LAKELAND FINANCIAL CORP 10-Q

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net income in the first three months of 2024 was $23.4 million, which decreased $877,000 , or 3.6%, from $24.3 million for the comparable period of 2023 . Diluted income per common share was $0.91 in the first three months of 2024 , a decrease of 3.2% from $0.94 in the comparable period of 2023 . The decrease in net income for 2024 was primarily due to a decrease to net interest income of $4.1 million, or 8.0%, and an increase in noninterest expense of $1.3 million, or 4.3%. Offsetting these effects was a decrease in provision for credit losses expense of $2.8 million, or 65.1%, and an increase to noninterest income of $2.3 million, or 22.3%. Pretax pre-provision earnings, a non-GAAP measure calculated by adding net interest income to noninterest income and subtracting noninterest expense, were $29.3 million in the first three months of 2024 , a decrease of $3.1 million , or 9.5%, compared to $32.4 million for the comparable period of 2023 . Annualized return on average total equity was 14.59% in the first three months of 2024 versus 16.81% in the comparable period of 2023 . Annualized return on average total assets was 1.44% in the first three months of 2024 versus 1.54% for the comparable period of 2023 . The Company's average equity to average assets ratio was 9.84% in the first three months of 2024 versus 9.13% in the comparable period of 2023 . Equity has been negatively impacted by unrealized losses from the available-for-sale investment securities portfolio, which are reported as a component of accumulated other comprehensive income (loss). Net income for the first three months of 2024 benefited from the recognition of $1.0 million in additional insurance recoveries associated with the wire fraud loss that occurred during the second quarter of 2023, creating an after-tax benefit of $0.03 diluted earnings per common share for the first three months of 2024. This recovery was in addition to insurance and loss recoveries of $6.3 million, or $0.18 diluted earnings per common share, that were recorded during the fourth quarter of 2023. Adjusting for these recoveries, the company's core operational profitability, a non-GAAP financial measure that excludes the impact of the wire fraud loss, insurance and loss recoveries and other related effects, was $22.7 million for the first three months of 2024, a decrease of $1.6 million, or 6.7%, compared to the first three months of 2023. Total assets were $6.567 billion as of March 31, 2024 versus $6.524 billion as of December 31, 2023, an increase of $42.8 million, or less than 1%. Total loans, net of the allowance for credit losses, increased $79.8 million, or 1.6%, which was the primary driver behind balance sheet expansion between December 31, 2023 and March 31, 2024. Offsetting the increase to loans, net of the allowance of credit losses, was a decrease in available-for-sale securities of $37.2 million, or 3.5%. The Company's primary funding source for the balance sheet expansion came from an increase in total borrowings of $150.0 million, or 300.0%, between December 31, 2023 and March 31, 2024. Total deposits decreased $102.4 million, or 1.8%, between December 31, 2023 and March 31, 2024. Total equity decreased $2.8 million, or less than 1%, from $649.8 million at December 31, 2023 to $647.0 million at March 31, 2024. Retained earnings increased $10.6 million, or 1.5%, primarily as a result of net income of $23.4 million and reduced by dividends declared and paid of $12.3 million. Accumulated other comprehensive income (loss) ("AOCI"), decreased $11.7 million, or 7.6%, from a decline in the fair market values of available-for-sale investment securities during the three months ended March 31, 2024. CRITICAL ACCOUNTING POLICIES The Company’s accounting policies are described in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2023. Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for credit losses. See “Note 4 – Allowance for Credit Losses and Credit Quality” for more information on this critical accounting policy. 36 Table of Contents RESULTS OF OPERATIONS Overview Selected income statement information for the three months ended March 31, 2024 and 2023 is presented in the following table: Three Months Ended March 31, (dollars in thousands) 2024 2023 Income Statement Summary: Net interest income (a) $ 47,416 $ 51,519 Provision for credit losses 1,520 4,350 Noninterest income (b) 12,612 10,314 Noninterest expense (c) 30,705 29,434 Other Data: Efficiency ratio (1) 51.15 % 47.60 % Diluted EPS $ 0.91 $ 0.94 Average Equity/Average Assets 9.84 % 9.13 % Tangible capital ratio (2) 9.80 9.34 Adjusted tangible capital ratio (3) 12.03 11.63 Net charge-offs to average loans 0.03 0.49 Net interest margin 3.15 3.54 Noninterest income to total revenue 21.01 16.68 Pretax pre-provision earnings (4) $ 29,323 $ 32,399 (1) Noninterest expense (c)/(Net interest income (a) plus Noninterest income (b). (2) 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. (3) 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 (loss) ("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. (4) Non-GAAP financial measure. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Management believes this is an important measure because it may enable investors to identify the trends in the Company's earnings exclusive of the effects of tax and provision expense, which may vary significantly from period to period. See reconciliation on the following pages. 