What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-02-16 compared with 2022-02-17 · 197 added, 266 removed, 613 unchanged (43% of the section changed)

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• Technological changes.

• The impact of climate change.

• Acquisitions and integration of acquired businesses.

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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.

Management has reviewed the application of these policies with the Audit, Finance and Risk Committee of the Board of Directors.

Following is a discussion of the areas we view as our most critical accounting policies.

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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.

The 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.

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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.

Forecast adjustments are fundamentally difficult to establish and the current environment presents challenges with persistent inflation, markedly higher interest rates, and heightened geopolitical uncertainty.

We endeavor to apply a forecast adjustment that is directionally consistent, reasonable, supportable, and reflective of current expectations and conditions.

We use a two-year reasonable and supportable period across all loan and lease segments to forecast economic conditions.

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Following this two-year forecasting period, we use a two-year reversion period to revert forecast rates to historical loss rates.

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.

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.

We have been diligent in our efforts to gain a thorough understanding of the CECL 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.

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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

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)

Medium and heavy duty truck — —

Aircraft — 13

Construction — 7

Commercial — 83

Residential real estate and home equity — —

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.

Business, Item 1A, Risk Factors for more information.

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

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Return on average common shareholders’ equity was 13.81% in 2022 versus 13.07% in 2021, and 9.41% in 2020.

Net income in 2022, as compared to 2021, was positively impacted by a $26.83 million or 11.34% increase in net interest income and a $1.45 million or 0.78% decrease in noninterest expense which was offset by a $17.55 million or 407.81% increase in the provision for credit losses and a $8.83 million or 8.82% decrease in noninterest income.

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 2022 amounted to $1.26 per share, compared to $1.21 per share in 2021, and $1.13 per share in 2020.

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.

The level of earnings reinvested and dividend payouts are determined by the Board of Directors based on various considerations, including liquidity needs, capital requirements, and 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.

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Tax-equivalent net interest income totaled $264.10 million for 2022, up $27.00 million from the $237.10 million reported in 2021.

Tax-equivalent net interest income for 2020 was up $1.81 million from the $224.55 reported for 2019.

Tax-equivalent net interest income for 2021 was up $10.73 million from the $226.36 million reported for 2020.

During 2022, average earning assets increased $322.53 million or 4.39% while average interest-bearing liabilities increased $217.47 million or 4.55% over the comparable period in 2021.

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.

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.

The yield on average earning assets increased 36 basis points to 3.84% for 2022 from 3.48% for 2021 primarily due to higher rates on loans and leases and investment securities.

Total cost of average interest-bearing liabilities increased 23 basis points to 0.61% during 2022 from 0.38% in 2021 as a result of the higher interest rate environment.

The result to the fully taxable-equivalent net interest margin was an increase of 22 basis points.

The largest contributor to the increase in the yield on average earning assets in 2022 was the 42 basis point improvement in the loan and lease portfolio yield primarily due to market conditions as a result of seven Federal Reserve interest rate increases during the year.

Average loans and leases increased $128.88 million or 2.37% in 2022 from 2021 while the yield increased to 4.74%.

The yield on net loans and leases was positively impacted by three basis points in 2022 due to the recognition of $2.70 million of fees on PPP loans which have been forgiven by the SBA or paid down by customers.

PPP forgiveness and customer payments totaled $74.88 million for the full year of 2022 with less than $1 million remaining.

Strong growth primarily within our specialty finance group portfolios drove total average loans and leases higher during the year.

During 2022, the tax-equivalent yield on investment securities available-for-sale increased 21 basis points to 1.50% while the average balance grew $401.97 million or 27.85% with the largest increases in U.S.

treasury and federal agency securities and mortgage-backed securities.

Average mortgages held for sale decreased $11.85 million or 69.59% during 2022 while the yield increased 156 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 decreased $196.48 million or 44.61% during 2022 while the yield increased 75 basis points.

The average balance decrease in other investments was primarily a result of lower balances held at the Federal Reserve Bank.

