Midland States Bancorp, Inc. 10-Q

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of certain significant factors which have affected the financial condition and results of operations of the Company as reflected in the unaudited consolidated balance sheet as of March 31, 2023, as compared to December 31, 2022, and operating results for the three months ended March 31, 2023 and 2022. These comments should be read in conjunction with the Company's unaudited consolidated financial statements and accompanying notes appearing elsewhere herein and our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 24, 2023. In addition to the historical information contained herein, this Form 10-Q includes “forward-looking statements” within the meaning of such term under the Private Securities Litigation Reform Act of 1995. These statements are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, including prevailing interest rates and the rate of inflation; the continuing effects of the recent failures of Silicon Valley Bank and Signature Bank, including anticipated effects on FDIC premiums, increased deposit volatility and potential regulatory developments; changes in the financial markets; changes in business plans as circumstances warrant; risks related to mergers and acquisitions and the integration of acquired businesses; developments and uncertainty related to the future use and availability of some reference rates, such as LIBOR, as well as other alternative reference rates, and the adoption of a substitute; changes to U.S. tax laws, regulations and guidance; and other risks detailed from time to time in filings made by the Company with the SEC. Readers should note that the forward-looking statements included herein are not a guarantee of future events, and that actual events may differ materially from those made in or suggested by the forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “will,” “propose,” “may,” “plan,” “seek,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” or “continue,” or similar terminology. Any forward-looking statements presented herein are made only as of the date of this document, and we do not undertake any obligation to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, or otherwise . Critical Accounting Policies The preparation of our consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances. These estimates form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates and judgments that management believes have the most effect on the Company’s reported financial position and results of operations are set forth in “Note 2 – Basis of Presentation and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements, included in our Annual Report on Form 10-K for the year ended December 31, 2022. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2022. Significant Developments and Transactions Each item listed below affects the comparability of our results of operations for the three months ended March 31, 2023 and 2022, and our financial condition as of March 31, 2023 and December 31, 2022, and may affect the comparability of financial information we report in future fiscal periods. Preferred Stock Issuance. On August 24, 2022, the Company issued and sold 4,600,000 depositary shares, each representing a 1/40th ownership interest in a share of the Company’s 7.75% fixed rate reset non-cumulative, non-convertible, perpetual preferred stock, Series A. The net proceeds were $110.5 million. Commercial FHA Mortgage Loan Servicing Rights. During the third quarter of 2022, we committed to a plan to sell the commercial servicing rights asset and transferred $24.0 million of commercial FHA loan servicing rights to held for sale. Servicing rights held for sale are recorded at the lower of their carrying amount or fair value less estimated costs to sell. No impairment was recognized in the first quarter of 2023. Redemption of Subordinated Notes. On October 15, 2022, the Company redeemed the outstanding Fixed-to-Floating Rate Subordinated Notes due October 15, 2027, having an aggregate principal amount of $40.0 million, in accordance with the terms of the notes. The aggregate redemption price was 100% of the aggregate principal amount of the subordinated notes, plus accrued and unpaid interest. The interest rate on the subordinated notes was 6.25%. 38 Table of Contents Recent Acquisitions. On June 17, 2022, the Company completed its acquisition of the deposits and certain loans and other assets associated with FNBC's branches in Mokena and Yorkville, Illinois. The Company acquired $79.8 million in assets, including $60.3 million in cash and $16.6 million in loans, and assumed $79.8 million in deposits. Results of Operations Overview. The following table sets forth condensed income statement information of the Company for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, (dollars in thousands, except per share data) 2023 2022 Income Statement Data: Interest income $ 95,539 $ 62,748 Interest expense 35,035 5,921 Net interest income 60,504 56,827 Provision for credit losses 3,135 4,167 Noninterest income 15,779 15,613 Noninterest expense 44,482 40,884 Income before income taxes 28,666 27,389 Income taxes 6,894 6,640 Net income 21,772 20,749 Preferred dividends 2,228 — Net income available to common shareholders $ 19,544 $ 20,749 Per Share Data: Basic earnings per common share $ 0.86 $ 0.92 Diluted earnings per common share $ 0.86 $ 0.92 Performance Metrics: Return on average assets 1.12 % 1.16 % Return on average shareholders' equity 11.51 % 12.80 % During the three months ended March 31, 2023, we generated net income available to common shareholders of $19.5 million, or $0.86 per diluted share, compared to $20.7 million, or $0.92 per diluted share, in the three months ended March 31, 2022. Earnings for the first quarter of 2023 compared to the first quarter of 2022 increased primarily due to a $3.7 million increase in net interest income, a $1.0 million decrease in provision for credit losses, and a $0.2 million increase in noninterest income. These positive results were partially offset by a $3.6 million increase in noninterest expense and a $0.3 million increase in income tax expense. These are discussed in further detail below. Net Interest Income and Margin. Our primary source of revenue is net interest income, which is the difference between interest income from interest-earning assets (primarily loans and securities) and interest expense of funding sources (primarily interest-bearing deposits and borrowings). Net interest income is influenced by many factors, primarily the volume and mix of interest-earning assets, funding sources, and interest rate fluctuations. Noninterest-bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. Net