1ST SOURCE CORP 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The purpose of this analysis is to provide the reader with information relevant to understanding and assessing our results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis you are encouraged to review the consolidated financial statements and statistical data presented in this document. FORWARD-LOOKING STATEMENTS This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. Words such as “believe,” “contemplate,” “seek,” “estimate,” “plan,” “project,” “anticipate,” “possible,” “assume,” “expect,” “intend,” “targeted,” “continue,” “remain,” “will,” “should,” “indicate,” “would,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements provide current expectations or forecasts of future events and are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation, and do not undertake, to update, revise, or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made. We have expressed our expectations, beliefs, and projections in good faith and we believe they have a reasonable basis. However, we make no assurances that our expectations, beliefs, or projections will be achieved or accomplished. The results or outcomes indicated by our forward-looking statements may not be realized due to a variety of factors, including, without limitation, the following: • Local, regional, national, and international economic conditions and the impact they may have on us and our clients and our assessment of that impact. • Changes in the level of nonperforming assets and charge-offs. • Changes in estimates of future cash reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements. • The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board. • Inflation, interest rate, securities market, and monetary fluctuations. • Political instability. • Acts of war or terrorism. • The spread of infectious diseases or pandemics. • Substantial changes in the cost of fuel. • The timely development and acceptance of new products and services and perceived overall value of these products and services by others. • Changes in consumer spending, borrowings, and savings habits. • Changes in the financial performance and/or condition of our borrowers. • Technological changes. • Acquisitions and integration of acquired businesses. • The ability to increase market share and control expenses. • The ability to expand effectively into new markets that we target. • Changes in the competitive environment among bank holding companies. • The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, insurance, and climate change) with which we and our subsidiaries must comply. • The effect of changes in accounting policies and practices and auditing requirements, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standard setters. 17 Table of Contents • Changes in our organization, compensation, and benefit plans. • The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquires and the results of regulatory examinations or reviews. • Greater than expected costs or difficulties related to the integration of new products and lines of business. • Our success at managing the risks described in Item 1A. Risk Factors. APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) and follow general practices within the industries in which we operate. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates or judgments reflect management’s view of the most appropriate manner in which to record and report our overall financial performance. Because these estimates or judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experience. As such, changes in these estimates, judgments, and/or assumptions may have a significant impact on our financial statements. All accounting policies are important, and all policies described in Part II, Item 8, Financial Statements and Supplementary Data – Note 1 of the Notes to Consolidated Financial Statements (Note 1), should be reviewed for a greater understanding of how our financial performance is recorded and reported. We have identified the following two policies as being critical because they require management to make particularly difficult, subjective, and/or complex estimates or judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the determination of the allowance for loan and lease losses and fair value measurements. Management believes it has used the best information available to make the estimations or judgments necessary to value the related assets and liabilities. Actual performance that differs from estimates or judgments and future changes in the key variables could change future valuations and impact net income. Management has reviewed the application of these policies with the Audit Committee of the Board of Directors. Following is a discussion of the areas we view as our most critical accounting policies. Allowance for Credit Losses — The allowance for credit losses represents management’s estimate of expected credit losses over the expected contractual life of our existing loan and lease portfolio and the establishment of an allowance that is sufficient to absorb those losses. As of December 31, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaced the incurred loss methodology with an expected loss methodology that is referred to as current expected credit losses (CECL). The new accounting standard was implemented at a time when we were experiencing conditions without historical precedent. Determining the appropriateness of the allowance is complex and requires judgement by management about the effect of matters that are inherently uncertain. In determining an appropriate allowance, management makes numerous judgments, assumptions, and estimates which are inherently subjective, as they require material estimates that may be susceptible to significant change. These estimates are derived based on continuous review of the loan and lease portfolio, assessments of client performance, movement through delinquency stages, probability of default, losses given default, collateral values, and disposition, as well as expected cash flows, economic forecasts, and qualitative factors, such as changes in current economic conditions. As stated in Note 1, we segment our loan and lease portfolios based on similar risk characteristics for collective evaluation using a non-discounted cash flow approach to estimate expected losses. We use a cohort cumulative loss methodology for select loan and lease segments. The cohort methodology has a steady state assumption. For other segments, we use a PD/LGD (probability of default/loss given default) model which aligns well with our internal risk rating system. When we observe limitations in the data or models, we use model overlays to make adjustments to model outputs to capture a particular risk or compensate for a known limitation, or in the case of the cohort model, changes in the steady state assumptions. Actual losses may differ from estimated amounts due to model inefficiencies or management’s inability to adequately determine appropriate model adjustment factors. The accounting standard further requires management to use forecasts about future economic conditions to determine the expected credit losses over the remaining life of the asset. Forecast adjustments are fundamentally difficult to establish and, in the current environment, due to uncertainty given the ongoing pandemic and the spread of the highly contagious Omicron COVID variant, persistent supply chain bottlenecks, and inflationary concerns, the task is even more formidable. Patterns from our history of normal business cycles are far less analogous to present economic conditions and consequently less relevant. We use a two-year reasonable and supportable period across all loan and lease segments to forecast economic conditions. We believe the two-year time horizon aligns with available industry guidance and various forecasting sources. Following this two-year forecasting period, we use a two-year reversion period to revert forecast rates to historical loss rates. 18 Table of Contents In assessing the factors used to derive an appropriate allowance, management benefits from a lengthy organizational history and experience with credit decisions and related outcomes, but is new to the application of CECL. We have been diligent in our efforts to gain a thorough understanding of the accounting standard, and have reviewed our portfolios, loan segmentations, methodologies and models and believe we have made appropriate and prudent decisions. Nonetheless, if management’s underlying assumptions prove to be inaccurate, the allowance for loan and lease losses would have to be adjusted. Our accounting policies related to the allowance for credit losses is disclosed in Note 1 under the heading “Allowance for Credit Losses.” Fair Value Measurements — We use fair value measurements to record certain financial instruments and to determine fair value disclosures. Available-for-sale securities, trading account securities, mortgage loans held for sale, and interest rate swap agreements are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve write-downs of, or specific reserves against, individual assets. GAAP establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable. Observable inputs reflect market-driven or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market data. For financial instruments that trade actively and have quoted market prices or observable market data, there is minimal subjectivity involved in measuring fair value. When observable market prices and data are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we use valuation techniques that require more management judgment to estimate the appropriate fair value measurement. Fair value is discussed further in Note 1 under the heading “Fair Value Measurements” and in Note 21, “Fair Value Measurements.” CORONAVIRUS (COVID-19) IMPACT The following is a description of the impact the Coronavirus (COVID-19) pandemic is having on our financial condition and results of operations and certain risks to our business that the pandemic creates or exacerbates. Operational Impact Pursuant to our preexisting disaster recovery plan addressing potential pandemic outbreaks, we created a dedicated executive COVID-19 response team that is closely monitoring developments and providing guidance for additional precautions and initiatives. Initially, we divided departments among various locations to help ensure that infection would not spread across entire departments. Additionally, we are encouraging virtual meetings and conference calls in place of in-person meetings, including our annual shareholder meeting which was held virtually again this year. Employees with health conditions putting them at higher risk of adverse effects from coronavirus infection were given the opportunity to work remotely. Travel was restricted and we promoted social distancing, frequent hand washing, disinfection of all surfaces, and the use of masks or nose and mouth coverings were mandated in all of our locations. We continue to offer paid time off to all of our colleagues to schedule vaccinations. As of early-February 2022, over 80% of our colleagues had received at least their first dose of vaccine. In April 2021, we fully reopened our banking center lobbies with safe social distancing and mask guidelines in place for the safety of our colleagues and clients. Banking center drive-ups, ATMs and online/mobile banking services continue to provide a more physically distanced alternative. Although infection rates in the communities we serve vary by region, the positive impact that vaccinations have had on curbing the spread of the virus allowed us to begin bringing departments back together and to loosen travel restrictions for colleagues who are fully vaccinated. Given the COVID-19 variants currently spreading, we