Average interest-bearing deposits increased $213.14 million or 4.78% during 2022 while the effective rate paid on those deposits increased 26 basis points.

The increased average balance was primarily due to increases in business, consumer and public fund deposits.

The increase in the average cost of interest-bearing deposits was primarily the result of higher rates and a shift in the deposit mix.

The deposit mix changed as the year progressed with clients moving their funds from non-maturity accounts to certificates of deposit due to the rising interest rate environment.

Additionally, brokered deposits grew during the fourth quarter.

Average noninterest-bearing demand deposits increased $155.71 million or 8.27% during 2022 due primarily to uncertain economic conditions and business customers maintaining a cautious stance with their funds and spending.

Average short-term borrowings increased $28.24 million or 15.12% during 2022 while the effective rate paid increased 63 basis points.

The increase in short-term borrowings was primarily the result of higher borrowings with the FHLB as part of liquidity management to support loan growth.

Average long-term debt and mandatorily redeemable securities balances decreased $23.91 million or 30.32% during 2022 as the effective rate decreased 301 basis points primarily due to lower rates on mandatorily redeemable securities from a reduction in book value per share during 2022.

Mandatorily redeemable shares are issued under the terms of one of our executive incentive compensation plans and are settled based on book value per share with changes from the previous reporting date recorded as interest expense.

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.

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Net interest income - FTE $ 4,124 $ 6,610 $ 10,734

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.

Noninterest Income — Noninterest income decreased $8.83 million or 8.82% in 2022 from 2021 following a $3.80 million or 3.65% decrease in 2021 from 2020.

The following table shows noninterest income for the most recent three years ended December 31.

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Total noninterest income $ 91,262 $ 100,092 $ 103,889

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 (which include investment management fees, estate administration fees, mutual fund fees, annuity fees, and fiduciary fees) decreased $0.68 million or 2.84% in 2022 from 2021 compared to a $2.67 million or 12.64% increase in 2021 over 2020.

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, 2022 and 2021 was $4.84 billion and $5.33 billion, respectively.

Strong stock market performance and new business results in 2021 helped improve the market value of trust assets under management.

The negative performance of the stock and bond markets in 2022 resulted in a decline in the market value of trust assets under management compared to 2021.

At December 31, 2022, these trust assets were comprised of $3.21 billion of personal and agency trusts and estate administration assets, $1.03 billion of employee benefit plan assets, $0.49 million of individual retirement accounts, and $0.11 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.

Service charges on deposit accounts increased by $1.56 million or 14.70% in 2022 from 2021 compared to an increase of $1.10 million or 11.64% in 2021 from 2020.

The growth in service charges on deposit accounts in 2022 was primarily due to increased consumer and business nonsufficient fund transactions.

The increase in service charges on deposit accounts in 2021 was primarily due to a 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 in 2021 led to a corresponding improvement in consumer and business activity.

Debit card income was relatively flat from 2022 to 2021 compared to an increase of $3.14 million or 20.97% in 2021 from 2020.

The decline in 2022 to 2021 was mainly the result of decreased discretionary spending and a focus on core expenses by consumers.

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.

Mortgage banking income dropped $7.70 million or 65.13% in 2022 over 2021, compared to a $3.85 million or 24.58% decrease in 2021 from 2020.

We had $0.81 million of MSR impairment recoveries in 2021 and $0.81 million of MSR impairment charges in 2020.

During 2022, 2021 and 2020, we determined that no permanent write-down was necessary for previously recorded impairment on MSRs.

During 2022, mortgage banking income decreased primarily due to reduced mortgage origination volumes resulting in lower income on loans sold in the secondary market.

Demand for mortgages has continued to decline with steep increases in interest rates, limited inventory, and fewer housing starts all of which impacted market activity.

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.

Insurance commissions declined $0.54 million or 7.51% in 2022 compared to 2021 and improved $0.22 million or 3.16% in 2021 compared to 2020.