interest margin is calculated as net interest income divided by average interest-earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pretax-equivalent income, assuming a federal income tax rate of 21% for three months ended March 31, 2023 and 2022. On March 22, 2023, the Federal Reserve enacted a quarter percentage point interest rate increase, expressing caution about the recent banking crisis and indicating that rate hikes are nearing an end. Along with its ninth hike since March 2022, the rate-setting Federal Open Market Committee noted that future increases are not assured and will depend largely on incoming data. The increase takes the benchmark federal funds rate to a target range between 4.75%-5.00%, compared to a target rate of 0.00%-0.25% at the beginning of 2022. During the three months ended March 31, 2023 , net interest income, on a tax-equivalent basis, increased to $60.7 million with a tax-equivalent net interest margin of 3.39% compared to net interest income, on a tax-equivalent basis, of $57.2 million and a tax-equivalent net interest margin of 3.50% for the three months ended March 31, 2022 . 39 Table of Contents Average Balance Sheet, Interest and Yield/Rate Analysis. The following tables present the average balance sheets, interest income, interest expense and the corresponding average yields earned and rates paid for the three months ended March 31, 2023 and 2022. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments. Three Months Ended March 31, 2023 2022 (tax-equivalent basis, dollars in thousands) Average balance Interest & fees Yield/ Rate Average balance Interest & fees Yield/ Rate Interest-earning assets: Federal funds sold and cash investments $ 85,123 $ 980 4.67 % $ 384,231 $ 171 0.18 % Investment securities : Taxable investment securities 731,075 5,370 2.98 760,783 3,897 2.05 Investment securities exempt from federal income tax (1) 78,773 625 3.22 133,851 1,065 3.18 Total securities 809,848 5,995 3.00 894,634 4,962 2.22 Loans : Loans (2) 6,264,591 87,459 5.66 5,201,449 56,586 4.41 Loans exempt from federal income tax (1) 55,811 538 3.91 72,602 694 3.88 Total loans 6,320,402 87,997 5.65 5,274,051 57,280 4.40 Loans held for sale 1,506 16 4.41 31,256 220 2.86 Nonmarketable equity securities 47,819 795 6.75 36,378 484 5.40 Total interest-earning assets 7,264,698 95,783 5.35 6,620,550 63,117 3.87 Noninterest-earning assets 610,811 631,187 Total assets $ 7,875,509 $ 7,251,737 Interest-bearing liabilities: Deposits: Checking and money market deposits $ 3,686,192 $ 22,955 2.53 % $ 3,164,324 $ 1,253 0.16 % Savings deposits 650,138 243 0.15 694,885 50 0.03 Time deposits 703,039 3,121 1.80 626,996 800 0.52 Brokered time deposits 14,572 86 2.39 21,437 58 1.10 Total interest-bearing deposits 5,053,941 26,405 2.12 4,507,642 2,161 0.19 Short-term borrowings 38,655 25 0.26 70,043 23 0.14 FHLB advances and other borrowings 540,278 6,006 4.51 311,282 1,212 1.58 Subordinated debt 99,812 1,370 5.57 139,139 2,011 5.78 Trust preferred debentures 50,047 1,229 9.96 49,451 514 4.21 Total interest-bearing liabilities 5,782,733 35,035 2.46 5,077,557 5,921 0.47 Noninterest-bearing liabilities: Noninterest-bearing deposits 1,250,899 1,435,020 Other noninterest-bearing liabilities 74,691 81,833 Total noninterest-bearing liabilities 1,325,590 1,516,853 Shareholders’ equity 767,186 657,327 Total liabilities and shareholders’ equity $ 7,875,509 $ 7,251,737 Net interest income / net interest margin (3) $ 60,748 3.39 % $ 57,196 3.50 % (1) Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%. Tax-equivalent adjustments totaled $244,000 and $369,000 for the three months ended March 31, 2023 and 2022, respectively. (2) Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs. (3) Net interest margin during the periods presented represents: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period. 40 Table of Contents Interest Rates and Operating Interest Differential. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. Changes which are not due solely to volume or rate have been allocated proportionally to the change due to volume and the change due to rate. Three Months Ended March 31, 2023 compared with Three Months Ended March 31, 2022 Change due to: Interest Variance (tax-equivalent basis, dollars in thousands) Volume Rate EARNING ASSETS: Federal funds sold and cash investments $ (1,788) $ 2,597 $ 809 Investment securities: Taxable investment securities (224) 1,697 1,473 Investment securities exempt from federal income tax (445) 5 (440) Total securities (669) 1,702 1,033 Loans: Loans 13,204 17,669 30,873 Loans exempt from federal income tax (161) 5 (156) Total loans 13,043 17,674 30,717 Loans held for sale (267) 63 (204) Nonmarketable equity securities 171 140 311 Total earning assets $ 10,490 $ 22,176 $ 32,666 INTEREST-BEARING LIABILITIES: Checking and money market deposits $ 1,976 $ 19,726 $ 21,702 Savings deposits (10) 203 193 Time deposits 217 2,104 2,321 Brokered deposits (29) 57 28 Total interest-bearing deposits 2,154 22,090 24,244 Short-term borrowings (15) 17 2 FHLB advances and other borrowings 1,749 3,045 4,794 Subordinated debt (567) (74) (641) Trust preferred debentures 10 705 715 Total interest-bearing liabilities $ 3,331 $ 25,783 $ 29,114 Net interest income $ 7,159 $ (3,607) $ 3,552 Interest Income. Interest income, on a tax-equivalent basis, increased $32.7 million to $95.8 million in the first quarter of 2023 as compared to the same quarter of 2022 due to the impact of rising interest rates over the past 12 months and growth in our average loan balances. The yield on earning assets increased 148 basis points to 5.35% from 3.87%. Average earning assets increased to $7.26 billion in the first quarter of 2023 from $6.62 billion in the same quarter of 2022. An increase in average loans of $1.05 billion was partially offset by decreases in federal funds sold and cash investments and investment securities of $299.1 million and $84.8 million, respectively. Average loans increased $1.05 billion in the first quarter of 2023 compared to the same quarter of 2022. Average commercial loans increased $144.5 million. Included in commercial loans are commercial FHA warehouse lines and PPP loans. Commercial FHA warehouse lines decreased $33.2 million to $13.3 million in the first quarter of 2023. PPP loan balances averaged $0.1 million in first quarter of 2023, compared to $36.2 million in the first quarter of 2022. Excluding the changes in the commercial FHA warehouse line and PPP loan portfolios, average commercial loans increased $213.3 million in the first quarter of 2023 compared to the same period one year prior. 