are strongly advising our colleagues who are fully vaccinated to get vaccination boosters. To show our appreciation for our colleagues who have been vaccinated, we announced a one-time reward of 10 shares of 1st Source Corporation common stock and $250 cash. We will continue to make prudent decisions for the safety of our colleagues and our clients following recommended Centers for Disease Control and local health department guidance. We are hopeful that infection rates will decline in the communities we serve as the percentage of fully vaccinated and boosted individuals continues to increase. Loan and lease modifications We began receiving requests from our borrowers for loan and lease deferrals in March 2020 which declined over the remainder of 2020 and throughout 2021. Modifications include the deferral of principal payments or the deferral of principal and interest payments for terms generally 90 - 180 days. Requests are evaluated individually and approved modifications are based on the unique circumstances of each borrower. We are committed to working with our clients to allow time to work through the 19 Table of Contents challenges of this pandemic. The following table shows coronavirus loan and lease modification balances in deferment as of December 31, 2021 and December 31, 2020, respectively. COVID-19 Related Loan and Lease Modifications (Dollars in millions) December 31, 2021 December 31, 2020 Auto and light truck rental $ — $ 5 Specialty vehicle (1) — 21 Medium and heavy duty truck — — Aircraft — 13 Construction — 7 Commercial — 83 Residential real estate and home equity — — Consumer — — Total loans and leases $ — $ 129 (1) Includes buses, step vans and funeral cars. Paycheck Protection Program (PPP) and Liquidity As part of the CARES Act, approved by President Trump on March 27, 2020 and extended on July 4, 2020, the Small Business Administration (SBA) was authorized to guarantee loans under the PPP through August 8, 2020 for businesses who met the necessary eligibility requirements in order to keep their workers on the payroll. We began accepting applications on April 3, 2020 and disbursed the final PPP loan on August 25, 2020 from the first round. On December 27, 2020, the Coronavirus Response and Relief Supplemental Appropriations Act was approved which authorized a second round of PPP loans. We disbursed the final PPP loan on May 28, 2021 from the second round. PPP loans are fully guaranteed by the SBA and as such do not represent a credit risk. The following table shows PPP loans of December 31, 2021. Number of Loans $ of Loans Originated Forgiveness/ Payments $ of Loans at December 31, 2021 2020 PPP Loans 3,540 $ 597,451 $ 596,673 $ 778 2021 PPP Loans 3,239 261,459 186,446 75,013 Total 6,779 $ 858,910 $ 783,119 $ 75,791 As of December 31, 2021, total PPP loans were $73.08 million which is net of an unearned discount of $2.71 million and located within the commercial and agricultural portfolio. At December 31, 2021, specialty finance customers had $19.33 million of PPP loans and traditional commercial banking customers had $53.75 million of PPP loans. On October 8, 2020, the SBA announced a streamlined loan forgiveness application for loans $50,000 or less. Of the 3,540 PPP loans we originated in 2020, 1,972 loans were for $50,000 or less. Of the 3,239 PPP loans we originated in 2021, 2,424 loans were for $50,000 or less. As of December 31, 2021, we had submitted loan forgiveness requests to the SBA for over 99% of the total PPP loan amounts we funded during 2020 and over 75% of the total PPP loan amounts we funded during 2021. We were able to secure loans for over 500 minority- and women-owned businesses, which represents approximately 15% of our overall efforts in this latest round of PPP funding. Additionally, we helped fund almost 400 PPP loans to new customers during 2021. On April 9, 2020, the FDIC, Federal Reserve and OCC created the Paycheck Protection Program Liquidity Facility (PPPLF) to bolster the effectiveness of the PPP by providing liquidity to and neutralizing the regulatory capital effects on participating financial institutions. As of December 31, 2021, we had not utilized the PPPLF. Asset impairment Our mortgage servicing rights (MSRs) had experienced a decrease in their fair value as of December 31, 2020 resulting in 2020 impairment charges of $0.81 million due to lower mortgage rates leading to faster prepayment speeds. During the twelve months ended December 31, 2021, we recognized $0.81 million of impairment recoveries due to reduced prepayment speeds. We will continue to evaluate MSRs at each reporting date to determine whether further valuation allowances are appropriate. At this time, we do not believe there exists any impairment to our intangible assets, long-lived assets, right of use assets, or available-for-sale investment securities due to the COVID-19 pandemic. Risks See Part I. Business, Item 1A, Risk Factors for more information. 20 Table of Contents Allowance for loan and lease losses During 2021, except for the bus segment of our auto and light truck portfolio, we experienced stable to improving credit quality. Special attention loan balances decreased $78.48 million year-to-date and nonperforming loans decreased $21.55 million year-to-date. The impact of COVID-19 has been particularly harsh on the bus segment of our auto and light truck portfolio where we continued to experience higher than normal downgrades, movement to nonaccrual status and charge-offs. During the fourth quarter, we charged-off an additional $2.74 million on bus accounts bringing year-to-date net charge-offs to $7.16 million. Many of our customers received long-awaited Coronavirus Economic Relief for Transportation Services (“CERTS”) funds and most have returned to normalized payment terms. As of year-end, we had no delinquency in the bus segment. Our local market customers have been buoyed in the short-term with funds from the PPP program. Thus far, we have not seen many downgrades or defaults in our commercial lending, but this may change, if businesses struggle to get back to normal or consumer preferences potentially change. During the last recession, we noted a delayed impact on our commercial lending as compared to our specialty finance lending. We also remain concerned about segments of our commercial real estate portfolio, particularly the hotel sector and commercial buildings and retail property. Many of our local hotel customers report improved occupancy but at somewhat lower rates. Our total loan losses remain moderate with net charge-offs of $5.15 million for the quarter and $8.86 million year-to-date. During the third quarter, we noted the growth momentum was softening in the U.S. a little earlier than we previously projected, which led us to revise our forecast adjustment to reflect the slowing economy. We reviewed our forecast adjustment at year-end and believe the assumptions remain pertinent. We continue to maintain the allowance for credit losses at a level we deem appropriate as some of the current and future downgrades and defaults may result in losses. See Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “Provision and Allowance for Credit Losses” for more information. EARNINGS SUMMARY Net income available to common shareholders in 2021 was $118.53 million, up from $81.44 million in 2020 and up from $91.96 million in 2019. Diluted net income per common share was $4.70 in 2021, $3.17 in 2020, and $3.57 in 2019. Return on average total assets was 1.53% in 2021 compared to 1.14% in 2020, and 1.41% in 2019. Return on average common shareholders’ equity was 13.07% in 2021 versus 9.41% in 2020, and 11.50% in 2019. Net income in 2021, as compared to 2020, was positively impacted by a $10.82 million or 4.79% increase in net interest income, a $40.30 million or 111.95% decrease in the provision for credit losses, and a $1.22 million or 0.65% decrease in noninterest expense which was offset by a $3.80 million or 3.65% decrease in noninterest income and a $11.45 million or 46.01% increase in income tax expense. Net income in 2020 was positively impacted by a $1.95 million or 0.87% increase in net interest income, a $2.76 million or 2.73% increase in noninterest income, a $1.64 million or 0.87% decrease in noninterest expense, and a $3.26 million or 11.58% decrease in income tax expense which was offset by a $20.17 million or 127.38% increase in provision for credit losses over 2019. Dividends paid on common stock in 2021 amounted to $1.21 per share, compared to $1.13 per share in 2020, and $1.10 per share in 2019. The level of earnings reinvested and dividend payouts are determined by the Board of Directors based on management’s assessment of future growth opportunities and the level of capital necessary to support them. Net Interest Income — Our primary source of earnings is net interest income, the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities while deposits and borrowings represent the major portion of interest-bearing liabilities. For purposes of the following discussion, comparison of net interest income is done on a tax-equivalent basis, which provides a common basis for comparing yields on earning assets exempt from federal income taxes to those which are fully taxable. Net interest margin (the ratio of net interest income to average earning assets) is significantly affected by movements in interest rates and changes in the mix of earning assets and the liabilities that fund those assets. Net interest margin on a fully taxable- equivalent basis was 3.23% in 2021, compared to 3.39% in 2020 and 3.68% in 2019. Net interest income was $236.64 million for 2021, compared to $225.82 million for 2020 and $223.87 million for 2019. Tax-equivalent net interest income totaled $237.10 million for 2021, up $10.73 million from the $226.36 million reported in 2020. Tax-equivalent net interest income for 2020 was up $1.81 million from the $224.55 reported for 2019. During 2021, average earning assets increased $654.39 million or 9.79% while average interest-bearing liabilities increased $238.15 million or 5.24% over the comparable period in 2020. The yield on average earning assets decreased 46 basis points to 3.48% for 2021 from 3.94% for 2020 primarily due to lower rates on loans and leases. Total cost of average interest-bearing liabilities decreased 44 basis points to 0.38% during 2021 from 0.82% in 2020 as a result of the lower interest rate environment. The result to the fully taxable-equivalent net interest margin was a decrease of 16 basis points. The largest contributor to the decrease in the yield on average earning assets in 2021 was the decline in the investment securities yield and the other investments yield primarily due to market conditions as a result of 2020 Federal Reserve interest rate decreases and increases in excess liquidity due to government stimulus programs. 