37 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. As of and For The Three Months Ended March 31, (dollars in thousands, except per share data) 2024 2023 Total Equity $ 647,009 $ 602,006 Less: Goodwill (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,167 Tangible Common Equity (A) 643,206 598,203 Market Value Adjustment in AOCI 166,189 166,612 Adjusted Tangible Common Equity (C) 809,395 764,815 Total Assets $ 6,566,861 $ 6,411,529 Less: Goodwill (4,970) (4,970) Plus: Deferred Tax Assets Related to Goodwill 1,167 1,167 Tangible Assets (B) 6,563,058 6,407,726 Market Value Adjustment in AOCI 166,189 166,612 Adjusted Tangible Assets (D) 6,729,247 6,574,338 Ending Common Shares Issued (E) 25,677,399 25,607,663 Tangible Book Value per Common Share (A/E) $ 25.05 $ 23.36 Tangible Capital Ratio (A/B) 9.80 % 9.34 % Adjusted Tangible Capital Ratio (C/D) 12.03 11.63 Net Interest Income $ 47,416 $ 51,519 Plus: Noninterest Income 12,612 10,314 Minus: Noninterest Expense (30,705) (29,434) Pretax Pre-Provision Earnings $ 29,323 $ 32,399 38 Table of Contents 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. Three Months Ended (dollars in thousands, except per share data) Mar. 31, 2024 Mar. 31, 2023 Noninterest Income $ 12,612 $ 10,314 Less: Recoveries (1,000) 0 Adjusted Core Noninterest Income $ 11,612 $ 10,314 Noninterest Expense $ 30,705 $ 29,434 Less: Wire Fraud Loss 0 0 Plus: Salaries and Employee Benefits 0 0 Adjusted Core Noninterest Expense $ 30,705 $ 29,434 Earnings Before Income Taxes $ 27,803 $ 28,049 Adjusted Core Impact: Noninterest Income (1,000) 0 Noninterest Expense 0 0 Total Adjusted Core Impact (1,000) 0 Adjusted Earnings Before Income Taxes 26,803 28,049 Tax Effect (4,153) (3,771) Core Operational Profitability (1) 22,650 24,278 Diluted Earnings Per Common Share $ 0.91 $ 0.94 Impact of Wire Fraud Loss, Net of Recoveries (0.03) 0.00 Core Operational Diluted Earnings Per Common Share $ 0.88 $ 0.94 Adjusted Core Efficiency Ratio 52.02 % 47.60 % (1) Core operational profitability was $751,000 lower than reported net income for the three months ended March 31, 2024. Net Income Net income was $23.4 million in the first three months of 2024, which decreased $877,000 , or 3.6%, from $24.3 million for the comparable period of 2023 . The decrease in net income for the first three months of 2024 was primarily due to a decrease to net interest income of $4.1 million, or 8.0%, and an increase in noninterest expense of $1.3 million, or 4.3%. Offsetting these effects was a decrease in the provision for credit losses of $2.8 million, or 65.1%, and an increase to noninterest income of $2.3 million, or 22.3%. Net income for the first three months of 2024 benefited from the recognition of $1.0 million in additional insurance recoveries associated with the wire fraud loss that occurred during the second quarter of 2023, creating an after-tax benefit of $0.03 diluted earnings per common share for the first three months of 2024. This recovery was in addition to insurance and loss recoveries of $6.3 million, or $0.18 diluted earnings per common share, that were recorded during the fourth quarter of 2023. Adjusting for these recoveries, the company's core operational profitability, a non-GAAP financial measure that excludes the impact of the wire fraud loss, insurance and loss recoveries and other related effects, was $22.7 million for the first three months of 2024, a decrease of $1.6 million, or 6.7%, compared to the first three months of 2023. 39 Table of Contents N et Interest Income The following tables set forth consolidated information regarding average balances and rates: Three Months Ended March 31, 2024 2023 (fully tax equivalent basis, dollars in thousands) Average Balance Interest Yield (1)/ Rate Average Balance Interest Yield (1)/ Rate Earning Assets Loans: Taxable (2)(3) $ 4,916,943 $ 82,042 6.71 % $ 4,667,867 $ 69,542 6.04 % Tax exempt (1) 54,077 1,118 8.31 57,560 1,126 7.93 Investments: Securities (1) 1,158,503 8,035 2.79 1,250,189 8,956 2.91 Short-term investments 2,710 33 4.90 2,242 22 3.98 Interest bearing deposits 84,696 1,073 5.10 89,718 942 4.26 Total earning assets $ 6,216,929 $ 92,301 5.97 % $ 6,067,576 $ 80,588 5.39 % Less: Allowance for credit losses (72,433) (73,266) Nonearning Assets Cash and due from banks 68,584 76,578 Premises and equipment 57,883 58,319 Other nonearning assets 283,505 282,873 Total assets $ 6,554,468 $ 6,412,080 Interest Bearing Liabilities Savings deposits $ 295,650 $ 49 0.07 % $ 392,567 $ 71 0.07 % Interest bearing checking accounts 3,046,958 30,365 4.01 2,757,120 21,402 3.15 Time deposits: In denominations under $100,000 224,139 1,918 3.44 180,502 642 1.44 In denominations over $100,000 789,581 8,832 4.50 494,873 2,803 2.30 Miscellaneous short-term borrowings 175,809 2,454 5.61 241,870 2,783 4.67 Total interest bearing liabilities $ 4,532,137 $ 43,618 3.87 % $ 4,066,932 $ 27,701 2.76 % Noninterest Bearing Liabilities Demand deposits 1,274,103 1,662,530 Other liabilities 103,221 97,014 Stockholders' Equity 645,007 585,604 Total liabilities and stockholders' equity $ 6,554,468 $ 6,412,080 Interest Margin Recap Interest income/average earning assets 92,301 5.97 % 80,588 5.39 % Interest expense/average earning assets 43,618 2.82 27,701 1.85 Net interest income and margin $ 48,683 3.15 % $ 52,887 3.54 % (1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $1.3 million and $1.4 million for the three-month periods ended March 31, 2024 and March 31, 2023, respectively. (2) Loan fees, which are immaterial in relation to total taxable loan interest income for the three months ended March 31, 2024 and 2023 , are included as taxable loan interest income. (3) Nonaccrual loans are included in the average balance of taxable loans. Net interest income, on a fully tax equivalent basis, decreased $4.2 million, or 7.9%, to $48.7 million for the three months ended March 31, 2024, compared to $52.9 million for the first three months of 2023 . The decline in net interest income on a fully tax equivalent basis was driven by an increase in deposit interest expense of $16.2 million , or 65.2% , from $24.9 million to $41.2 million between the two periods. Securities interest income contributed further to the decline in fully tax equivalent net interest income, declining $779,000, or 7.9%. Loan interest income positively impacted fully tax equivalent net interest income, increasing $12.5 million, or 17.7%, from $70.7 million to $83.2 million between the two periods. Borrowings expense declined $329,000, or 11.8%. 