41 Table of Contents Average commercial real estate loans increased this quarter by $511.2 million, compared to the prior year first quarter. Average balances in our consumer loans, construction loans and lease portfolios also increased this quarter by $150.0 million, $129.5 million and $76.0 million, respectively, compared to the prior year first quarter. Consumer loan growth was primarily the result of our new relationship with an additional consumer loan origination firm and our continuing relationship with GreenSky. On January 24, 2023, we notified GreenSky of our intent to terminate our participation in their loan origination program in October 2023, pursuant to our contractual notice requirements. Following the termination, GreenSky is expected to continue servicing all loans originated through the program. Interest Expense. Interest expense increased $29.1 million to $35.0 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The cost of interest-bearing liabilities increased to 2.46% for the first quarter of 2023, compared to 0.47% for the first quarter of 2022, due to the increase in deposit costs as a result of the rate increases announced by the Federal Reserve. Interest expense on deposits increased $24.2 million to $26.4 million for the three months ended March 31, 2023 from the comparable period in 2022. The increase was primarily due to an increase in rates paid on deposits. Average balances of interest-bearing deposit accounts increased $546.3 million, or 12.1%, to $5.05 billion for the three months ended March 31, 2023 compared to the same period one year earlier. The increase in volume was attributable to increases of retail deposits, commercial deposits, servicing deposits, and brokered deposits of $168.1 million, $30.1 million, $54.0 million, and $78.1 million, respectively. In addition, our Insured Cash Sweep product balances increased $219.1 million. Interest expense on FHLB advances and other borrowings increased $4.8 million for the three months ended March 31, 2023, from the comparable period in 2022. Average balances increased $229.0 million for the three months ended March 31, 2023, from the comparable period in 2022, to provide funding for the increase in earning assets. Interest expense on subordinated debt decreased $0.6 million for the three months ended March 31, 2023, from the comparable period in 2022, primarily due to the redemption of $40.0 million of subordinated debt on October 15, 2022. The interest rate on the subordinated notes was 6.25%. Interest expense on trust preferred debentures increased $0.7 million for the three months ended March 31, 2023, from the comparable period in 2022, due to interest rate increases, as these debt instruments reprice quarterly. Provision for Credit Losses. The Company's provision for credit losses totaled $3.1 million for the three months ended March 31, 2023, all of which was attributable to loans. Provision expense for the three months ended March 31, 2022 totaled $4.2 million, with $4.1 million expense attributable to loans, $0.3 million expense related to unfunded loan commitments and a $0.2 million benefit related to investment securities. The provision for credit losses on loans recognized during the three months ended March 31, 2023 was made at a level deemed necessary by management to absorb estimated losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for credit losses is completed quarterly by management, the results of which are used to determine provision for credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and reasonable and supportable forecasts along with other qualitative and quantitative factors. 42 Table of Contents Noninterest Income. Noninterest income increased 1.06% for the three months ended March 31, 2023, compared to the same period of 2022. The following table sets forth the major components of our noninterest income for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, Increase (decrease) (dollars in thousands) 2023 2022 Noninterest income: Wealth management revenue $ 6,411 $ 7,139 $ (728) Residential mortgage banking revenue 405 599 (194) Service charges on deposit accounts 2,568 2,068 500 Interchange revenue 3,412 3,280 132 Loss on sales of investment securities, net (648) — (648) Impairment on commercial mortgage servicing rights — (394) 394 Company-owned life insurance 876 1,019 (143) Other income 2,755 1,902 853 Total noninterest income $ 15,779 $ 15,613 $ 166 Wealth management revenue . Wealth management revenue decreased $0.7 million for the three months ended March 31, 2023, as compared to the same period in 2022. Assets under administration decreased to $3.50 billion at March 31, 2023 from $3.93 billion at March 31, 2022, primarily due to a decline in market performance in 2022, resulting in a decrease in revenue. Loss on sale of investment securities . T he Company took advantage of certain market conditions during the first quarter of 2023 to reposition out of lower yielding tax-exempt securities into other structures, which should result in improved overall margin, liquidity and capital allocations. These transactions resulted in losses of $0.6 million in the current quarter, with expected paybacks to occur within the calendar year. Other noninterest income. Other income totaled $2.8 million for the three months ended March 31, 2023, an increase of $0.9 million, as compared to the same period of 2022 . As a result of designating our commercial FHA loan servicing rights as held for sale, we no longer amortize the servicing asset nor record impairment. In the first quarter of 2022, amortization and impairment totaled $0.7 million and $0.4 million, respectively. Noninterest Expense. The following table sets forth the major components of noninterest expense for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, Increase (decrease) (dollars in thousands) 2023 2022 Noninterest expense: Salaries and employee benefits $ 24,243 $ 21,870 $ 2,373 Occupancy and equipment 4,443 3,755 688 Data processing 6,311 5,873 438 FDIC insurance 1,329 830 499 Professional 1,760 1,972 (212) Marketing 703 688 15 Communications 511 712 (201) Loan expense 818 943 (125) Amortization of intangible assets 1,291 1,398 (107) Other expense 3,073 2,843 230 Total noninterest expense $ 44,482 $ 40,884 $ 3,598 Salaries and employee benefits. For the three months ended March 31, 2023, salaries and employee benefits expense increased $2.4 million as compared to the same period in 2022, primarily due to annual salary increases, a modest increase in staffing levels and increased medical insurance expense. The Company employed 931 employees at March 31, 2023 compared to 920 employees at March 31, 2022. 