21 Table of Contents During 2021, the tax-equivalent yield on investment securities available-for-sale decreased 53 basis points to 1.28% while the average balance grew $385.32 million or 36.42% with the largest increases in U.S. treasury and federal agency securities and mortgage-backed securities due to continued investment of excess liquidity. Average mortgages held for sale decreased $3.60 million or 17.46% during 2021 while the yield decreased 28 basis points. Average other investments, which include federal funds sold, time deposits with other banks, Federal Reserve Bank excess balances, Federal Reserve Bank and Federal Home Loan Bank (FHLB) stock and commercial paper increased $298.29 million or 209.89% during 2021 while the yield decreased 59 basis points. The average balance increase in other investments was primarily a result of excess liquidity held at the Federal Reserve Bank. The yield on net loans and leases was positively impacted by 15 basis points in 2021 due to the recognition of $16.84 million of fees on PPP loans which have been forgiven by the SBA or paid down by customers offset by PPP loan balances outstanding which earn interest at 1.00%. Average net loans and leases decreased $25.62 million or 0.47% in 2021 from 2020 while the yield decreased to 4.32%. The largest contributor to the decrease in average net loans and leases was Paycheck Protection Program average loan balances of $293.99 million in 2021 compared to $376.43 million in 2020. Average interest-bearing deposits increased $254.46 million or 6.05% during 2021 while the effective rate paid on those deposits decreased 44 basis points. The increased average balance was primarily due to the impact of government stimulus programs on consumer savings levels. The decline in the average cost of interest-bearing deposits was primarily the result of lower rates and a shift in the deposit mix. Average noninterest-bearing demand deposits increased $351.47 million or 22.96% during 2021 due primarily to PPP loan fundings as business customers remain cautious with their funds and spending. Average short-term borrowings decreased $14.44 million or 7.18% during 2021 while the effective rate paid decreased 20 basis points. The decrease in short-term borrowings was primarily the result of lower borrowings with the Federal Home Loan Bank. Interest paid on subordinated notes decreased 17 basis points due to a variable rate on one tranche. Average long-term debt and mandatorily redeemable securities balances decreased $1.87 million or 2.32% during 2021 as the effective rate decreased 41 basis points primarily due to lower rates on mandatorily redeemable securities. 22 Table of Contents The following table provides an analysis of net interest income and illustrates interest income earned and interest expense charged for each major component of interest earning assets and the interest bearing liabilities. Yields/rates are computed on a tax-equivalent basis, using a 21% rate. Nonaccrual loans and leases are included in the average loan and lease balance outstanding. 2021 2020 2019 (Dollars in thousands) Average Balance Interest Income/Expense Yield/Rate Average Balance Interest Income/Expense Yield/Rate Average Balance Interest Income/Expense Yield/Rate ASSETS Investment securities available-for-sale: Taxable $ 1,410,797 $ 17,767 1.26 % $ 1,009,794 $ 18,080 1.79 % $ 945,396 $ 20,946 2.22 % Tax-exempt (1) 32,583 741 2.27 % 48,266 1,105 2.29 % 69,263 1,662 2.40 % Mortgages held for sale 17,026 448 2.63 % 20,628 600 2.91 % 15,601 610 3.91 % Loans and leases, net of unearned discount (1) 5,437,817 234,902 4.32 % 5,463,436 242,505 4.44 % 5,000,161 258,113 5.16 % Other investments 440,416 1,373 0.31 % 142,122 1,284 0.90 % 74,252 2,232 3.01 % Total earning assets (1) 7,338,639 255,231 3.48 % 6,684,246 263,574 3.94 % 6,104,673 283,563 4.65 % Cash and due from banks 77,275 71,626 67,726 Allowance for loan and lease losses (139,141) (130,776) (105,340) Other assets 454,374 494,913 461,215 Total assets $ 7,731,147 $ 7,120,009 $ 6,528,274 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing deposits $ 4,460,359 $ 12,276 0.28 % $ 4,205,904 $ 30,459 0.72 % $ 4,105,097 $ 50,495 1.23 % Short-term borrowings: Securities sold under agreements to repurchase 180,610 112 0.06 % 173,398 317 0.18 % 139,101 356 0.26 % Other short-term borrowings 6,119 3 0.05 % 27,767 200 0.72 % 66,810 1,578 2.36 % Subordinated notes 58,764 3,267 5.56 % 58,764 3,367 5.73 % 58,764 3,677 6.26 % Long-term debt and mandatorily redeemable securities 78,845 2,476 3.14 % 80,715 2,868 3.55 % 71,133 2,905 4.08 % Total interest-bearing liabilities 4,784,697 18,134 0.38 % 4,546,548 37,211 0.82 % 4,440,905 59,011 1.33 % Noninterest-bearing deposits 1,882,168 1,530,698 1,171,639 Other liabilities 112,291 145,807 106,945 Shareholders’ equity 906,951 865,278 799,736 Noncontrolling interests 45,040 31,678 9,049 Total liabilities and equity $ 7,731,147 $ 7,120,009 $ 6,528,274 Less: Fully tax-equivalent adjustments (459) (543) (686) Net interest income/margin (GAAP-derived) (1) $ 236,638 3.22 % $ 225,820 3.38 % $ 223,866 3.67 % Fully tax-equivalent adjustments 459 543 686 Net interest income/margin - FTE (1) $ 237,097 3.23 % $ 226,363 3.39 % $ 224,552 3.68 % (1) See “Reconciliation of Non-GAAP Financial Measures” for more information on this performance measure/ratio. 23 Table of Contents Reconciliation of Non-GAAP Financial Measures — Our accounting and reporting policies conform to GAAP in the United States and prevailing practices in the banking industry. However, certain non-GAAP performance measures are used by management to evaluate and measure the Company’s performance. These include taxable-equivalent net interest income (including its individual components) and net interest margin (including its individual components). Management believes that these measures provide users of the Company’s financial information a more meaningful view of the performance of the interest-earning assets and interest-bearing liabilities. Management reviews yields on certain asset categories and the net interest margin of the Company and its banking subsidiaries on a fully taxable-equivalent (“FTE”) basis. In this non-GAAP presentation, net interest income is adjusted to reflect tax-exempt interest income on an equivalent before-tax basis. This measure ensures comparability of net interest income arising from both taxable and tax-exempt sources. The following table shows the reconciliation of non-GAAP financial measures for the most recent three years ended December 31. (Dollars in thousands) 2021 2020 2019 Calculation of Net Interest Margin (A) Interest income (GAAP) $ 254,772 $ 263,031 $ 282,877 Fully tax-equivalent adjustments: (B) - Loans and leases 319 333 375 (C) - Tax-exempt investment securities 140 210 311 (D) Interest income - FTE (A+B+C) 255,231 263,574 283,563 (E) Interest expense (GAAP) 18,134 37,211 59,011 (F) Net interest income (GAAP) (A-E) 236,638 225,820 223,866 (G) Net interest income - FTE (D-E) 237,097 226,363 224,552 (H) Total earning assets $ 7,338,639 $ 6,684,246 $ 6,104,673 Net interest margin (GAAP-derived) (F/H) 3.22 % 3.38 % 3.67 % Net interest margin - FTE (G/H) 3.23 % 3.39 % 3.68 % 24 Table of Contents The change in interest due to both rate and volume illustrated in the following table has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. The following table shows changes in tax-equivalent interest earned and interest paid, resulting from changes in volume and changes in rates. Increase (Decrease) due to (Dollars in thousands) Volume Rate Net 2021 compared to 2020 Interest earned on: Investment securities available-for-sale: Taxable $ 5,961 $ (6,274) $ (313) Tax-exempt (357) (7) (364) Mortgages held for sale (98) (54) (152) Loans and leases, net of unearned discount (1,133) (6,470) (7,603) Other investments 1,350 (1,261) 89 Total earning assets $ 5,723 $ (14,066) $ (8,343) Interest paid on: Interest-bearing deposits $ 1,741 $ (19,924) $ (18,183) Short-term borrowings: Securities sold under agreements to repurchase 13 (218) (205) Other short-term borrowings (90) (107) (197) Subordinated notes — (100) (100) Long-term debt and mandatorily redeemable securities (65) (327) (392) Total interest-bearing liabilities $ 1,599 $ (20,676) $ (19,077) Net interest income - FTE $ 4,124 $ 6,610 $ 10,734 2020 compared to 2019 Interest earned on: Investment securities available-for-sale: Taxable $ 1,355 $ (4,221) $ (2,866) Tax-exempt (484) (73) (557) Mortgages held for sale 169 (179) (10) Loans and leases, net of unearned discount 22,581 (38,189) (15,608) Other investments 1,232 (2,180) (948) Total earning assets $ 24,853 $ (44,842) $ (19,989) Interest paid on: Interest-bearing deposits $ 1,211 $ (21,247) $ (20,036) Short-term borrowings: Securities sold under agreements to repurchase 76 (115) (39) Other short-term borrowings (629) (749) (1,378) Subordinated notes — (310) (310) Long-term debt and mandatorily redeemable securities 365 (402) (37) Total interest-bearing liabilities $ 1,023 $ (22,823) $ (21,800) Net interest income - FTE $ 23,830 $ (22,019) $ 1,811 25 Table of Contents Noninterest Income — Noninterest income decreased $3.80 million or 3.65% in 2021 from 2020 following a $2.76 million or 2.73% increase in 2020 over 2019. The following table shows noninterest income for the most recent three years ended December 31. (Dollars in thousands) 2021 2020 2019 Noninterest income: Trust and wealth advisory $ 23,782 $ 21,114 $ 20,692 Service charges on deposit accounts 10,589 9,485 11,010 Debit card 18,125 14,983 14,209 Mortgage banking 11,822 15,674 4,698 Insurance commissions 7,247 7,025 6,761 Equipment rental 16,647 23,380 30,741 (Losses) gains on investment securities available-for-sale (680) 279 — Other 12,560 11,949 13,019 Total noninterest income $ 100,092 $ 103,889 $ 101,130 Trust and wealth advisory fees (which include investment management fees, estate administration fees, mutual fund fees, annuity fees, and fiduciary fees) increased $2.67 million or 12.64% in 2021 from 2020 compared to a $0.42 million or 2.04% increase in 2020 over 2019. Trust and wealth advisory fees are largely based on the number and size of client relationships and the market value of assets under management. The market value of trust assets under management at December 31, 2021 and 2020 was $5.33 billion and $4.74 billion, respectively. Strong stock market performance and new business results in 2021 helped improve the market value of trust assets under management. At December 31, 2021, these trust assets were comprised of $3.44 billion of personal and agency trusts and estate administration assets, $1.21 billion of employee benefit plan assets, $556.63 million of individual retirement accounts, and $115.28 million of custody assets. Service charges on deposit accounts increased by $1.10 million or 11.64% in 2021 from 2020 compared to a decrease of $1.53 million or 13.85% in 2020 from 2019. The increase in service charges on deposit accounts in 2021 was primarily due to higher customer ATM fees from an increased volume of transactions and a change in the fees charged. As well as increased business deposit account fees offset by a decrease in consumer nonsufficient fund transactions. Economic recovery led to a corresponding improvement in consumer and business activity. The decrease in service charges on deposit accounts in 2020 was primarily due to a lower volume of nonsufficient fund transactions and reduced ATM fees. Debit card income improved $3.14 million or 20.97% in 2021 from 2020 compared to an increase of $0.77 million or 5.45% in 2020 from 2019. The increase in 2021 and 2020 was mainly the result of an increased volume of debit card transactions. Debit card transactions in 2021 were helped significantly by the reopened economy driving increased consumer activity. Mortgage banking income decreased $3.85 million or 24.58% in 2021 over 2020, compared to a $10.98 million or 233.63% increase in 2020 from 2019. We had $0.81 million of MSR impairment recoveries in 2021 as a result of reduced prepayment speeds compared to $0.81 million of MSR impairment charges in 2020 and none in 2019. During 2021, 2020 and 2019, we determined that no permanent write-down was necessary for previously recorded impairment on MSRs. During 2021, mortgage banking income decreased primarily due to reduced margins on a lower volume of loan sales. During 2020, mortgage banking income increased primarily due to better margins on a higher volume of loan sales as a result of more loans originated for the secondary market. Insurance commissions grew $0.22 million or 3.16% in 2021 compared to 2020 and improved $0.26 million or 3.90% in 2020 compared to 2019. The increase in 2021 was primarily due to higher contingent commissions received due to achieving sales goals set