expressly details their respective roles. Potential risk scenarios are identified and the plan includes multiple scenarios, including short-term and long-term funding crisis situations. Under the long-term funding crisis, two additional scenarios are identified: a moderate risk scenario and a highly stressed scenario. The CFP details the responsibilities and the actions to be taken by the CFP team under each scenario. Quarterly reports to management and the Board under the CFP include an early warning indicator matrix and pro forma cash flows for the various scenarios. The following table discloses information on the maturity of the Company’s contractual long-term obligations as of December 31, 2023. Payments Due by Period (dollars in thousands) Total One year or less 2-3 years 4-5 years After 5 years Operating leases $ 5,168 $ 744 $ 1,487 $ 1,346 $ 1,591 Pension and SERP plans 2,073 314 591 445 723 Total contractual long-term cash obligations $ 7,241 $ 1,058 $ 2,078 $ 1,791 $ 2,314 During the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk in order to meet the financing needs of its customers. These financial instruments include commitments to make loans and open-ended revolving lines of credit. The Company follows the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as it follows for those loans that are recorded in its financial statements. The Company’s exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments. Off-balance sheet transactions are more fully discussed in "Note 17 – Commitments, Off-Balance Sheet Risks and Contingencies". 57 Table of Contents The following table discloses information on the maturity of the Company’s commitments. Amount of Commitment Expiration Per Period (dollars in thousands) Total Amount Committed One year or less Over one year Unused loan commitments $ 2,871,286 $ 1,505,958 $ 1,365,328 Standby letters of credit 51,383 47,566 3,817 Total commitments and letters of credit $ 2,922,669 $ 1,553,524 $ 1,369,145 Interest Rate Risk Interest rate risk is the risk that the estimated fair value of the Company’s assets, liabilities and derivative financial instruments will decline as a result of changes in interest rates or financial market volatility, or that net income will be significantly reduced by interest rate changes. Interest rate risk represents the Company’s primary market risk exposure. The Company does not have material exposure to foreign currency exchange risk and does not maintain a trading portfolio. The Corporate Risk Committee of the Board annually reviews and approves the ALCO policy and the Derivatives and Hedging policy used to manage interest rate risk. These policies set guidelines for balance sheet structure, which are designed to protect the Company from the impact that interest rate changes could have on net income, but it does not necessarily indicate the effect on future net interest income. Generally, the Bank is asset sensitive due to the impact of the variable rate commercial loan portfolio on the Bank's sensitivity to market rates. During 2023, asset sensitivity declined due to a shift to short-term interest bearing deposit accounts such as money market accounts. As a result, the Company expects net interest margin to remain stable in the first 25-50 basis points potential declines in the federal funds rate due to a more neutral posture for balance sheet sensitivity. Deposit re-pricing in a declining interest rate environment is expected to exceed past easing cylces. Earnings can also be affected by the monetary and fiscal policies of the U.S. Government and its agencies, particularly the Federal Reserve Board. During 2023 the Federal Reserve Board’s Federal Open Market Committee (“FOMC”) increased the target federal funds rate a total of 100 basis points, following an increase of 425 basis points in 2022. Rate increases were implemented during the first half of 2023 at the January, March, May and July FOMC meetings. The combined effect of these actions increased the target federal funds rate to a range of 5.25% to 5.50%. The FOMC statement released for the meeting in December 2023 recognized that inflation has eased over the past year but remains elevated and confirmed that the FOMC remains highly attentive to inflation risks. The updated economic projections released at the December meeting project the median federal funds rate decreasing to 4.6% in 2024 (lowering of the target federal funds rate by 75 basis points), with continued easing to 3.6% in 2025. Additionally, the longer run median forecast for the federal funds rate was left unchanged at 2.50%. The combined result of the increase in the yield on earning assets, which was more than offset by an increase in the cost of funds due to increased competition for deposits experienced during 2023, led to a decrease in net interest margin from 3.40% for 2022 to 3.31% for 2023. The Company’s yield on earning assets increased 170 basis points during 2023 as assets repriced at higher rates primarily due to the FOMC rate increases during both 2022 and 2023 and a higher yield curve for the majority of 2023 as when compared to 2022. The commercial loan portfolio represents 89% of the total loan portfolio. Approximately 64% of the commercial loan portfolio are variable rate loans which are primarily indexed to Prime, One Month Term SOFR and FHLB indices. The increase in earning asset yields was offset by an increase in the Company's funding costs, as depositors sought higher interest bearing deposit products and competition for deposits increased throughout the industry. The rate paid on deposit accounts and purchased funds increased 179 basis points for 2023. The realized increase in the rate paid on deposit accounts and purchased funds was magnified by a decrease in the average balance of non-interest bearing demand deposit accounts for 2023 verses 2022, primarily in commercial deposit accounts. The Company anticipates that cost of funds could continue to rise in 2024 if market competition for deposits continues and if noninterest bearing deposits continue to shift to interest-bearing deposit products. Future changes in the net interest margin will be dependent upon multiple factors including further actions by the FOMC during 2024 in response to inflation, economic conditions and geopolitical concerns, the results of any of the administration’s changes to economic policy and laws, competitive pressures in the various markets served, and changes in the structure of the balance sheet as a result of changes in customer demands for products and services. In general, we expect loans to reprice quicker than deposits in a rising and falling rate environment as quantified in the sensitivity to market rates table in Item 7A. 58 Table of Contents The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the consumer price index (“CPI”) coincides with changes in interest rates. The price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by the Company. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the reverse situation may occur.