40 Table of Contents Total average earning assets were $6.217 billion for the three months ended March 31, 2024, an increase of $149.4 million, or 2.5%, compared to $6.068 billion for the three months ended March 31, 2023 . Average loans outstanding drove the increase to total average earning assets, increasing $245.6 million, or 5.2%, to $4.971 billion from $4.725 billion for the three months ended March 31, 2024 and 2023, respectively . Offsetting this increase was a decrease to average investment securities of $91.7 million, or 7.3%, to $1.159 billion from $1.250 billion between the respective periods . Total average interest bearing liabilities were $4.532 billion for the three months ended March 31, 2024, an increase of $465.2 million, or 11.4%, from $4.067 billion for the three months ended March 31, 2023. This increase was driven by increased interest bearing deposits of $531.3 million, or 13.9%, from $3.825 billion for the three months ended March 31, 2023 to $4.356 billion for the three months ended March 31, 2024. Offsetting the increase to average interest bearing deposits was a decrease in total average borrowings of $66.1 million, or 27.3%, to $175.8 million from $241.9 million for the three months ended March 31, 2024 and 2023, respectively. Noninterest bearing demand deposits decreased $388.4 million, or 23.4%, to $1.274 billion from $1.663 billion between the respective periods. The tax equivalent net interest margin was 3.15% for the three months ended March 31, 2024, compared to 3.54% during the first three months of 2023, representing a 39 basis point, or 11.0%, contraction between the two periods. The net interest margin contraction was primarily driven by an increase to interest expense as a percentage of average earning assets, which increased to 2.82% for the three months ended March 31, 2024 , up from 1.85% for the comparable period of 2023, for an increase of 97 basis points, or 52.4%. This increase was attributable to an increase in the rate for total interest bearing liabilities of 111 basis points, or 40.2%, to 3.87% from 2.76% between the respective periods. This increase was driven by increased costs associated with the Company's interest bearing deposits, as depositors sought higher rates on interest bearing deposit products and competition for deposits remains high throughout the industry, and by higher FHLB advances. The increase in rate for interest bearing deposits was a result of a combination of an increase in average interest bearing deposits of $531.3 million , or 13.9% , from $3.825 billion to $4.356 billion , and an increase in the average rate for interest bearing deposits of 116 basis points, from 2.64% to 3.80% for the three months ended March 31, 2023 as compared to the three months ended March 31, 2024. The Company anticipates the costs of funds may continue to remain elevated as a result of increased market competition, shifts from noninterest bearing deposits into interest bearing deposits, and elevated wholesale funding costs. Offsetting the increase to interest expense as a percentage of average earning assets was an increase to interest income as a percentage of average earning assets of 58 basis points, or 10.8%, to 5.97% for the three months ended March 31, 2024 , up from 5.39% for the comparable period of 2023. This increase was attributable to an increase in loan yields, which was driven by the combination of an increase in average loans of $245.6 million, or 5.2%, to $4.971 billion from $4.725 billion, and an increase in average yield of 66 basis points to 6.73% from 6.07% between the respective periods. Loan yields benefited from an increase in the target Federal Funds rate of 50 basis points between the two periods, increasing to a range of 5.25%-5.50% during the three months ended March 31, 2024. The Company expects the elevated interest rate environment will further benefit tax equivalent net interest margin as more commercial fixed rate loans mature and are renewed at higher interest rates. Provision for Credit Losses The Company recorded provision for credit losses expense of $1.5 million for the three months ended March 31, 2024, compared to provision expense of $4.4 million during the comparable period of 2023, a decrease of $2.8 million, or 65.1%. Net charge-offs were $312,000 during the three month period ended March 31, 2024, compared to $5.7 million during the comparable period of 2023, a decrease of $5.4 million, or 94.6%. The decrease in charge-offs between the respective periods was the result of a charge-off of $5.5 million attributable to a single commercial borrower during the first quarter of 2023. Additional factors considered by management included key loan quality metrics, including reserve coverage of nonperforming loans and economic conditions in the Company’s markets, and changes in the facts and circumstances of watch list credits, which includes the security position of the borrower. Management’s overall view on current credit quality was also a factor in the determination of the provision for credit losses. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans. 41 Table of Contents Noninterest Income Noninterest income categories for the three months ended March 31, 2024 and 2023 are shown in the following tables: Three Months Ended March 31, (dollars in thousands) 2024 2023 Dollar Change Percent Change Wealth advisory fees $ 2,455 $ 2,200 $ 255 11.6 % Investment brokerage fees 522 534 (12) (2.2) Service charges on deposit accounts 2,691 2,630 61 2.3 Loan and service fees 2,852 2,846 6 0.2 Merchant and interchange fee income 863 877 (14) (1.6) Bank owned life insurance income 1,036 691 345 49.9 Mortgage banking income (loss) 52 (99) 151 (152.5) Net securities gains (losses) (46) 16 (62) (387.5) Other income 2,187 619 1,568 253.3 Total noninterest income $ 12,612 $ 10,314 $ 2,298 22.3 % Noninterest income to total revenue 21.01 % 16.68 % Noninterest income increased by $2.3 million, or 22.3%, to $12.6 million for the three months ended March 31, 2024, compared to $10.3 million for the prior year three month period. The increase in noninterest income was driven primarily by an increase in other income of $1.6 million , or 253.3% , due to the recognition of an insurance recovery of $1.0 million during the first three months of 2024. Contributing further to the increase in other income was the recognition of a death benefit from the Company's bank owned life insurance program, increased FHLB dividend income and increased limited partnership investment income. Additionally, bank owned life insurance income increased $345,000 , or 49.9% , wealth advisory fees increased $255,000 , or 11.6% , and mortgage banking income increased $151,000 . The increase to bank owned life insurance was driven by an improvement in market valuation for the Company's variable owned life insurance policies, which are tied to the performance of the equity markets. Wealth advisory fees benefited from new volume growth in addition to favorable market performance. The increase to mortgage banking income was attributable to growth in the Company's mortgage pipeline, which favorably impacted secondary market loan sale gains and mortgage rate lock income. Adjusted core noninterest income, a non-GAAP financial measure that excludes the impact of the $1.0 million insurance recovery, was $11.6 million for the first three months of 2024, an increase of $1.3 million, or 12.6%, compared to the first three months of 2023. Noninterest Expense Noninterest expense categories for the three months ended March 31, 2024 and 2023 are shown in the following tables: Three Months Ended March 31, (dollars in thousands) 2024 2023 Dollar Change Percent Change Salaries and employee benefits $ 16,833 $ 16,063 $ 770 4.8 % Net occupancy expense 1,740 1,572 168 10.7 Equipment costs 1,412 1,438 (26) (1.8) Data processing fees and supplies 3,839 3,452 387 11.2 Corporate and business development 1,381 1,431 (50) (3.5) FDIC insurance and other regulatory fees 789 795 (6) (0.8) Professional fees 2,463 2,121 342 16.1 Other expense 2,248 2,562 (314) (12.3) Total noninterest expense $ 30,705 $ 29,434 $ 1,271 4.3 % Efficiency ratio 51.15 % 47.60 % 42 Table of Contents Noninterest expense increased by $1.3 million, or 4.3%, for the three months ended March 31, 2024, from $29.4 million to $30.7 million. The increase in noninterest expense during the three months ended March 31, 2024 was driven by an increase of salaries and employee benefits of $770,000 , or 4.8% . The increase to salaries and employees and benefits expense was driven by increases to expenses for employee salaries, incentive pay and health insurance as well as deferred compensation expense linked to the increase in market valuation of the Company's variable owned life insurance. Data processing fees and supplies expense increased $387,000 , or 11.2% , from increased software as well as digital and core data processing expenses. Professional fees increased $342,000 , or 16.1% , from continued investment in customer-facing and operational technology solutions. Other expense decreased $314,000 , or 12.3% , due to a reduction in expenses related to credit card recourse reserve expense, telephone expense and semi-annual director share grant expense. The Company's income tax expense increased $631,000, or 16.7%, to $4.4 million in the three months ended March 31, 2024, compared to $3.8 million for the same period in 2023. The effective tax rate was 15.8% in the three months ended March 31, 2024, compared to 13.4% for the comparable period of 2023. The year-to-date effective tax rate was increased due to adoption of ASU 2023-02, to account for the Company's investment in low-income housing tax credit structures, as well as a reduction in the tax benefit recognized from stock-based compensation vesting of shares for plan participants. FINANCIAL CONDITION Overview Total assets were $6.567 billion as of March 31, 2024 versus $6.524 billion as of December 31, 2023, an increase of $42.8 million, or less than 1%. Total loans, net of the allowance for credit losses, increased $79.8 million, or 1.6%, between December 31, 2023 and March 31, 2024. Offsetting the increase to loans, net of the allowance for credit losses, was a decrease in available-for-sale securities of $37.2 million, or 3.5%. Total deposits decreased $102.4 million, or 1.8%, between December 31, 2023 and March 31, 2024. The decrease in total deposits was driven the change in noninterest bearing deposits which decreased $99.3 million, or 7.3%. An increase in total borrowings of $150.0 million, or 300.0%, offset the decrease in total deposits to fund the balance sheet growth between December 31, 2023 and March 31, 2024. Total equity decreased $2.8 million, or less than 1%, from $649.8 million at December 31, 2023 to $647.0 million at March 31, 2024. Retained earnings increased $10.6 million, or 1.5%, as a result of net income of $23.4 million but was reduced by dividends declared and paid of $12.3 million. Accumulated other comprehensive income (loss), decreased $11.7 million, or 7.6%, due primarily to a decline in available-for-sale securities fair market values during the three months ended March 31, 2024. Uses of Funds Total Cash and Cash Equivalents Total cash and cash equivalents decreased by $4.1 million, or 2.7%, to $147.7 million at March 31, 2024, from $151.8 million at December 31, 2023. Cash and cash equivalents include short-term investments. The fluctuation in cash and cash equivalents at March 31, 2024 was driven by a decrease in cash and due from banks of $14.9 million, or 21.2% and offset by an increase in interest bearing short-term investment accounts of $10.8 million, or 