forth by various carrier incentive programs. The increase in 2020 was primarily due to new business offset by a reduction in contingent commissions received. Equipment rental income generated from operating leases decreased by $6.73 million or 28.80% during 2021 from 2020 compared to a decrease of $7.36 million or 23.95% during 2020 from 2019. The average equipment rental portfolio decreased 29.16% in 2021 over 2020 as a result of reduced leasing volume primarily in the construction equipment and the auto and light truck portfolios due to changing customer preferences and decreased 23.36% in 2020 over 2019 as a result of reduced leasing volume primarily in the construction equipment, aircraft, and auto and light truck portfolios. In 2021 and 2020, the decrease in rental income was offset by a similar decrease in depreciation on equipment owned under operating leases. Losses on the sale of investment securities available-for-sale during 2021 were $0.68 million. Gains on the sale of investment securities available-for-sale during 2020 were $0.28 million. There were no sales of investment securities available-for-sale for the year ended 2019. Losses in 2021 and gains in 2020 on the sale of investment securities available-for-sale were primarily from the sale of corporate securities in managing portfolio risk. 26 Table of Contents Other income increased $0.61 million or 5.11% in 2021 from 2020 compared to a decrease of $1.07 million or 8.22% in 2020 from 2019. The increase in 2021 was mainly a result of higher brokerage fees and commissions and a rise in partnership investment gains offset by reduced customer swap fees and lower bank owned life insurance policy claims. The decline in 2020 was mainly a result of nonrecurring rental income on a repossessed asset of $0.96 million during 2019, which was not present in 2020, and a decrease in customer swap fees offset by higher gains on partnership investments. Noninterest Expense — Noninterest expense decreased $1.22 million or 0.65% in 2021 over 2020 following a $1.64 million or 0.87% decrease in 2020 from 2019. The following table shows noninterest expense for the most recent three years ended December 31. (Dollars in thousands) 2021 2020 2019 Noninterest expense: Salaries and employee benefits $ 105,808 $ 101,556 $ 97,098 Net occupancy 10,524 10,276 10,528 Furniture and equipment 25,854 25,688 24,815 Depreciation — leased equipment 13,694 20,203 25,128 Professional fees 8,676 6,317 6,952 Supplies and communications 5,942 5,563 6,454 FDIC and other insurance 2,677 2,606 1,795 Business development and marketing 8,013 4,157 6,303 Loan and lease collection and repossession 30 3,099 3,402 Other 4,930 7,902 6,534 Total noninterest expense $ 186,148 $ 187,367 $ 189,009 Total salaries and employee benefits increased $4.25 million or 4.19% in 2021 from 2020, following a $4.46 million or 4.59% increase in 2020 from 2019. Employee salaries increased $2.93 million or 3.54% in 2021 from 2020 compared to an increase of $4.71 million or 6.03% in 2020 from 2019. The increase in 2021 was mainly a result of higher base salaries due to normal merit increases and a rise in incentive compensation including a one-time special reward to COVID-19 vaccinated employees announced at the end of 2021 offset by a decrease in commission compensation primarily in our residential mortgage area. The increase in 2020 was mainly a result of higher base salaries due to normal merit increases, a rise in commission compensation primarily in our residential mortgage area as well as a one-time special award made to most employees at the end of 2020 as recognition for the dedication they have shown in serving our clients and embracing their role as essential workers. Employee benefits increased $1.32 million or 7.05% in 2021 from 2020, compared to a $0.25 million or 1.31% decrease in 2020 from 2019. During 2021, company contributions to employee retirement accounts increased due to higher salaries during 2021 and a rise in group insurance costs as healthcare access and usage increased from levels in 2020. In 2020, group insurance costs decreased as a result of overall lower health insurance claims experience offset by higher company contributions to employee retirement accounts. Occupancy expense rose $0.25 million or 2.41% in 2021 from 2020, compared to a decrease of $0.25 million or 2.39% in 2020 from 2019. The increased expense in 2021 was primarily the result of higher premises repairs and cleaning offset by lower real estate taxes and reduced lease expenses. The reduced expense in 2020 was primarily the result of lower repair expenses offset by increased building depreciation. Furniture and equipment expense, including depreciation, grew by $0.17 million or 0.65% in 2021 from 2020 compared to an increase of $0.87 million or 3.52% in 2020 from 2019. The higher expense in 2021 was primarily due to computer processing charges and increased software maintenance expense offset by a reduction in furniture and equipment depreciation. The higher expense in 2020 was primarily due to computer processing charges and increased software maintenance expense offset by a reduction in equipment depreciation. Depreciation on equipment owned under operating leases decreased $6.51 million or 32.22% in 2021 from 2020, following a $4.93 million or 19.60% decrease in 2020 from 2019. In 2021 and 2020, depreciation on equipment owned under operating leases correlated with the change in equipment rental income. Professional fees increased $2.36 million or 37.34% in 2021 from 2020, compared to a $0.64 million or 9.13% decrease in 2020 from 2019. The higher expense in 2021 was primarily due to a rise in legal fees and increased utilization of consulting services for technology projects. The lower expense in 2020 compared to 2019 was primarily due to reduced utilization of consulting services offset by an increase in board of directors fees. 27 Table of Contents Supplies and communications expense increased $0.38 million or 6.81% in 2021 from 2020, and decreased $0.89 million or 13.81% in 2020 from 2019. The increase during 2021 was due to higher postage and shipping fees and a rise in printing costs offset by reduced telephone line and equipment expenses. The decline during 2020 was due to lower printing costs, telephone line and equipment expenses and postage fees. FDIC and other insurance expense increased $0.07 million or 2.72% in 2021 from 2020 and increased $0.81 million or 45.18% in 2020 from 2019. The increase in 2021 was mainly the result of $0.55 million in FDIC insurance premium credits received during 2020 which were not present in 2021 offset by a one-time $0.38 million recovery of an incurred but not reported insurance reserve in 2021. The increase in 2020 was mainly due to $0.88 million in FDIC insurance premium credits received during 2019 compared to $0.55 million in 2020. Business development and marketing expenses rose $3.86 million or 92.76% in 2021 from 2020 and declined $2.15 million or 34.05% in 2020 from 2019. The higher expense in 2021 was mainly the result of a charitable contribution of $3.00 million made during 2021 to support COVID-19 initiatives and increased business development expense as a result of more business entertainment and travel opportunities tied to fewer COVID-19 restrictions. The lower expense in 2020 was mainly the result of decreased business development expense as a result of fewer business entertainment and travel opportunities tied to COVID-19 precautions and a reduction in marketing promotions. Loan and lease collection and repossession expenses decreased $3.07 million or 99.03% in 2021 from 2020 compared to a decrease of $0.30 million or 8.91% in 2020 from 2019. Loan and lease collection and repossession expense was lower in 2021 primarily due to lower general collection and repossession expenses, fewer valuation adjustments on repossessed assets and higher gains on the sale of repossessed assets. Loan and lease collection and repossession expense was lower in 2020 primarily due to fewer valuation adjustments on repossessed assets offset by increased general collection and repossession expenses. Other expenses were lower by $2.97 million or 37.61% in 2021 as compared to 2020 and increased $1.37 million or 20.94% in 2020 as compared to 2019. The reduction in 2021 was primarily the result of a lower provision for interest rate swaps with customers, a decrease in the provision of unfunded loan commitments, and fewer losses on operating lease equipment offset by reduced gains on the sale of operating lease equipment and higher employee training expenses due to fewer COVID-19 travel restrictions. The increase in 2020 was primarily the result of lower gains on the sale of fixed assets, a rise in the provision for unfunded loan commitments, a higher provision for interest rate swaps with customers, and a loss on operating lease equipment offset by lower employee training expenses due to COVID-19 travel precautions and higher gains of the sale of operating lease equipment. Income Taxes — 1st Source recognized income tax expense in 2021 of $36.33 million, compared to $24.88 million in 2020, and $28.14 million in 2019. The effective tax rate in 2021 was 23.45% compared to 23.40% in 2020, and 23.42% in 2019. For a detailed analysis of 1st Source’s income taxes see Part II, Item 8, Financial Statements and Supplementary Data — Note 17 of the Notes to Consolidated Financial Statements. FINANCIAL CONDITION Loan and Lease Portfolio — The following table shows 1st Source’s loan and lease distribution at the end of each of the last two years as of December 31. (Dollars in thousands) 2021 2020 Commercial and agricultural $ 918,712 $ 1,186,118 Solar 348,302 292,604 Auto and light truck 603,775 542,369 Medium and heavy duty truck 259,740 279,172 Aircraft 898,401 861,460 Construction equipment 754,273 714,888 Commercial real estate 929,341 969,864 Residential real estate and home equity 500,590 511,379 Consumer 133,080 131,447 Total loans and leases $ 5,346,214 $ 5,489,301 At December 31, 2021, there were no concentrations within the loan portfolio of 10% or more of total loans and leases. Loans and leases, net of unearned discount, at December 31, 2021, were $5.35 billion and were 66.03% of total assets, compared to $5.49 billion and 75.03% of total assets at December 31, 2020. Average loans and leases, net of unearned discount, decreased $25.62 million or 0.47% and increased $463.28 million or 9.27% in 2021 and 2020, respectively. PPP loans, net of unearned discount, at December 31, 2021 and 2020 were $73.08 million and $351.56 million, respectively, and were located in the Commercial and agricultural lending portfolio. 