43 Table of Contents Occupancy and Equipment Expense. For the three months ended March 31, 2023, occupancy and equipment expense increased $0.7 million as compared to the same period in 2022 primarily as a result of the non-controllable seasonal expenses, including snow removal. In addition, the Company transitioned to an outsourced facilities management program and incurred increased repair expenses as a result of deferred maintenance. FDIC Insurance Expense. For the three months ended March 31, 2023, FDIC insurance expense increased $0.5 million as compared to the same period in 2022, primarily as a result of the FDIC increasing the base assessment rate by 2 basis points, effective January 1, 2023. Income Tax Expense. Income tax expense was $6.9 million for the three months ended March 31, 2023, as compared to $6.6 million for the three months ended March 31, 2022. The resulting effective tax rates were 24.0% and 24.2% for the three months ended March 31, 2023 and 2022, respectively. Financial Condition Assets. Total assets increased to $7.93 billion at March 31, 2023, as compared to $7.86 billion at December 31, 2022. Loans. The loan portfolio is the largest category of our assets. At March 31, 2023, total loans were $6.35 billion as compared to $6.31 billion at December 31, 2022. The following table shows loans by category as of March 31, 2023 and December 31, 2022: March 31, 2023 December 31, 2022 (dollars in thousands) Book Value % Book Value % Loans: Commercial: Equipment finance loans $ 632,206 10.0 % $ 616,751 9.8 % Equipment finance leases 510,029 8.0 491,744 7.8 Commercial FHA lines 10,275 0.2 25,029 0.4 SBA PPP loans 90 — 1,916 — Other commercial loans 937,829 14.8 870,878 13.8 Total commercial loans and leases 2,090,429 33.0 2,006,318 31.8 Commercial real estate 2,448,158 38.5 2,433,159 38.6 Construction and land development 326,836 5.1 320,882 5.1 Residential real estate 369,910 5.8 366,094 5.8 Consumer 1,118,938 17.6 1,180,014 18.7 Total loans, gross 6,354,271 100.0 % 6,306,467 100.0 % Allowance for credit losses on loans (62,067) (61,051) Total loans, net $ 6,292,204 $ 6,245,416 Total loans increased $47.8 million to $6.35 billion at March 31, 2023, as compared to December 31, 2022. The loan growth was primarily reflected in our commercial loans and leases and commercial real estate portfolios, which increased $84.1 million and $15.0 million, respectively. Commercial loans and leases, which includes commercial FHA warehouse lines, increased $84.1 million to $2.09 billion at March 31, 2023, as compared to December 31, 2022. Advances on commercial FHA warehouse lines decreased $14.8 million to $10.3 million at March 31, 2023. Excluding the decrease in commercial FHA warehouse lines, commercial loans and leases increased $98.9 million, primarily from our equipment financing business. Consumer loans decreased $61.1 million at March 31, 2023 primarily due to a decrease in loans originated through the program with GreenSky. On January 24, 2023, the Company notified GreenSky that, effective October 21, 2023, the Company would terminate its participation in GreenSky’s loan origination program. Following the termination, GreenSky is expected to continue servicing all loans originated through the program. 44 Table of Contents The principal segments of our loan portfolio are discussed below: Commercial loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small- and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs, business expansions and farm operations. Commercial loans generally include lines of credit and loans with maturities of five years or less. The loans are generally made with business operations as the primary source of repayment, but may also include collateralization by inventory, accounts receivable and equipment, and generally include personal guarantees. The commercial loan category also includes loans originated by the equipment financing business that are secured by the underlying equipment. Commercial real estate loans. Our commercial real estate loans consist of both real estate occupied by the borrower for ongoing operations and non-owner occupied real estate properties. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as owner occupied offices, warehouses and production facilities, office buildings, hotels, mixed-use residential and commercial facilities, retail centers, multifamily properties and assisted living facilities. Our commercial real estate loan portfolio also includes farmland loans. Farmland loans are generally made to a borrower actively involved in farming rather than to passive investors. Construction and land development loans. Our construction and land development loans are comprised of residential construction, commercial construction and land acquisition and development loans. Interest reserves are generally established on real estate construction loans. Residential real estate loans. Our residential real estate loans consist of residential properties that generally do not qualify for secondary market sale. Consumer loans. Our consumer loans include direct personal loans, indirect automobile loans, lines of credit and installment loans originated through home improvement specialty retailers and contractors. Personal loans are generally secured by automobiles, boats and other types of personal property and are made on an installment basis. Lease financing. Our equipment leasing business provides financing leases to varying types of businesses nationwide for purchases of business equipment and software. The financing is secured by a first priority interest in the financed asset and generally requires monthly payments. The following table shows the contractual maturities of our loan portfolio and the distribution between fixed and adjustable interest rate loans at March 31, 2023: March 31, 2023 Within One Year One Year to Five Years Five Years to 15 Years After 15 Years (dollars in thousands) Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Total Commercial $ 111,817 $ 380,545 $ 666,518 $ 112,088 $ 210,367 $ 95,391 $ — $ 3,674 $ 1,580,400 Commercial real estate 191,157 265,032 978,205 398,020 396,918 191,450 5,501 21,875 2,448,158 Construction and land development 5,865 77,951 83,255 113,004 21,146 21,240 2,582 1,793 326,836 Total commercial loans 308,839 723,528 1,727,978 623,112 628,431 308,081 8,083 27,342 4,355,394 Residential real estate 1,214 3,992 8,181 18,160 29,862 39,181 150,884 118,436 369,910 Consumer 1,508 3,418 1,082,189 520 31,303 — — — 1,118,938 Lease financing 12,460 — 374,373 — 123,196 — — — 510,029 Total loans $ 324,021 $ 730,938 $ 3,192,721 $ 641,792 $ 812,792 $ 347,262 $ 158,967 $ 145,778 $ 6,354,271 Loan Quality We use what we believe is a comprehensive methodology to monitor credit quality and prudently manage credit concentration within our loan portfolio. Our underwriting policies and practices govern the risk profile, credit and geographic concentration for our loan portfolio. We also have what we believe to be a comprehensive methodology to monitor these credit quality standards, including a risk classification system that identifies potential problem loans based on risk characteristics by loan type as well as the early identification of deterioration at the individual loan level. 