13.2%. Investment Portfolio The amortized cost and the fair value of securities as of March 31, 2024 and December 31, 2023 were as follows: March 31, 2024 December 31, 2023 (dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Available-for-Sale U.S government sponsored agencies $ 144,693 $ 116,452 $ 146,692 $ 119,479 Mortgage-backed securities: residential 511,037 432,018 522,275 447,842 State and municipal securities 548,685 466,011 557,352 484,407 Total available-for-sale $ 1,204,415 $ 1,014,481 $ 1,226,319 $ 1,051,728 Held-to-Maturity State and municipal securities $ 130,335 $ 115,467 $ 129,918 $ 119,215 Total Investment Portfolio $ 1,334,750 $ 1,129,948 $ 1,356,237 $ 1,170,943 43 Table of Contents At March 31, 2024 and December 31, 2023, there were no holdings of securities of any one issuer, other than the U.S. government agencies and government sponsored entities, in an amount greater than 10% of stockholders’ equity. Management is aware that, as interest rates rise, any unrealized loss in the available-for-sale investment securities portfolio will increase, and as interest rates fall the unrealized gain in the investment portfolio will rise. Since the majority of the bonds in the investment portfolio are fixed-rate, with only a few adjustable-rate bonds, we would expect our investment portfolio to follow this market value pattern. This is taken into consideration when evaluating the gain or loss of investment securities in the portfolio and the potential for an allowance for credit losses. There were no purchases of available-for-sale securities in the first three months of 2024. Investment securities represented 17.4% of total assets on March 31, 2024, compared to 18.1% of total assets on December 31, 2023. Effective duration for the investment portfolio was 6.6 years at March 31, 2024, compared to 4.0 years at December 31, 2019 prior to the pandemic, and 6.5 years at December 31, 2023. Effective duration of the portfolio expanded following the deployment of excess liquidity to the portfolio and the rise in interest rates during the recent Federal Reserve tightening cycle. The ratio of investment securities as a percentage of total assets remains elevated over historical levels of approximately 12%-14% during 2014 to 2020. The Company expects the investment securities portfolio as a percentage of assets to decrease over time as the proceeds from pay downs, sales and maturities of these investment securities are used to fund loan portfolio growth and for other general liquidity purposes. Paydowns from prepayments and scheduled payments of $13.5 million were received in the first three months of 2024, and the amortization of premiums, net of the accretion of discounts, was $1.3 million. There were no maturities or calls of securities during the first three months of 2024. Sales of available-for-sale investment securities totaled $7.1 million in the first three months of 2024 and resulted in net losses of $46,000. No allowance for credit losses was recognized for available-for-sale or held-to-maturity securities as of March 31, 2024 and December 31, 2023. The fair value of the available-for-sale investment securities portfolio as of March 31, 2024 included net unrealized losses of $189.9 million, compared to net unrealized losses of $174.6 million as of December 31, 2023. Unrealized losses in the available-for-sale investment securities portfolio resulted from the declines in market values of the investment securities. These declines were driven by the rising interest rate environment as a result of the Federal Reserve's recent monetary tightening policy. The investment portfolio is managed by a third-party firm to provide for an appropriate balance between liquidity, credit risk, interest rate risk management and investment return and to limit the Company’s exposure to credit risk in the investment securities portfolio. The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds under what is commonly referred to as the “Volcker Rule” of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Real Estate Mortgage Loans Held-for-Sale Real estate mortgage loans held-for-sale increased by $501,000, or 43.3%, to $1.7 million at March 31, 2024, from $1.2 million at December 31, 2023. The balance of this asset category is subject to a high degree of variability depending on, among other factors, recent mortgage loan rates and the timing of loan sales into the secondary market. The Company generally sells conforming qualifying mortgage loans it originates on the secondary market. Proceeds from sales of residential mortgages totaled $4.1 million in the first three months of 2024, compared to $672,000 in the first three months of 2023. Management expects the volume of loans originated for sale in the secondary market to remain at reduced levels due to elevated mortgage rates, limited inventory, and existing homeowners being locked in at historically low rates. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others were $328.8 million and $333.1 million, as of March 31, 2024 and December 31, 2023, respectively. 