28 Table of Contents Commercial and agricultural lending, excluding those loans secured by real estate but including PPP loans, decreased $267.41 million or 22.54% in 2021 over 2020. Commercial and agricultural lending outstandings were $918.71 million and $1.19 billion at December 31, 2021 and December 31, 2020, respectively. The 2021 decline was attributed exclusively to loan forgiveness and customer pay downs on PPP loans. Excluding PPP loans, commercial and agricultural outstandings were $845.63 million and $834.56 million, respectively. Excluding PPP loans, commercial and agricultural lending outstandings increased 1.33% in 2021 as business borrowers generally adopted a more conservative outlook, resulting in conserving cash and reducing borrowings. Solar loans and leases increased $55.70 million or 19.04% in 2021 over 2020. Solar loan and lease outstandings were $348.30 million and $292.60 million at December 31, 2021 and 2020, respectively. The increase during 2021 was due to continued positive momentum in this business line. We expect that momentum to continue into 2022. Auto and light truck loans increased $61.41 million or 11.32% in 2021 over 2020. At December 31, 2021, auto and light truck loans had outstandings of $603.78 million and $542.37 million at December 31, 2020. This increase was primarily attributable to customers maintaining their fleet levels due to concerns that sufficient cars will not be available in the spring. Additionally, we gained significant new client relationships in the auto and light truck rental and step van portfolios including the refinancing of seasoned debt from industry participants exiting certain geographic locations offset by a reduction in our bus lending portfolio through large pay downs and charge-offs during the year. Medium and heavy duty truck loans and leases decreased $19.43 million or 6.96% in 2021. Medium and heavy duty truck financing at December 31, 2021 and 2020 had outstandings of $259.74 million and $279.17 million, respectively. The decrease at December 31, 2021 from December 31, 2020 can be mainly attributed to normal runoff and some early payoffs of loans and leases, industry-wide limited fleet availability, and our ongoing pricing discipline. Aircraft financing at year-end 2021 increased $36.94 million or 4.29% from year-end 2020. Aircraft financing at December 31, 2021 and 2020 had outstandings of $898.40 million and $861.46 million, respectively. The increase during 2021 was due to higher domestic outstandings of $23.69 million and foreign outstandings of $13.25 million. Our 2021 originations increased as demand was bolstered by a greater acceptance of business jets as a safe and efficient alternative to commercial air travel during the COVID-19 pandemic, drawing a number of first time entrants to private aircraft ownership. Our foreign outstandings increased 7.36% year over year. Our foreign loan and lease outstandings, all denominated in U.S. dollars were $193.31 million and $180.06 million as of December 31, 2021 and 2020, respectively. Loan and lease outstandings to borrowers in Brazil and Mexico were $65.24 million and $117.90 million as of December 31, 2021, respectively, compared to $66.98 million and $103.52 million as of December 31, 2020, respectively. Outstanding balances to other borrowers in other countries were insignificant. Construction equipment financing increased $39.39 million or 5.51% in 2021 compared to 2020. Construction equipment financing at December 31, 2021 had outstandings of $754.27 million, compared to outstandings of $714.89 million at December 31, 2020. The growth in this category was primarily due to significant new client relationships and continued growth with existing customers. Commercial loans secured by real estate, of which approximately 54% is owner occupied, decreased $40.52 million or 4.18% in 2021 over 2020. Commercial loans secured by real estate outstanding at December 31, 2021 were $929.34 million and $969.86 million at December 31, 2020. The decrease in 2021 was driven by more modest growth of owner occupied borrowings, within certain business sectors of our markets. Our non-owner occupied real estate portfolio declined slightly as some stabilized projects took advantage of low market rates and refinanced via the secondary markets. In addition, some of our newer projects have been delayed due to labor and material shortages. Residential real estate and home equity loans were $500.59 million at December 31, 2021 and $511.38 million at December 31, 2020. Residential real estate and home equity loans decreased $10.79 million or 2.11% in 2021 from 2020. Residential mortgage and home equity outstandings were lower in 2021 due to favorable secondary market conditions. The trends from 2020 continued in 2021 as clients continued to take advantage of low secondary market rates to lock in their payments versus the variable rates of home loan equity lines. Consumer loans increased $1.63 million or 1.24% in 2021 over 2020. Consumer loans outstanding at December 31, 2021, were $133.08 million and $131.45 million at December 31, 2020. Volumes modestly increased as consumer spending improved as clients learned how to live with the COVID-19 pandemic. In addition, an increase in new and used car prices resulted in an increase in average loan size. 29 Table of Contents The following table shows the contractual maturities of loans and leases outstanding as of December 31, 2021 as well as classification according to the sensitivity to changes in interest rates. (Dollars in thousands) 0-1 Year 1-5 Years 5-15 Years Over 15 Years Total Commercial and agricultural Fixed rate $ 180,827 $ 188,686 $ 9,490 $ — $ 379,003 Variable rate 312,654 206,331 20,714 10 539,709 Total commercial and agricultural 493,481 395,017 30,204 10 918,712 Solar Fixed rate 50,493 29,115 1,645 — 81,253 Variable rate 72,995 148,656 45,028 370 267,049 Total solar 123,488 177,771 46,673 370 348,302 Auto and light truck Fixed rate 121,893 196,145 5,321 1 323,360 Variable rate 121,350 159,058 7 — 280,415 Total auto and light truck 243,243 355,203 5,328 1 603,775 Medium and heavy duty truck Fixed rate 90,089 166,139 2,347 — 258,575 Variable rate 944 221 — — 1,165 Total medium and heavy duty truck 91,033 166,360 2,347 — 259,740 Aircraft Fixed rate 96,278 523,343 9,673 — 629,294 Variable rate 77,213 135,691 56,203 — 269,107 Total aircraft 173,491 659,034 65,876 — 898,401 Construction equipment Fixed rate 230,645 463,889 11,938 — 706,472 Variable rate 9,887 26,255 11,659 — 47,801 Total construction equipment 240,532 490,144 23,597 — 754,273 Commercial real estate Fixed rate 99,522 351,944 38,711 190 490,367 Variable rate 56,018 193,455 176,340 13,161 438,974 Total commercial real estate 155,540 545,399 215,051 13,351 929,341 Residential real estate and home equity Fixed rate 78,320 171,133 94,012 12,679 356,144 Variable rate 37,059 67,756 38,802 829 144,446 Total residential real estate and home equity 115,379 238,889 132,814 13,508 500,590 Consumer Fixed rate 52,350 60,575 133 — 113,058 Variable rate 16,844 3,177 1 — 20,022 Total consumer 69,194 63,752 134 — 133,080 Total loans and leases Fixed rate 1,000,417 2,150,969 173,270 12,870 3,337,526 Variable rate 704,964 940,600 348,754 14,370 2,008,688 Total loans and leases $ 1,705,381 $ 3,091,569 $ 522,024 $ 27,240 $ 5,346,214 During 2021, approximately 68% of the Bank’s residential mortgage originations were sold into the secondary market. Mortgage loans held for sale were $13.28 million at December 31, 2021 and were $12.89 million at December 31, 2020. 1st Source Bank sells residential mortgage loans to Fannie Mae as well as FHA-insured and VA-guaranteed loans in Ginnie Mae mortgage-backed securities. Additionally, we have sold loans on a service released basis to various other financial institutions in the past. The agreements under which we sell these mortgage loans contain various representations and warranties regarding the acceptability of loans for purchase. On occasion, we may be asked to indemnify the loan purchaser for credit losses on loans that were later deemed ineligible for purchase or we may be asked to repurchase a loan. Both circumstances are collectively referred to as “repurchases.” Within the industry, repurchase demands have decreased during recent years. We believe the loans we have underwritten and sold to these entities have met or exceeded applicable transaction parameters. Our exposure risk for repurchases started to reduce in 2016 as a result of the enhancements made by FNMA in 2013 to the selling representations and warranties framework as warranties on loans sold prior to implementation of such changes lapse. 30 Table of Contents Our liability for repurchases, included in Accrued Expenses and Other Liabilities on the Statements of Financial Condition, was $0.22 million and $0.33 million as of December 31, 2021 and 2020, respectively. Our (recovery) expense for repurchase losses, included in Loan and Lease Collection and Repossession expense on the Statements of Income, was $(0.09) million in 2021 compared to $0.03 million in 2020 and $0.01 million in 2019. The mortgage repurchase liability represents our best estimate of the loss that we may incur. The estimate is based on specific loan repurchase requests and a historical loss ratio with respect to origination dollar volume. Because the level of mortgage loan repurchase losses is dependent on economic factors, investor demand strategies and other external conditions that may change over the life of the underlying loans, the level of liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment. CREDIT EXPERIENCE Allowance for Credit Losses — As of December 31, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaced the incurred loss methodology with an expected loss methodology that is referred to as current expected credit losses (CECL) methodology. The allowance for credit losses considers the historical loss experience, current conditions, and reasonable and supportable forecasts. To estimate expected loan and lease losses under CECL, we use a broader range of data than under previous U.S. GAAP. We are able to access loan data over a long-time horizon, generally back to the fourth quarter of 2007, thus capturing most of the economic business cycle which includes the Great Recession and the subsequent long slow recovery which supports full lifetime losses. The CECL methodology requires our loan portfolio to be segregated into pools based on similar risk characteristics. We evaluate each portfolio, establishing numerous segments. We then review risk characteristics for each segment, noting that some pools were either too small for meaningful analysis or contained risk characteristics similar to other pools. Thus, some pools were consolidated. Loans and leases within each pool are collectively evaluated using either the cohort cumulative loss rate methodology or the probability of default (PD)/loss given default (LGD) methodology with transition matrix PD/historical average LGD. Our management evaluates the allowance quarterly, reviewing all loans and leases over a fixed-dollar amount ($250,000) where the internal credit quality grade is at or below a predetermined classification, actual and anticipated loss experience, current economic events in specific industries, and other pertinent factors including general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates and adjustments to historical loss rates to capture differences that may exist between the current and historical conditions, including consideration of environmental factors, principally economic risk which is generally reflected in forecast adjustments, specific industry risk and concentration risk, all of which may be susceptible to significant and unforeseen changes. We review the status of the loan and lease portfolio to identify borrowers that might develop financial problems in order to aid borrowers in the handling of their accounts and to mitigate losses. Our allowance for loan and lease losses is provided for by direct charges to the provision for credit losses. Losses on loans and leases are charged against the allowance and likewise, recoveries during the period for prior losses are credited to the allowance. Because business processes and credit risks associated with unfunded credit commitments are essentially the same as for loans, we utilize similar processes to estimate our liability for unfunded credit commitments. Our allowance for unfunded credit commitments is located in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Position and is provided by direct charges to the provision for unfunded credit commitments located in Other Noninterest Expense on the Consolidated Statements of Income. See Part II, Item 8, Financial Statements and Supplementary Data — Note 1 of the Notes to Consolidated Financial Statements for additional information on management’s evaluation of the allowance for credit losses. We perform a thorough analysis of charge-offs, non-performing