45 Table of Contents Analysis of the Allowance for Credit Losses on Loans. The allowance for credit losses on loans was $62.1 million, or 0.98% of total loans, at March 31, 2023 compared to $61.1 million, or 0.97% of total loans, at December 31, 2022. The following table allocates the allowance for credit losses on loans by loan category: March 31, 2023 December 31, 2022 (dollars in thousands) Allowance % (1) Allowance % (1) Commercial $ 15,762 1.00 % $ 14,639 0.97 % Commercial real estate 28,216 1.15 29,290 1.20 Construction and land development 2,442 0.75 2,435 0.76 Total commercial loans 46,420 1.07 46,364 1.09 Residential real estate 4,350 1.18 4,301 1.17 Consumer 4,129 0.37 3,599 0.30 Lease financing 7,168 1.41 6,787 1.38 Total allowance for credit losses on loans $ 62,067 0.98 % $ 61,051 0.97 % (1) Represents the percentage of the allowance to total loans in the respective category. We measure expected credit losses over the life of each loan utilizing a combination of models which measure probability of default and loss given default, among other things. The measurement of expected credit losses is impacted by loan and borrower attributes and certain macroeconomic variables. Models are adjusted to reflect the impact of certain current macroeconomic variables as well as their expected changes over a reasonable and supportable forecast period. The allowance allocated to commercial loans totaled $15.8 million, or 1.00% of total commercial loans, at March 31, 2023, compared to $14.6 million, or 0.97%, at December 31, 2022. Modeled expected credit losses increased $0.9 million and qualitative factor ("Q-Factor") adjustments related to commercial loans increased $0.3 million. The allowance allocated to commercial real estate loans totaled $28.2 million, or 1.15% of total commercial real estate loans, at March 31, 2023 compared to $29.3 million, or 1.20% of total commercial real estate loans, at December 31, 2022. Modeled expected credit losses related to commercial real estate loans decreased $1.1 million and Q-Factor adjustments related to commercial real estate loans increased $0.2 million. Specific allocations for commercial real estate loans that were evaluated for expected credit losses on an individual basis increased from $1.5 million at December 31, 2022 to $1.7 million at March 31, 2023. The allowance allocated to consumer loans totaled $4.1 million, or 0.37% of total consumer loans at March 31, 2023, compared to $3.6 million, or 0.30%, at December 31, 2022. Modeled expected credit losses increased $0.4 million and Q-Factor adjustments increased $0.1 million. The allowance allocated to the lease portfolio totaled $7.2 million, or 1.41% of total commercial leases, at March 31, 2023, increasing $0.4 million from $6.8 million, or 1.38% of total commercial leases at December 31, 2022. Modeled expected credit losses and Q-Factor adjustments related to commercial leases each increased $0.2 million. In estimating expected credit losses as of March 31, 2023, we utilized certain forecasted macroeconomic variables from Oxford Economics in our models. The forecasted projections included, among other things, (i) growth of U.S. gross domestic product slowing from approximately 2.0% in the first half of 2023 to -0.5% in the second half of 2023 and first quarter of 2024; (ii) Federal Reserve raising the policy rate by 25 basis points at the May 2023 meeting; and (iii) Illinois Unemployment rate averaging 5.82% through the fourth quarter of 2023. These economic metrics forecast a slowing economy in 2023. We qualitatively adjust the model results based on this scenario for various risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. Q-Factor adjustments are based upon management judgment and current assessment as to the impact of risks related to changes in lending policies and procedures; economic and business conditions; loan portfolio attributes and credit concentrations; and external factors, among other things, that are not already captured within the modeling inputs, assumptions and other processes. Management assesses the potential impact of such items within a range of severely negative impact to positive impact and adjusts the modeled expected credit loss by an aggregate adjustment percentage based upon the assessment. As a result of this assessment as of March 31, 2023, modeled expected credit losses were adjusted upwards with a Q-Factor adjustment of approximately 52 basis points of total loans, increasing from 50 basis points at December 31, 2022. The Q-Factor adjustment at 46 Table of Contents March 31, 2023 was based primarily on declining economic conditions, including rising inflation fears and an increasing risk of recession and the impact of rising fuel prices on businesses and consumers. The following table provides an analysis of the allowance for credit losses on loans, provision for credit losses on loans and net charge-offs for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, (dollars in thousands) 2023 2022 Balance, beginning of period $ 61,051 $ 51,062 Charge-offs: Commercial 969 2,154 Commercial real estate 746 227 Construction and land development — 6 Residential real estate 31 104 Consumer 263 305 Lease financing 390 206 Total charge-offs 2,399 3,002 Recoveries: Commercial 94 11 Commercial real estate 2 67 Construction and land development — 6 Residential real estate 17 113 Consumer 93 162 Lease financing 74 387 Total recoveries 280 746 Net charge-offs 2,119 2,256 Provision for credit losses on loans 3,135 4,132 Balance, end of period $ 62,067 $ 52,938 Gross loans, end of period $ 6,354,271 $ 5,539,961 Average total loans $ 6,320,402 $ 5,274,051 Net charge-offs to average loans 0.14 % 0.17 % Allowance for credit losses to total loans 0.98 % 0.96 % Individual loans considered to be uncollectible are charged off against the allowance. Factors used in determining the amount and timing of charge-offs on loans include consideration of the loan type, length of delinquency, sufficiency of collateral value, lien priority and the overall financial condition of the borrower. Collateral value is determined using updated appraisals and/or other market comparable information. Charge-offs are generally taken on loans once the impairment is determined to be other-than-temporary. Recoveries on loans previously charged off are added to the allowance. Net charge-offs for the three months ended March 31, 2023 totaled $2.1 million, compared to $2.3 million for the same period one year ago. Net charge-offs to average loans were 0.14% and 0.17% for the three months ended March 31, 2023 and 2022, respectively. 