44 Table of Contents Loan Portfolio The loan portfolio by portfolio segment as of March 31, 2024 and December 31, 2023 is summarized as follows: (dollars in thousands) March 31, 2024 December 31, 2023 Current Period Change Commercial and industrial loans $ 1,477,276 29.5 % $ 1,420,764 28.9 % $ 56,512 Commercial real estate and multi-family residential loans 2,477,442 49.6 2,437,534 49.5 39,908 Agri-business and agricultural loans 367,852 7.3 388,764 7.9 (20,912) Other commercial loans 120,302 2.4 120,726 2.5 (424) Consumer 1-4 family mortgage loans 460,516 9.2 456,187 9.3 4,329 Other consumer loans 97,369 2.0 96,022 1.9 1,347 Subtotal, gross loans 5,000,757 100.0 % 4,919,997 100.0 % 80,760 Less: Allowance for credit losses (73,180) (71,972) (1,208) Net deferred loan fees (3,198) (3,463) 265 Loans, net $ 4,924,379 $ 4,844,562 $ 79,817 Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, increased by $80.8 million, or 1.6%, to $5.001 billion at March 31, 2024 from $4.920 billion at December 31, 2023. The increase was primarily driven by originations of loans concentrated in the commercial and industrial and commercial real estate and multi-family residential loans categories and was offset by paydowns in the agri-business and agricultural loans segment which traditionally experiences seasonal fluctuations in activity. The following table summarizes the Company’s non-performing assets as of March 31, 2024 and December 31, 2023: (dollars in thousands) March 31, 2024 December 31, 2023 Nonaccrual loans $ 14,762 $ 15,687 Loans past due over 90 days and still accruing 7 27 Total nonperforming loans 14,769 15,714 Other real estate owned 384 384 Repossessions 78 8 Total nonperforming assets $ 15,231 $ 16,106 Individually analyzed loans $ 15,181 $ 16,124 Nonperforming loans to total loans 0.30 % 0.32 % Nonperforming assets to total assets 0.23 % 0.25 % Total nonperforming assets decreased by $875,000, or 5.4%, to $15.2 million during the three month period ended March 31, 2024. The ratio of nonperforming assets to total assets decreased 2 basis point from 0.25% at December 31, 2023 to 0.23% at March 31, 2024. A loan is individually analyzed when full payment under the original loan terms is not expected. The analysis for smaller loans that are similar in nature and which are not in nonaccrual or modified status, such as residential mortgage, consumer, and credit card loans, is determined based on the class of loans. If a loan is individually analyzed, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows or at the fair value of collateral if repayment is expected solely from the collateral. Total individually analyzed loans decreased by $943,000, or 5.8%, to $15.2 million at March 31, 2024 from $16.1 million at December 31, 2023, due primarily to loan paydowns. Loans are charged against the allowance for credit losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb current expected credit losses relating to specifically identified loans based on an evaluation of the loans by management, as well as other current expected losses in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current 45 Table of Contents economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. General allowance is determined after considering the following factors: application of loss percentages using a probability of default/loss given default approach subject to a floor, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans: Substandard, Doubtful and Loss. The regulations also contain a Special Mention category. Special Mention applies to loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as Substandard, Doubtful or Loss but do possess credit deficiencies or potential weaknesses deserving management’s close attention. The Company’s policy is to establish a specific allowance for credit losses for any assets where management has identified conditions or circumstances that indicate an asset is nonperforming. If an asset or portion, thereof is classified as a loss, the Company’s policy is to either establish specified allowances for credit losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount. At March 31, 2024, the allowance for credit losses was 1.46% of total loans, which was unchanged from December 31, 2023. At March 31, 2024, management believed the allowance for credit losses was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions deteriorate, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for credit losses. The process of identifying credit losses is a subjective process. The Company has a relatively high percentage of commercial and commercial real estate loans, which are extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing relatively conservative credit structures, by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and market area. The Company has limited exposure to commercial office space borrowers, all of which are located in the Bank's Indiana markets. Loans totaling $73.6 million for this sector represented 1.5% of total loans at March 31, 2024. Additionally, commercial real estate loans secured by multi-family residential properties and secured by non-farm non-residential properties were approximately 205% of the Bank's risk-based capital at March 31, 2024. As of March 31, 2024, based on management’s review of the loan portfolio, the Company had 70 credit relationships totaling $183.3 million on the classified loan list versus 68 credit relationships totaling $183.1 million as of December 31, 2023. As of March 31, 2024, the Company had $147.9 million of assets classified as Special Mention, $35.3 million classified as Substandard, $0 classified as Doubtful and $0 classified as Loss as compared to $143.6 million, $39.4 million, $0 and $0, respectively, at December 31, 2023. Watch list loans as a percentage of total loans decreased to 3.67% as of March 31, 2024 from 3.72% as of December 31, 2023. Allowance estimates are developed by management after taking into account actual loss experience adjusted for current economic conditions and a reasonably supportable forecast period. The Company has annual discussions regarding this methodology with regulatory authorities. Allowance estimates are considered a prudent measurement of the risk in the Company’s loan portfolio based upon loan segment. In accordance with applicable accounting guidance, the allowance is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. For a more thorough discussion of the allowance for credit losses methodology see the ("Critical Accounting Policies") section of this Item 2. The allowance for credit losses increased $1.2 million, or 1.7%, from $72.0 million at December 31, 2023 to $73.2 million at March 31, 2024. The increase was a result of provision expense of $1.5 million which was offset by net