asset levels, special attention outstandings and delinquency in order to review portfolio trends, including specific industry risks and economic conditions, which may have an impact on the allowance and allowance ratios applied to various portfolios. We adjust the calculated historical-based ratio as a result of our analysis of environmental factors, principally specific industry risk, collateral risk and concentration risk, in addition to global economic and political issues. We also have a forecast adjustment that includes key economic factors affecting our portfolios such as growth in gross domestic product, unemployment rates, housing market trends, commodity prices, and inflation. Forecast adjustments were difficult to establish due to unprecedented uncertainty given the national emergency due to the pandemic, the Omicron COVID variant spreading across the globe, the ongoing supply chain disruptions and inflation reaching a 39-year high. Patterns from our history of business cycles, mainly the Great Recession of 2008, are not particularly relevant due to the extraordinary monetary and fiscal stimulus provided by the U.S. government and the Federal Reserve. Recent indicators, beginning late in the third quarter, have been somewhat discouraging with increasing inflation and slowing job growth, signaling the economy may be slowing. The current political turmoil, the growing confrontation between China and the U.S., and ongoing strife in the Middle East, cause increased uncertainty. Collateral values are significant to underwriting our specialty finance portfolios and volatility or declining values pose a threat. Concentration risk is impacted primarily by geographic concentration in northern Indiana and southwestern Michigan in our business banking and commercial real estate portfolios and by collateral concentration in our specialty finance portfolios. 31 Table of Contents World economies are generally in a recession due to the pandemic and challenges persist. Current concerns include high numbers of COVID-19 cases, corruption scandals and political uncertainty in Latin American countries, the competitive and complex nature of U.S.-China relations, the geopolitical tensions with Russia, the persistent threats of terrorist attacks, and in Brazil and Mexico where we have a presence with our aircraft lending, significant inflation particularly in Brazil and concerns with global supply chain disruptions impeding auto production in Mexico are concerning. We include a factor in our qualitative adjustments for global risk, as we are increasingly aware of the threat that global concerns may affect our customers. While we are unable to determine with any precision the impact of global economic and political issues on 1st Source Bank’s loan and lease portfolios, we feel the risks are real and significant. We believe there is a risk of negative consequences for our borrowers that would affect their ability to repay their financial obligations. Therefore, we continued to include a factor for global risk in our analysis for 2021. The following discussion focuses on relevant economic conditions and various circumstances impacting the December 31, 2021 allowance for loan and lease losses of each of our loan and lease segments. Commercial and agricultural – There are several industries represented in the commercial and agricultural portfolio. This portfolio benefited from the monetary and fiscal stimulus, particularly the Paycheck Protection Program (PPP) loans. The outlook for the portfolio is guarded. We have some exposure to the hospitality industry, which has come back better than anticipated but continues to suffer from reduced rates and, to a lesser extent, lower occupancy. Restaurants continue to struggle as COVID cases surge. The recreational vehicle industry which is centered in our footprint is going strong and our customers engaged in manufacturing for and supplying to the industry are doing well. Small business confidence increased slightly in December as business owners expect the economy to improve somewhat in the next six months. The outlook for our agricultural portfolio has improved with stronger commodity prices, particularly for corn and beans, and with projected higher incomes for farmers for the second consecutive year. Increasing input prices will likely result in thinner but still profitable margins next year. Our customers have had favorable growing conditions which have resulted in strong crop yields. In the commercial and agricultural portfolio, we have experienced stable credit quality trends with low delinquencies and minimal charge-offs. We reviewed the historical loss ratios and assessed the environmental factors and concentration issues affecting these portfolios and believe the qualitative adjustments we made to our allowance ratios are appropriate and adequate. Solar – Our entry into solar financing over five years ago continues to look promising and gain momentum in terms of performance of existing projects financed, loan growth opportunities and overall credit quality. Risks include construction and developer related risks and delays, site issues, climate and weather risks, regulatory problems and permitting issues, as well as risks related to utility companies and their ability and willingness to facilitate the solar customer tying into the grid, among others. To date, we have not incurred any losses in this portfolio. Auto and light truck – Our auto and light truck portfolio was initially impacted by the national emergency caused by the pandemic and subsequent shutdowns, shelter in place and social distancing mandates but rebounded due to vehicle shortages supporting strong rental rates and high used car values. Loan outstandings remain strong as customers are maintaining their fleet levels through the slower winter months as they are concerned that they will not be able to get sufficient cars in the spring. Like last year, the losses in the portfolio were concentrated in the bus sector where we continued to place additional accounts into non-accrual status and recognized several write-downs. Collateral values, particularly for motor coaches, plummeted in this sector. At year-end, we reviewed our special attention accounts and charged-off exposures on non-accrual accounts which we felt would not be cured via payments over the next six months. Long-term, there is still significant uncertainty. Some of the bus portfolio customers will likely not be able to adapt to the new environment and may experience further losses. We reviewed the annual historical incurred losses and the life of the loan calculated historical loss ratios as of year-end and adjusted our qualitative factors downward given that loss rates are increasing because of the large charge-off volumes during the past two years and our expectation is that future losses will be lower than our recent experience. We believe we appropriately recognized the losses in our portfolio and that peak charge-offs occurred in 2021 and note special attention balances were 38% lower at year-end 2021 than 2020; however, we remain concerned and therefore continue to use qualitative adjustments to recognize bus segment risks. The auto rental portion of the portfolio continues to be more stable and we did not make adjustments to the qualitative factors in the auto rental segment. Medium and heavy duty truck – We experienced ongoing credit quality stability in the medium and heavy duty truck portfolio. We recognized sizable losses during 2009 and the first half of 2010; however, since then we have had only two charge-offs, one small account in 2018 and a mid-sized credit in 2019. COVID-19 transformed e-commerce, benefiting the trucking industry. The industry continues to struggle with ongoing driver shortages and elevated Class 8 tractor order backlogs due to microchip shortages. Loan growth opportunities are stymied by lack of new equipment and competitive rate pressures. We believe our reserve ratios for this portfolio are appropriate. 32 Table of Contents Aircraft – Another area of concern continues to be our aircraft portfolio, which was among the sectors affected most by the sluggish economy following the Great Recession. This sector was immediately impacted by COVID-19 related shutdowns and business travel remains thwarted. However, private jet providers appeal to a segment of the market that wishes to either minimize exposure to COVID-19 or to avoid contending with disrupted airline schedules. Aircraft collateral values, particularly those in our niche, have strengthened in this economic cycle. In this portfolio we also have $193 million of foreign exposure, primarily in Mexico and Brazil. Both Mexico and Brazil are suffering recessionary impacts from COVID-19. The Mexican economy had contracted prior to the pandemic shock. Manufacturing registered a significant decline at the outset of the pandemic but is currently experiencing robust growth, partly due to the spillover effect of economic activity in the U.S. Growth continues to be threatened by drug trafficking and related violence. Brazil’s economic recovery was interrupted by the pandemic as GDP plunged in the second quarter of 2020 and the country continues to struggle to achieve minimal growth and is further hampered by increased inflation fears and political uncertainties. Our historical loss ratios reflect our high and volatile loss histories. We adjusted the historical ratios for current conditions, principally decreased collateral concentration risk due to strong aircraft values and robust credit underwriting, partially offset by uncertain economic conditions in foreign markets. We believe the ratios as adjusted are appropriate. Construction equipment – Our construction equipment portfolio historically has been characterized by stable credit quality; however, recently we have had increased concerns as there have been unanticipated downgrades to special attention in each of the last three quarters. The construction industry benefited from growth in private residential construction and a lesser impact of COVID-19 related shutdowns than many industries. Nonetheless, certain sectors are experiencing stress and we continue to monitor for credit weaknesses. Historically, 1st Source has experienced less volatility in this portfolio than the industry as losses have been mitigated by appropriate underwriting and a global market for used construction equipment. The potential continued infrastructure spending as we emerge from this recession could have a positive impact for the industry’s used equipment markets. We did modify our qualitative factors to recognize the increased volume of accounts moving into special attention. Commercial real estate – Similar to the commercial portfolio, our commercial real estate loans are concentrated in our local market with local customers, with approximately 54% of the Bank’s exposure being owner occupied facilities where we are the primary relationship bank for our customers. Nevertheless, we were not immune to the dramatic declines in real estate values following the Great Recession of 2008, similar to other U.S. markets and we experienced losses in these categories from 2009 through 2011. From 2012 through 2021, we have experienced small recoveries in the portfolio with the exception of 2018 when we realized a small loss. We reviewed our qualitative adjustments and made some modifications as we are concerned stimulus funds may be delaying problem recognition in our owner-occupied segment resulting in a slight increase in our qualitative adjustment, and a detailed review of our hotel portfolio indicated reduced COVID-related concerns relative to when the factor was originally established. We believe our ratios as adjusted are appropriate and adequate as of December 31, 2021. Residential real estate and home equity – Our