47 Table of Contents Nonperforming Loans . The following table sets forth our nonperforming assets by asset categories as of the dates indicated. Nonperforming loans include nonaccrual loans and loans past due 90 days or more and still accruing interest. The balances of nonperforming loans reflect the net investment in these assets, including deductions for purchase discounts. (dollars in thousands) March 31, 2023 December 31, 2022 Nonperforming loans: Commercial $ 6,403 $ 7,853 Commercial real estate 36,472 29,602 Construction and land development 200 229 Residential real estate 4,496 8,449 Consumer 885 921 Lease financing 2,257 2,369 Total nonperforming loans 50,713 49,423 Other real estate owned and other repossessed assets 8,093 8,401 Nonperforming assets $ 58,806 $ 57,824 Nonperforming loans to total loans 0.80 % 0.78 % Nonperforming assets to total assets 0.74 % 0.74 % Allowance for credit losses to nonperforming loans 122.39 % 123.53 % We did not recognize interest income on nonaccrual loans during the three months ended March 31, 2023 or 2022 while the loans were in nonaccrual status. Additional interest income that would have been recorded on nonaccrual loans had they been current in accordance with their original terms was $0.8 million for both the three months ended March 31, 2023 and 2022. We utilize an asset risk classification system in compliance with guidelines established by the Federal Reserve as part of our efforts to improve asset quality. In connection with examinations of insured institutions, examiners have the authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: “substandard,” “doubtful,” and “loss.” Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full questionable and there is a high probability of loss based on currently existing facts, conditions and values. An asset classified as loss is not considered collectable and is of such little value that continuance of booking the asset is not warranted. We use a ten grade risk rating system to categorize and determine the credit risk of our loans. Potential problem loans include loans with a risk grade of 7, which are "special mention," and loans with a risk grade of 8, which are "substandard" loans that are not considered to be nonperforming. These loans generally require more frequent loan officer contact and receipt of financial data to closely monitor borrower performance. Potential problem loans are managed and monitored regularly through a number of processes, procedures and committees, including oversight by a loan administration committee comprised of executive officers and other members of the Bank's senior management team. The following table presents the recorded investment of potential problem commercial loans by loan category at the dates indicated: Commercial Commercial real estate Construction & land development Risk category Risk category Risk category (dollars in thousands) 7 8 (1) 7 8 (1) 7 8 (1) Total March 31, 2023 $ 20,273 $ 8,582 $ 35,510 $ 82,732 $ 210 $ 8,406 $ 155,713 December 31, 2022 12,693 9,579 42,770 82,949 210 8,415 156,616 (1) Includes only those 8-rated loans that are not included in nonperforming loans. Commercial loans with a risk rating of 7 or 8 increased $6.6 million to $28.9 million as of March 31, 2023, compared to $22.3 million as of December 31, 2022. Commercial real estate loans with a risk rating of 7 or 8 decreased $7.5 million to $118.2 million as of March 31, 2023, compared to $125.7 million as of December 31, 2022, primarily due to risk rating upgrades within the portfolio. 48 Table of Contents Investment Securities. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk. The types and maturities of securities purchased are primarily based on our current and projected liquidity and interest rate sensitivity positions. The following table sets forth the book value and percentage of each category of investment securities at March 31, 2023 and December 31, 2022. The book value for investment securities classified as available for sale is equal to fair market value. March 31, 2023 December 31, 2022 (dollars in thousands) Book Value % of Total Book Value % of Total Investment securities available for sale: U.S. Treasury securities $ 52,798 6.5 % $ 81,230 10.6 % U.S. government sponsored entities and U.S. agency securities 54,136 6.7 37,509 4.9 Mortgage-backed securities - agency 489,491 60.2 448,150 58.3 Mortgage-backed securities - non-agency 42,514 5.2 20,754 2.7 State and municipal securities 66,256 8.2 94,636 12.3 Collateralized loan obligations 22,695 2.8 — — Corporate securities 84,395 10.4 85,955 11.2 Total investment securities, available for sale, at fair value $ 812,285 100.0 % $ 768,234 100.0 % The following table sets forth the book value, maturities and weighted average yields for our investment portfolio at March 31, 2023. The book value for investment securities classified as available for sale is equal to fair market value. 49 Table of Contents (dollars in thousands) Book value % of total Weighted average yield Investment securities available for sale: U.S. Treasury securities: Maturing within one year $ 1,024 0.1 % 3.64 % Maturing in one to five years 51,774 6.4 1.96 Maturing in five to ten years — — — Maturing after ten years — — — Total U.S. Treasury securities $ 52,798 6.5 % 1.99 % U.S. government sponsored entities and U.S. agency securities: Maturing within one year $ 9,992 1.2 % 5.19 % Maturing in one to five years 26,064 3.2 2.70 Maturing in five to ten years 18,080 2.3 4.28 Maturing after ten years — — — Total U.S. government sponsored entities and U.S. agency securities $ 54,136 6.7 % 3.67 % Mortgage-backed securities - agency: Maturing within one year $ 7,409 0.9 % 3.71 % Maturing in one to five years 192,827 23.7 3.39 Maturing in five to ten years 166,379 20.5 3.82 Maturing after ten years 122,876 15.1 3.03 Total mortgage-backed securities - agency $ 489,491 60.2 % 3.44 % Mortgage-backed securities - non-agency: Maturing within one year $ — — % — % Maturing in one to five years 10,092 1.2 1.97 Maturing in five to ten years — — — Maturing after ten years 32,422 4.0 4.01 Total mortgage-backed securities - non-agency $ 42,514 5.2 % 3.49 % State and municipal securities (1) : Maturing within one year $ 1,527 0.2 % 3.96 % Maturing in one to five years 11,854 1.4 2.56 Maturing in five to ten years 32,470 4.1 3.31 Maturing after ten years 20,405 2.5 3.12 Total state and municipal securities $ 66,256 8.2 % 3.14 % Collateralized loan obligations: Maturing within one year $ 11,121 1.3 % 1.03 % Maturing in one to five years 11,574 1.5 2.94 Maturing in five to ten years — — — Maturing after ten years — — — Total collateralized loan obligations $ 22,695 2.8 % 2.00 % Corporate securities: Maturing within one year $ — — % — % Maturing in one to five years 9,655 1.2 3.25 Maturing in five to ten years 74,740 9.2 3.43 Maturing after ten years — — — Total corporate securities $ 84,395 10.4 % 3.41 % Total investment securities, available for sale $ 812,285 100.0 % 3.30 % (1) Weighted average yield for tax-exempt securities are presented on a tax-equivalent basis assuming a federal income tax rate of 21%. 