charge-offs of $312,000. Provision expense recorded during the three months ended March 31, 2024 was attributable to loan growth. As the bulk of the Company’s lending activity is concentrated in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits, management has historically considered growth and portfolio composition when determining credit loss allocations. Sources of Funds The Company's sources of funds include a diversified deposit base gathered throughout the Company's footprint and includes a stable mix of commercial, retail and public funds deposit accounts. While the traditional base of core deposits represents the primary source of funding for the Company, the Company has access to a robust array of other liquidity sources, including secured borrowings available from the Federal Home Loan Bank and the Federal Reserve Bank Discount Window. In addition, the Company has access to unsecured borrowing capacity through long established relationships within the brokered deposit markets, Federal Funds lines from correspondent bank partners and Insured Cash Sweep (ICS) one-way buy funds 46 Table of Contents available from the Intrafi network. As of March 31, 2024, the Company had access to $3.13 billion in unused liquidity available from these aggregate sources as compared to $3.41 billion at December 31, 2023. The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the three months ended March 31, 2024 and 2023 are summarized in the following table: Three months ended March 31, 2024 2023 (dollars in thousands) Balance Rate Balance Rate Noninterest bearing demand deposits $ 1,274,103 0.00 % $ 1,662,530 0.00 % Savings and transaction accounts: Savings deposits 295,650 0.07 392,567 0.07 Interest bearing demand deposits 3,046,958 4.01 2,757,120 3.15 Time deposits: . Deposits of $100,000 or more 789,581 4.50 494,873 2.30 Other time deposits 224,139 3.44 180,502 1.44 Total deposits $ 5,630,431 2.94 % $ 5,487,592 1.84 % FHLB advances and other borrowings 175,809 5.61 241,870 4.67 Total funding sources $ 5,806,240 3.02 % $ 5,729,462 1.96 % Average total deposits were $5.630 billion for the three months ended March 31, 2024, an increase of $142.8 million, or 2.6%, from the comparable period in 2023. Average total borrowings were $175.8 million for the three months ended March 31, 2024, a decrease of $66.1 million, or 27.3%, from the comparable period in 2023. Total average deposit costs increased 110 basis points from 1.84% for the three months ended March 31, 2023, to 2.94% for the three months ended March 31, 2024. Total average borrowing costs increased 94 basis points from 4.67% for the three months ended March 31, 2023 to 5.61% for the three months ended March 31, 2024. As a result, total funding costs increased by 106 basis points from 1.96% for the three months ended March 31, 2023, to 3.02% for the three months ended March 31, 2024. This increase was driven by an increase in rates on interest bearing deposits and deposit migration from noninterest bearing deposits to interest bearing deposits. Deposits and Borrowings As of March 31, 2024, total deposits decreased by $102.4 million, or 1.8%, from December 31, 2023. Core deposits, which excludes brokered deposits, decreased by $152.8 million, or 2.7%, to $5.432 billion as of March 31, 2024 from $5.585 billion as of December 31, 2023. Total brokered deposits were $185.8 million at March 31, 2024, compared to $135.4 million at December 31, 2023, an increase of $50.4 million. The following table summarizes deposit composition at March 31, 2024 and December 31, 2023: (dollars in thousands) March 31, 2024 Percentage of Total December 31, 2023 Percentage of Total Current Period Change Retail $ 1,770,007 31.5 % $ 1,794,958 31.4 % $ (24,951) Commercial 2,117,536 37.7 2,227,147 38.9 (109,611) Public funds 1,544,775 27.5 1,563,015 27.3 (18,240) Core deposits $ 5,432,318 96.7 % $ 5,585,120 97.6 % $ (152,802) Brokered deposits 185,767 3.3 135,405 2.4 50,362 Total deposits $ 5,618,085 100.0 % $ 5,720,525 100.0 % $ (102,440) Core deposits declined $152.8 million, or 2.7%, during the first three months of 2024. Utilization of brokered deposits as a wholesale funding alternative has returned to pre-pandemic levels. On March 31, 2024 commercial deposits represented 37.7% of total deposits versus 38.9% at December 31, 2023. Retail deposits represented 31.5% at March 31, 2024 versus 31.4% at December 31, 2023. Public Funds deposits represented 27.5% at March 31, 2024 versus 27.3% at December 31, 2023. Brokered deposits represented 3.3% of total deposits at March 31, 2024 versus 2.4% at December 31, 2023. Commercial deposits contracted $109.6 million, or 4.9%, from $2.23 billion at December 31, 2023 to $2.12 billion at March 31, 2024; retail 47 Table of Contents deposits contracted $25.0 million, or 1.4%, from $1.79 billion at December 31, 2023 to $1.77 billion at March 31, 2024; and public funds deposits contracted $18.2 million, or 1.2%, from $1.56 billion at December 31, 2023 to $1.54 billion at March 31, 2024. Deposits not covered by FDIC deposit insurance were 54% as of March 31, 2024, versus 57% at December 31, 2023. Deposits not covered by FDIC deposit insurance or the Indiana Public Deposit Insurance Fund (which insures public fund deposits in Indiana), were 27% of total deposits as of March 31, 2024, versus 31% as of December 31, 2023. As of March 31, 2024 and December 31, 2023, 98% of deposit accounts had deposit balances less than $250,000. Capital As of March 31, 2024, total stockholders’ equity was $647.0 million, a decrease of $2.8 million, or less than 1%, from $649.8 million at December 31, 2023. The decrease to total stockholders' equity was driven by net income of $23.4 million and was reduced by a decrease of $11.7 million in accumulated other comprehensive income (loss) and dividends declared and paid of $12.3 million. The impact on equity for other comprehensive income (loss) is not included in