residential real estate and home equity portfolio consists of loans to individuals in the communities we serve. Generally, residential mortgage loans are originated using standards that result in salable mortgages. Home equity loans are also advanced in compliance with regulatory guidelines and the Bank’s credit policy. Losses in these portfolios have been minuscule since 2013, but we did experience losses during the housing crises. We reviewed our qualitative adjustments, which are primarily for reasonable and supportable forecasts, and believe they are appropriate and adequate. Consumer – Our consumer loan portfolio consists of loans to individuals in the communities we serve. This portfolio consists primarily of loans secured by autos with advances in compliance with the Bank’s underwriting standards. Losses are stable during good economic times and tend to tick up when there is deterioration in local economic factors and employment rates. We reviewed our qualitative adjustments, which are primarily for reasonable and supportable forecasts, and believe they are appropriate. The allowance for loan and lease losses at December 31, 2021, totaled $127.49 million and was 2.38% of loans and leases, compared to $140.65 million or 2.56% of loans and leases at December 31, 2020 and $111.25 million or 2.19% of loans and leases at December 31, 2019. It is our opinion that the allowance for loan and lease losses was appropriate to absorb current expected credit losses inherent in the loan and lease portfolio as of December 31, 2021. Charge-offs for loan and lease losses were $12.52 million for 2021, compared to $13.97 million for 2020 and $7.59 million for 2019. We had one notable loss in the commercial and agricultural portfolio and several small losses which were sizeable when aggregated in the bus segment of the auto and light truck portfolio. The (recovery of) provision for credit losses was $(4.30) million for 2021, compared to $36.00 million for 2020 and $15.83 million for 2019 to accommodate net charge-offs, loan and lease growth and, for 2021, decreased credit risk relative to our expectations principally due to significant government stimulus payments. 33 Table of Contents The following table summarizes our loan and lease loss experience for each of the last three years ended December 31. (Dollars in thousands) 2021 2020 2019 Amounts of loans and leases outstanding at end of period $ 5,346,214 $ 5,489,301 $ 5,085,527 Average amount of net loans and leases outstanding during period $ 5,437,817 $ 5,463,436 $ 5,000,161 Balance of allowance for loan and lease losses at beginning of period $ 140,654 $ 111,254 $ 100,469 Impact from adoption of ASC 326 — 2,584 — Adjusted balance of allowance for loan and lease losses at beginning of period 140,654 113,838 100,469 Charge-offs: Commercial and agricultural 2,930 903 1,040 Solar — — — Auto and light truck 7,797 7,107 991 Medium and heavy duty truck — 15 1,132 Aircraft — 855 3,066 Construction equipment 856 4,090 238 Commercial real estate — 37 5 Residential real estate and home equity 228 74 53 Consumer 712 893 1,066 Total charge-offs 12,523 13,974 7,591 Recoveries: Commercial and agricultural 812 663 664 Solar — — — Auto and light truck 1,316 499 97 Medium and heavy duty truck — 18 32 Aircraft 687 1,800 1,143 Construction equipment 473 1,415 160 Commercial real estate 19 58 75 Residential real estate and home equity 16 33 85 Consumer 341 303 287 Total recoveries 3,664 4,789 2,543 Net charge-offs (recoveries) 8,859 9,185 5,048 (Recovery of) provision for loan and lease losses (4,303) 36,001 15,833 Balance at end of period $ 127,492 $ 140,654 $ 111,254 Ratio of net charge-offs (recoveries) to average net loans and leases outstanding 0.16 % 0.17 % 0.10 % Ratio of allowance for loan and lease losses to net loans and leases outstanding end of period 2.38 % 2.56 % 2.19 % Coverage ratio of allowance for loan and lease losses to nonperforming loans and leases 327.28 % 232.47 % 1,101.74 % The following table shows net charge-offs (recoveries) as a percentage of average loans and leases by portfolio type: 2021 2020 2019 Commercial and agricultural 0.19 % 0.02 % 0.03 % Solar — — — Auto and light truck 1.11 1.18 0.15 Medium and heavy duty truck — — 0.38 Aircraft (0.08) (0.12) 0.24 Construction equipment 0.05 0.37 0.01 Commercial real estate — — (0.01) Residential real estate and home equity 0.04 0.01 (0.01) Consumer 0.28 0.43 0.57 Total net charge-offs (recoveries) to average portfolio loans and leases 0.16 % 0.17 % 0.10 % 34 Table of Contents The allowance for loan and lease losses has been allocated according to the amount deemed necessary to provide for the estimated current expected credit losses. The following table shows the amount of such components of the allowance for loan and lease losses at December 31 and the ratio of such loan and lease categories to total outstanding loan and lease balances. 2021 2020 (Dollars in thousands) Allowance Amount Percentage of Loans and Leases in Each Category to Total Loans and Leases Allowance Amount Percentage of Loans and Leases in Each Category to Total Loans and Leases Commercial and agricultural $ 15,409 17.18 % $ 16,680 21.61 % Solar 6,585 6.51 5,549 5.33 Auto and light truck 19,624 11.30 28,926 9.88 Medium and heavy duty truck 6,015 4.87 6,400 5.09 Aircraft 33,628 16.80 34,053 15.69 Construction equipment 19,673 14.11 19,166 13.02 Commercial real estate 19,691 17.38 22,758 17.67 Residential real estate and home equity 5,084 9.36 5,374 9.32 Consumer 1,783 2.49 1,748 2.39 Total $ 127,492 100.00 % $ 140,654 100.00 % Nonperforming Assets — Nonperforming assets include loans past due over 90 days, nonaccrual loans and leases, other real estate, repossessions and other nonperforming assets we own. Our policy is to discontinue the accrual of interest on loans and leases where principal or interest is past due and remains unpaid for 90 days or more, or when an individual analysis of a borrower’s credit worthiness indicates a credit should be placed on nonperforming status, except for residential real estate and home equity loans, which are placed on nonaccrual at the time the loan is placed in foreclosure and consumer loans that are both well secured and in the process of collection. Nonperforming assets amounted to $41.33 million at December 31, 2021, compared to $64.53 million at December 31, 2020, and $19.24 million at December 31, 2019. During 2021, interest income on nonaccrual loans and leases would have increased by approximately $2.62 million compared to $3.49 million in 2020 if these loans and leases had earned interest at their full contractual rate. Nonperforming assets at December 31, 2021 decreased from December 31, 2020, mainly due to decreases in nonaccrual loans and leases and in repossessions. Repossessions consisted mainly of construction equipment. We had no other real estate as all such properties were sold prior to year-end. 35 Table of Contents Nonperforming assets at December 31 (Dollars in thousands) 2021 2020 Loans past due over 90 days $ 249 $ 115 Nonaccrual loans and leases: Commercial and agricultural 2,053 5,933 Solar — — Auto and light truck 24,170 36,945 Medium and heavy duty truck 273 720 Aircraft 649 828 Construction equipment 7,090 12,373 Commercial real estate 2,996 1,494 Residential real estate and home equity 1,225 1,718 Consumer 250 377 Total nonaccrual loans and leases 38,706 60,388 Total nonperforming loans and leases 38,955 60,503 Other real estate — 359 Repossessions: Commercial and agricultural — — Auto and light truck 75 1,120 Medium and heavy duty truck — — Aircraft — 750 Construction equipment 757 — Consumer 29 106 Total repossessions 861 1,976 Operating leases 1,518 1,695 Total nonperforming assets $ 41,334 $ 64,533 Nonperforming loans and leases to loans and leases, net of unearned discount 0.73 % 1.11 % Nonperforming assets to loans and leases and operating leases, net of unearned discount 0.77 % 1.16 % Potential Problem Loans — Potential problem loans consist of loans that are performing but for which management has concerns about the ability of a borrower to continue to comply with repayment terms because of the borrowers’ potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. As of December 31, 2021 and 2020, we had $1.23 million and $16.60 million, respectively, in loans of this type which are not included in either of the non-accrual or 90 days past due loan categories. At December 31, 2021, potential problem loans consisted of one credit relationship in the construction equipment segment of our loan portfolio. Weakness in the borrowers’ operating performance and payment patterns have caused us to heighten attention given to this credit. INVESTMENT PORTFOLIO The amortized cost of securities available-for-sale at year-end 2021 increased 59.90% from 2020, following a 13.49% increase from year-end 2019 to year-end 2020. The amortized cost of securities available-for-sale at December 31, 2021 was $1.88 billion or 23.17% of total assets, compared to $1.17 billion or 16.04% of total assets at December 31, 2020. The following table shows the amortized cost of investment securities available-for-sale as of December 31. (Dollars in thousands) 2021 2020 U.S. Treasury and Federal agencies securities $ 1,093,780 $ 610,195 U.S. States and political subdivisions securities 95,700 78,812 Mortgage-backed securities — Federal agencies 663,441 442,748 Corporate debt securities 22,510 40,813 Foreign government securities 600 700 Total investment securities available-for-sale $ 1,876,031 $ 1,173,268 36 Table of Contents Yields on tax-exempt obligations are calculated on a fully tax-equivalent basis assuming a 21% tax rate. The following table shows the maturities of securities available-for-sale at December 31, 2021, at the amortized costs and weighted average yields of such securities. (Dollars in thousands) Amount Yield U.S. Treasury and Federal agencies securities Under 1 year $ 83,322 1.92 % 1 – 5 years 881,289 0.86 5 – 10 years 129,169 1.15 Over 10 years — — Total U.S. Treasury and Federal agencies securities 1,093,780 0.98 U.S. States and political subdivisions securities Under 1 year 16,552 2.71 1 – 5 years 50,087 2.02 5 – 10 years 28,591 1.15 Over 10 years 470 3.38 Total U.S. States and political subdivisions securities 95,700 1.89 Corporate debt securities Under 1 year 5,985 3.12 1 – 5 years 16,525 2.64 5 – 10 years — — Over 10 years — — Total Corporate debt securities 22,510 2.77 Foreign government securities Under 1 year — — 1 – 5 years 600 2.12 5 – 10 years — — Over 10 years — — Total Foreign government securities 600 2.12 Mortgage-backed securities — Federal agencies 663,441 1.44 Total investment securities available-for-sale $ 1,876,031 1.21 % At December 31, 2021, the residential mortgage-backed securities we held consisted of GNMA, FNMA and FHLMC pass-through certificates (Government Sponsored Enterprise, GSEs). The type of loans underlying the securities were all conforming loans at the time of issuance. The underlying GSEs backing these mortgage-backed securities are rated Aaa or AA+ from the rating agencies. At December 31, 2021, the vintage (years originated) of the underlying loans comprising our securities are: 54% in the year 2021; 22% in the year 2020; 9% in the years 2018 and 2019; 8% in the years 2016 and 2017; 1% in the years 2014 and 2015; and 6% in years 2013 and prior. DEPOSITS The following table shows the average daily amounts of deposits and rates paid on such deposits. 