50 Table of Contents The table below presents the credit ratings for our investment securities classified as available for sale, at fair value, at March 31, 2023. Amortized Estimated Average credit rating (dollars in thousands) cost fair value AAA AA+/- A+/- BBB+/- <BBB- Not Rated Investment securities available for sale: U.S. Treasury securities $ 56,913 $ 52,798 $ 52,553 $ 245 $ — $ — $ — $ — U.S. government sponsored entities and U.S. agency securities 57,925 54,136 44,000 10,136 — — — — Mortgage-backed securities - agency 559,278 489,491 10 489,481 — — — — Mortgage-backed securities - non-agency 46,300 42,514 42,514 — — — — — State and municipal securities 72,732 66,256 156 60,510 707 738 — 4,145 Collateralized loan obligations 22,695 22,695 14,361 5,990 — 2,344 — — Corporate securities 95,219 84,395 — 32,004 25,998 26,393 — — Total investment securities, available for sale $ 911,062 $ 812,285 $ 153,594 $ 598,366 $ 26,705 $ 29,475 $ — $ 4,145 Cash and Cash Equivalents. Cash and cash equivalents decreased $22.3 million to $138.3 million at March 31, 2023 compared to December 31, 2022, as the excess liquidity was used to fund loan growth during the quarter. Liabilities. At March 31, 2023, liabilities totaled $7.15 billion compared to $7.10 billion at December 31, 2022. Deposits. We emphasize developing total client relationships with our customers in order to increase our retail and commercial core deposit bases, which are our primary funding sources. Our deposits consist of noninterest-bearing and interest-bearing demand, savings and time deposit accounts. Total deposits increased $60.5 million to $6.43 billion at March 31, 2023, as compared to December 31, 2022. Interest rate promotions offered during the first quarter of 2023 on money market and time deposit products resulted in increases in balances of $79.7 million and $143.6 million, respectively, at March 31, 2023, compared to December 31, 2022. These increases were partially offset by a decrease in noninterest-bearing demand account balances of $146.4 million, as a result of increasing deposit rates in response to the rate increases announced by the Federal Reserve. (dollars in thousands) March 31, 2023 December 31, 2022 Book Value % of Total Book Value % of Total Noninterest-bearing demand $ 1,215,758 18.9 % $ 1,362,158 21.4 % Interest-bearing: Checking 2,502,827 39.0 2,494,073 39.2 Money market 1,263,813 19.7 1,184,101 18.6 Savings 636,832 9.9 661,932 10.4 Time 805,971 12.5 662,388 10.4 Total deposits $ 6,425,201 100.0 % $ 6,364,652 100.0 % 51 Table of Contents The following table summarizes our average deposit balances and weighted average rates for the three months ended March 31, 2023 and 2022: Three months ended March 31, 2023 Three months ended March 31, 2022 (dollars in thousands) Average Balance Weighted Average Rate Average Balance Weighted Average Rate Deposits: Noninterest-bearing demand $ 1,250,899 — $ 1,435,020 — Interest-bearing: Checking 2,497,714 2.65 % 2,284,700 0.18 % Money market 1,188,478 2.26 879,624 0.10 Savings 650,138 0.15 694,885 0.03 Time, insured 573,206 1.64 482,043 0.51 Time, uninsured 129,833 2.50 144,953 0.53 Time, brokered 14,572 2.39 21,437 1.10 Total interest-bearing 5,053,941 2.12 4,507,642 0.19 Total deposits $ 6,304,840 1.70 % $ 5,942,662 0.15 % The Company estimates that uninsured deposits (1) totaled $1.32 billion, or 21% of total deposits, at March 31, 2023 compared to $1.55 billion, or 24%, at December 31, 2022. The following table sets forth the maturity of uninsured time deposits as of March 31, 2023: (dollars in thousands) Amount Three months or less $ 23,445 Three to six months 6,856 Six to 12 months 71,865 After 12 months 37,869 Total $ 140,035 (1) Uninsured deposits include the Call Report estimate of uninsured deposits less affiliate deposits, estimated insured portion of servicing deposits, additional structured FDIC coverage and collateralized deposits. Capital Resources and Liquidity Management Capital Resources. Shareholders’ equity is influenced primarily by earnings, dividends, issuances and redemptions of common and preferred stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized holding gains or losses, net of taxes, on available-for-sale investment securities and cash flow hedges. Shareholders’ equity increased $17.1 million to $775.6 million at March 31, 2023 as compared to December 31, 2022. The Company generated net income of $21.8 million during 2023 and accumulated other comprehensive loss decreased by $6.0 million. Offsetting these increases to shareholders’ equity were dividends to common shareholders of $6.7 million, dividends to preferred shareholders of $2.2 million and repurchases of common stock of $2.8 million. The Company has a share repurchase program, whereby the Board of Directors authorized the Company to repurchase up to $25.0 million of its common stock. This program terminates December 31, 2023. As of March 31, 2023, $2.8 million, or 124,266 shares of the Company’s common stock, had been repurchased under the program, with approximately $22.2 million of remaining repurchase authority. Liquidity Management. Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders. 52 Table of Contents Integral to our liquidity management is the administration of short-term borrowings. To the extent we are unable to obtain sufficient liquidity through core deposits, we seek to meet our liquidity needs through wholesale funding or other borrowings on either a short- or long-term basis. Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction, which represents the amount of the Bank’s obligation. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. Investment securities with a carrying amount of $33.9 million and $46.1 million at March 31, 2023 and December 31, 2022, respectively, were pledged for securities sold under agreements to repurchase. The table below presents our sources of liquidity as of March 31, 2023 and December 31, 2022: (dollars in millions) March 31, 2023 December 31, 2022 Cash and cash equivalents $ 138.3 $ 160.6 Unpledged securities 310.3 209.2 FHLB committed liquidity 932.8 997.4 FRB discount window availability 207.7 12.2 Total Estimated Liquidity $ 1,589.1 $ 1,379.4 Conditional Funding Based on Market Conditions Additional credit facility $ 250.0 $ 250.0 Brokered CDs (additional capacity) $ 500.0 $ 500.0 The Company is a corporation separate and apart from the Bank and, therefore, must provide for its own liquidity. The Company’s main source of funding is dividends declared and paid to it by the Bank. There are statutory, regulatory and debt covenant limitations that affect the ability of the Bank to pay dividends to the Company. Management believed at March 31, 2023, that these limitations will not impact our ability to meet our ongoing short-term cash obligations. Regulatory Capital Requirements We are subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action”, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies. In December 2018, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the CECL accounting standard. In March 2020, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company is adopting the capital transition relief over the permissible five-year period. At March 31, 2023, the Company and the Bank exceeded the regulatory minimums and met the regulatory definition of well-capitalized. 53 Table of Contents The following table presents the Company's and the Bank’s capital ratios and the minimum requirements at March 31, 2023: Ratio Actual Minimum Regulatory Requirements (1) Well Capitalized Total risk-based capital ratio Midland States Bancorp, Inc. 12.46 % 10.50 % N/A Midland States Bank 11.59 10.50 10.00 % Tier 1 risk-based capital ratio Midland States Bancorp, Inc. 10.25 8.50 N/A Midland States Bank 10.76 8.50 8.00 Common equity tier 1 risk-based capital ratio Midland States Bancorp, Inc. 7.84 7.00 N/A Midland States Bank 10.76 7.00 6.50 Tier 1 leverage ratio Midland States Bancorp, Inc. 9.54 4.00 N/A Midland States Bank 10.02 4.00 5.00 (1) Total risk-based capital ratio, Tier 1 risk-based capital ratio and Common equity tier 1 risk-based capital ratio include the capital conservation buffer of 2.5%. Quantitative and Qualitative Disclosures About Market Risk Market Risk. Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We are primarily exposed to interest rate risk as a result of offering a wide array of financial products to our customers and secondarily to price risk from investments in securities backed by mortgage loans. Interest Rate Risk. Interest rate risk is the risk to earnings arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (reprice risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR (basis risk). We actively manage interest rate risk, as changes in market interest rates may have a significant impact on reported earnings. Changes in market interest rates may result in changes in the fair market value of our financial instruments, cash flows, and net interest income. We seek to achieve consistent growth in net interest income while managing volatility arising from shifts in market interest rates. Our Board of Directors’ Risk Policy and Compliance Committee oversees interest rate risk, as well as the establishment of risk measures, limits, and policy guidelines for managing the amount of interest rate risk and its effect on net interest income. The Committee meets quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the board of directors’ approved risk limits. Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints. An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin. Interest rate risk measurement is calculated and reported to the Risk Policy and Compliance Committee at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk. 54 Table of Contents We use Net Interest Income at Risk (“NII at Risk”) to model interest rate risk utilizing various assumptions for assets, liabilities, and derivatives. NII at Risk uses net interest income simulation analysis which involves forecasting net interest earnings under a variety of scenarios including changes in the level of interest rates, the shape of the yield curve, and spreads between market interest rates. The sensitivity of net interest income to changes in interest rates is measured using numerous interest rate scenarios including shocks, gradual ramps, curve flattening, curve steepening as well as forecasts of likely interest rates scenarios. Modeling the sensitivity of net interest earnings to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. To the extent that actual performance is different than what was assumed, actual net interest earnings sensitivity may be different than projected. We use a data warehouse to study interest rate risk at a transactional level and use various ad-hoc reports to continuously refine assumptions. Assumptions and methodologies regarding administered rate liabilities (e.g., savings accounts, money market accounts and interest-bearing checking accounts), balance trends, and repricing relationships reflect our best estimate of expected behavior and these assumptions are reviewed periodically. The following table shows NII at Risk at the dates indicated: Net interest income sensitivity (Shocks) Immediate change in rates (dollars in thousands) -100 +100 +200 March 31, 2023: Dollar change $ (10,614) $ 9,258 $ 18,380 Percent change (3.8) % 3.3 % 6.5 % December 31, 2022: Dollar change $ (12,560) $ 10,814 $ 21,357 Percent change (4.2) % 3.6 % 7.2 % We report NII at Risk to isolate the change in income related solely to interest-earning assets and interest-bearing liabilities. The NII at Risk results included in the table above reflect the analysis used quarterly by management. It models −100, +100 and +200 basis point parallel shifts in market interest rates, implied by the forward yield curve over the next twelve months. We were within board policy limits for the -100, +100 and +200 basis point scenarios at March 31, 2023. Tolerance levels for risk management require the continuing development of remedial plans to maintain residual risk within approved levels as we adjust the balance sheet. NII at Risk reported at March 31, 2023 projects that our earnings exhibit reduced sensitivity to changes in interest rates for all three scenarios compared to December 31, 2022. Price Risk. Price risk represents the risk of loss arising from adverse movements in the prices of financial instruments that are carried at fair value and are subject to fair value accounting. We have price risk from mortgage-backed securities, derivative instruments, and equity investments. ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The quantitative and qualitative disclosures about market risk are included under “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures about Market Risk”. 55 Table of Contents