regulatory capital. The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1, or core capital, as a percentage of average assets, to measure the soundness of a financial institution. In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations. As of March 31, 2024, the Company's capital levels remained characterized as “well-capitalized”. The actual capital amounts and ratios of the Company and the Bank as of March 31, 2024 and December 31, 2023, are presented in the table below. Capital ratios for March 31, 2024 are preliminary until the Call Report and FR Y-9C are filed. Actual Minimum Required For Capital Adequacy Purposes For Capital Adequacy Purposes Plus Capital Conservation Buffer Minimum Required to Be Well Capitalized Under Prompt Corrective Action Regulations (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio As of March 31, 2024: Total Capital (to Risk Weighted Assets) Consolidated $ 880,112 15.46 % $ 455,440 8.00 % $ 597,765 N/A N/A N/A Bank $ 873,760 15.36 % $ 455,116 8.00 % $ 597,340 10.50 % $ 568,895 10.00 % Tier I Capital (to Risk Weighted Assets) Consolidated $ 808,862 14.21 % $ 341,580 6.00 % $ 483,905 N/A N/A N/A Bank $ 802,533 14.11 % $ 341,337 6.00 % $ 483,561 8.50 % $ 455,116 8.00 % Common Equity Tier 1 (CET1) Consolidated $ 808,862 14.21 % $ 256,185 4.50 % $ 398,510 N/A N/A N/A Bank $ 802,533 14.11 % $ 256,003 4.50 % $ 398,226 7.00 % $ 369,782 6.50 % Tier I Capital (to Average Assets) Consolidated $ 808,862 12.01 % $ 269,353 4.00 % $ 269,353 N/A N/A N/A Bank $ 802,533 11.93 % $ 269,154 4.00 % $ 269,154 4.00 % $ 336,442 5.00 % As of December 31, 2023: Total Capital (to Risk Weighted Assets) Consolidated $ 870,390 15.47 % $ 450,211 8.00 % $ 590,901 N/A N/A N/A Bank $ 852,405 15.16 % $ 449,894 8.00 % $ 590,486 10.50 % $ 562,367 10.00 % Tier I Capital (to Risk Weighted Assets) Consolidated $ 799,929 14.21 % $ 337,658 6.00 % $ 478,349 N/A N/A N/A Bank $ 781,999 13.91 % $ 337,420 6.00 % $ 478,012 8.50 % $ 449,894 8.00 % Common Equity Tier 1 (CET1) Consolidated $ 799,929 14.21 % $ 253,243 4.50 % $ 393,934 N/A N/A N/A Bank $ 781,999 13.91 % $ 253,065 4.50 % $ 393,657 7.00 % $ 365,539 6.50 % Tier I Capital (to Average Assets) Consolidated $ 799,929 11.82 % $ 270,636 4.00 % $ 270,636 N/A N/A N/A Bank $ 781,999 11.58 % $ 270,041 4.00 % $ 270,041 4.00 % $ 337,551 5.00 % 48 Table of Contents FORWARD-LOOKING STATEMENTS This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the federal securities law. Forward-looking statements are not historical facts and are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “project,” “possible,” “continue,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain and, accordingly, the reader is cautioned not to place undue reliance on any forward-looking statement made by the Company. Actual results could differ materially from those addressed in the forward-looking statements as a result of numerous factors, including, without limitation: • the effects of future economic, business and market conditions and changes, particularly in our Indiana market area, including prevailing interest rates and the rate of inflation; • governmental monetary and fiscal policies; • the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand and the values and liquidity of loan collateral, securities and other interest sensitive assets and liabilities; • changes in borrowers’ credit risks and payment behaviors; • the failure of assumptions and estimates used in our reviews of our loan portfolio, underlying the establishment of reserves for possible credit losses, our analysis of our capital position and other estimates; • the effects of disruption and volatility in capital markets on the value of our investment portfolio; • the performance of our commercial real estate loan portfolio, including the effects of the elevated interest rate environment, the strength of the commercial real estate market in our Indiana markets, and recent changes in retail and office usage patterns; • risk of cyber-security attacks that could result in damage to the Company's or third-party service providers' networks or data of the Company; • the outcome of pending litigation and other claims we may be subject to from time to time; • the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services; • the effects of war or other conflicts, acts of terrorism or other catastrophic events, including storms, droughts, tornados and flooding, that may affect general economic conditions, including agricultural production and demand and prices for agricultural goods and land used for agricultural purposes, generally and in our markets; • the timing and scope of any legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators; • changes in the scope and cost of FDIC insurance, the state of Indiana’s Public Deposit Insurance Fund and other coverages; • changes in the prices, values and sales volumes of residential real estate; • the risks related to the recent failures of First Republic Bank, Silicon Valley Bank and Signature Bank, including the effects already recognized and increased deposit volatility; • the risk of labor shortages, trade policy and tariffs, as well as supply chain constraints could impact loan demand from the manufacturing sector; • the effects of fraud by or affecting employees, customers or third parties; • changes in the availability and cost of credit and capital in the financial markets; • changes in technology or products that may be more difficult or costly, or less effective than anticipated; 49 Table of Contents • the risks related to mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions; • changes in accounting policies, rules and practices; and • the risks noted in the Risk Factors discussed under Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2023, as well as other risks and uncertainties set forth from time to time in the Company’s other filings with the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.