2021 2020 2019 (Dollars in thousands) Amount Rate Amount Rate Amount Rate Noninterest bearing demand $ 1,882,168 — % $ 1,530,698 — % $ 1,171,639 — % Interest bearing demand 2,278,498 0.13 1,827,673 0.24 1,635,209 0.82 Savings 1,172,411 0.07 926,585 0.11 825,292 0.20 Time 1,009,450 0.84 1,451,646 1.73 1,644,596 2.16 Total deposits $ 6,342,527 $ 5,736,602 $ 5,276,736 37 Table of Contents The following table shows the estimated scheduled maturities of the portion of time deposits in U.S. offices in excess of the FDIC insurance limit and time deposits that are otherwise uninsured. (Dollars in thousands) Under 3 Months $ 45,880 4 – 6 Months 71,928 7 – 12 Months 76,050 Over 12 Months 111,621 Total $ 305,479 See Part II, Item 8, Financial Statements and Supplementary Data — Note 10 of the Notes to Consolidated Financial Statements for additional information on deposits. SHORT-TERM BORROWINGS The following table shows the distribution of our short-term borrowings and the weighted average interest rates thereon at the end of each of the last two years. Also provided are the maximum amount of borrowings and the average amount of borrowings, as well as weighted average interest rates for the last two years. (Dollars in thousands) Federal Funds Purchased and Securities Repurchase Agreements Commercial Paper Federal Home Loan Bank Advances Other Short-Term Borrowings Total Borrowings 2021 Balance at December 31, 2021 $ 194,727 $ 3,967 $ — $ 1,333 $ 200,027 Maximum amount outstanding at any month-end 210,275 5,141 — 3,007 218,423 Average amount outstanding 180,610 4,316 — 1,802 186,728 Weighted average interest rate during the year 0.06 % 0.08 % — % — % 0.06 % Weighted average interest rate for outstanding amounts at December 31, 2021 0.04 % 0.04 % N/A — % 0.04 % 2020 Balance at December 31, 2020 $ 143,564 $ 4,766 $ — $ 2,311 $ 150,641 Maximum amount outstanding at any month-end 226,473 5,068 141,000 2,643 375,184 Average amount outstanding 174,088 4,679 20,582 1,816 201,165 Weighted average interest rate during the year 0.19 % 0.23 % 0.87 % — % 0.26 % Weighted average interest rate for outstanding amounts at December 31, 2020 0.08 % 0.13 % N/A — % 0.08 % LIQUIDITY AND CAPITAL RESOURCES Core Deposits — Our major source of investable funds is provided by stable core deposits consisting of all interest bearing and noninterest bearing deposits, excluding brokered certificates of deposit, listing services certificates of deposit and certain certificates of deposit over $250,000 based on established FDIC insured deposits. In 2021, average core deposits equaled 78.04% of average total assets, compared to 73.64% in 2020 and 71.48% in 2019. The effective rate of core deposits in 2021 was 0.12%, compared to 0.39% in 2020 and 0.77% in 2019. Average noninterest bearing core deposits increased 22.96% in 2021 compared to an increase of 30.65% in 2020. These represented 31.20% of total core deposits in 2021, compared to 29.20% in 2020, and 25.11% in 2019. Purchased Funds — We use purchased funds to supplement core deposits, which include certain certificates of deposit over $250,000, brokered certificates of deposit, listing services certificates of deposit, over-night borrowings, securities sold under agreements to repurchase, commercial paper, and other short-term borrowings. Purchased funds are raised from customers seeking short-term investments and are used to manage the Bank’s interest rate sensitivity. During 2021, our reliance on purchased funds decreased to 6.41% of average total assets from 9.76% in 2020. Shareholders’ Equity — Average shareholders’ equity equated to 11.73% of average total assets in 2021, compared to 12.15% in 2020. Shareholders’ equity was 11.32% of total assets at year-end 2021, compared to 12.12% at year-end 2020. We include unrealized gains (losses) on available-for-sale securities, net of income taxes, in accumulated other comprehensive income (loss) which is a component of shareholders’ equity. While regulatory capital adequacy ratios exclude unrealized gains (losses), it does impact our equity as reported in the audited financial statements. The unrealized (losses) gains on available-for-sale securities, net of income taxes, were $(9.86) million and $18.37 million at December 31, 2021 and 2020, respectively. 38 Table of Contents Other Liquidity — Under Indiana law governing the collateralization of public fund deposits, the Indiana Board of Depositories determines which financial institutions are required to pledge collateral based on the strength of their financial ratings. We have been informed that no collateral is required for our public fund deposits. However, the Board of Depositories could alter this requirement in the future and adversely impact our liquidity. Our potential liquidity exposure if we must pledge collateral is approximately $923 million. Liquidity Risk Management — The Bank’s liquidity is monitored and closely managed by the Asset/Liability Management Committee (ALCO), whose members are comprised of the Bank’s senior management. Asset and liability management includes the management of interest rate sensitivity and the maintenance of an adequate liquidity position. The purpose of interest rate sensitivity management is to stabilize net interest income during periods of changing interest rates. Liquidity management is the process by which the Bank ensures that adequate liquid funds are available to meet short-term and long-term financial commitments on a timely basis. Financial institutions must maintain liquidity to meet day-to-day requirements of depositors and borrowers, take advantage of market opportunities and provide a cushion against unforeseen needs. Liquidity of the Bank is derived primarily from core deposits, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources. The most stable source of liability-funded liquidity is deposit growth and retention of the core deposit base. The principal source of asset-funded liquidity is available-for-sale investment securities, cash and due from banks, overnight investments, securities purchased under agreements to resell, and loans and interest bearing deposits with other banks maturing within one year. Additionally, liquidity is provided by repurchase agreements, and the ability to borrow from the Federal Reserve Bank (FRB) and the Federal Home Loan Bank (FHLB). The Bank’s liquidity strategy is guided by internal policies and the Interagency Policy Statement on Funding and Liquidity Risk Management. Internal guidelines consist of: (i) Available Liquidity (sum of short term borrowing capacity) greater than $500 million; (ii) Liquidity Ratio (total of net cash, short term investments and unpledged marketable assets divided by the sum of net deposits and short term liabilities) greater than 15%; (iii) Dependency Ratio (net potentially volatile liabilities minus short term investments divided by total earning assets minus short term investments) less than 15%; and (iv) Loans to Deposits Ratio less than 100% At December 31, 2021, we were in compliance with the foregoing internal policies and regulatory guidelines. The Bank also maintains a contingency funding plan that assesses the liquidity needs under various scenarios of market conditions, asset growth and credit rating downgrades. The plan includes liquidity stress testing which measures various sources and uses of funds under the different scenarios. The contingency plan provides for ongoing monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and to cover unanticipated events that could affect liquidity. We have borrowing sources available to supplement deposits and meet our funding needs. 1st Source Bank has established relationships with several banks to provide short term borrowings in the form of federal funds purchased. At December 31, 2021, we had no borrowings in the federal funds market. We could borrow $245.00 million in additional funds for a short time from these banks on a collective basis. As of December 31, 2021, we had $44.15 million outstanding in FHLB advances and could borrow an additional $510.31 million contingent on the FHLB activity-based stock ownership requirement. We also had no outstandings with the FRB and could borrow $453.93 million as of December 31, 2021. Interest Rate Risk Management — ALCO monitors and manages the relationship of earning assets to interest bearing liabilities and the responsiveness of asset yields, interest expense, and interest margins to changes in market interest rates. In the normal course of business, we face ongoing interest rate risks and uncertainties. We may utilize interest rate swaps to partially manage the primary market exposures associated with the interest rate risk related to underlying assets, liabilities, and anticipated transactions. 39 Table of Contents A hypothetical change in net interest income was modeled by calculating an immediate 200 basis point (2.00%) and 100 basis point (1.00%) increase and a 100 basis point (1.00%) decrease in interest rates across all maturities. The following table shows the aggregate hypothetical impact to pre-tax net interest income. Percentage Change in Net Interest Income December 31, 2021 December 31, 2020 Basis Point Interest Rate Change 12 Months 24 Months 12 Months 24 Months Up 200 0.34% 7.00% 0.18% 7.13% Up 100 (0.51)% 2.86% (0.23)% 3.46% Down 100 (3.22)% (8.00)% (1.21)% (2.30)% The earnings simulation model excludes the earnings dynamics related to how fee income and noninterest expense may be affected by changes in interest rates. Actual results may differ materially from those projected. The use of this methodology to quantify the market risk of the balance sheet should not be construed as an endorsement of its accuracy or the accuracy of the related assumptions. At December 31, 2021 and 2020, the impact of these hypothetical fluctuations in interest rates on our derivative holdings was not significant, and, as such, separate disclosure is not presented. We manage the interest rate risk related to mortgage loan commitments by entering into contracts for future delivery of loans with outside parties. See Part II, Item 8, Financial Statements and Supplementary Data — Note 18 of the Notes to Consolidated Financial Statements. Commitments and Contractual Obligations — In the ordinary course of operations, we enter into certain contractual obligations. Such obligations include customer deposits, the funding of operations through debt issuances as well as operating leases for the rent of premises and equipment. Additionally, we routinely enter into contracts for services that may require payment to be provided in the future and may contain penalty clauses for early termination of the contract. Further discussion of commitments and contractual obligations is included in Part II, Item 8, Financial Statements and Supplementary Data — Notes 10, 11, 12 and 18 of the Notes to Consolidated Financial Statements. We also enter into derivative contracts under which we are required to either receive cash from, or pay cash to, counterparties depending on changes in interest rates. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. The fair value of the contracts changes daily as market interest rates change. Further discussion of derivative contracts is included in Part II, Item 8, Financial Statements and Supplementary Data — Note 19 of the Notes to Consolidated Financial Statements. OFF-BALANCE SHEET ARRANGEMENTS Assets under management and assets under custody are held in fiduciary or custodial capacity for our clients. In accordance with U.S. generally accepted accounting principles, these assets are not included on our balance sheet. We are also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our clients. These financial instruments include commitments to extend credit and standby letters of credit. Further discussion of these commitments is included in Part II, Item 8, Financial Statements and Supplementary Data — Note 18 of the Notes to Consolidated Financial Statements. Item 7A. Quantitative and Qualitative Disclosures about Market Risk. For information regarding Quantitative and Qualitative Disclosures about Market Risk, see Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Interest Rate Risk Management.