The decrease in 2022 was primarily due to a reduced book of business and fewer contingent commissions received.

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.

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.

Equipment rental income generated from operating leases decreased by $4.37 million or 26.27% during 2022 from 2021 compared to a reduction of $6.73 million or 28.80% during 2021 from 2020.

The average equipment rental portfolio decreased 21.27% in 2022 over 2021 and 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 competitive pricing pressures for new business.

In 2022 and 2021, the decline in rental income was offset by a similar decline in depreciation on equipment owned under operating leases.

Losses on the sale of investment securities available-for-sale were $0.18 million and $0.68 million in 2022 and 2021, respectively.

There were gains of $0.28 million on the sale of investment securities available-for-sale for the year ended 2020.

Losses and gains on the sale of investment securities available-for-sale were primarily from the sale of Federal agency securities in 2022 and corporate securities in 2021 and 2020, with the goal of managing portfolio risk and liquidity.

Other income improved $2.48 million or 19.76% in 2022 from 2021 compared to an increase of $0.61 million or 5.11% in 2021 from 2020.

The increase in 2022 was mainly a result of partnership investment gains on sale of renewable energy tax equity investments of $2.24 million and higher bank owned life insurance policy claims offset by a write down of $0.37 million on small business capital investments and reduced customer swap fees of $0.33 million.

The increase in 2021 was mainly a result of higher brokerage fees and commissions and increased partnership investment gains offset by reduced customer swap fees and lower bank owned life insurance policy claims.

Noninterest Expense — Noninterest expense decreased $1.45 million or 0.78% in 2022 from 2021 following a $1.22 million or 0.65% decrease in 2021 from 2020.

The following table shows noninterest expense for the most recent three years ended December 31.

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Furniture and equipment 5,448 5,977 6,541

Data Processing 22,375 19,877 19,147

Depreciation — leased equipment 10,023 13,694 20,203

Professional fees 7,280 8,676 6,317

Supplies and communications 5,942 5,563 6,454

FDIC and other insurance 3,625 2,677 2,606

Business development and marketing 5,823 8,013 4,157

Loan and lease collection and repossession 30 3,099 3,402

Other 14,287 10,902 16,564

Total noninterest expense $ 184,699 $ 186,148 $ 187,367

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.

Total salaries and employee benefits were relatively flat in 2022 from 2021, following a $4.25 million or 4.19% increase in 2021 from 2020.

Employee salaries grew $0.62 million or 0.73% in 2022 from 2021 compared to an increase of $2.93 million or 3.54% in 2021 from 2020.

The increase in 2022 was mainly a result of higher base salaries due to normal merit increases offset by a decrease in incentive compensation and commission compensation primarily in our residential mortgage area.

The growth 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.

Employee benefits decreased $1.32 million or 6.58% in 2022 from 2021, compared to a $1.32 million or 7.05% increase in 2021 from 2020.

During 2022, group insurance costs were lower due to decreased claims experienced compared to levels in 2021.

In 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.

Occupancy expense rose $0.20 million or 1.94% in 2022 from 2021, compared to an increase of $0.25 million or 2.41% in 2021 from 2020.

The elevated expense in 2022 was primarily the result of higher snow removal costs due to inclement weather conditions.

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.

Furniture and equipment expense, including depreciation, declined by $0.53 million or 8.85% in 2022 from 2021 compared to a decrease of $0.56 million or 8.62% in 2021 from 2020.

The lower expense in 2022 was primarily due to a reduction in equipment rental and depreciation expenses.

The lower expense in 2021 was primarily due to a reduction in furniture and equipment depreciation and lower corporate aircraft maintenance.

Data processing expense rose by $2.50 million or 12.57% in 2022 from 2021, following a $0.73 million or 3.81% increase in 2021 from 2020.

The increase in 2022 was due to a rise in software maintenance costs and higher computer processing charges related to a variety of technology projects.

The increase in 2021 was a result of increases in software maintenance costs and point of sale computer operating expenses.

Depreciation on equipment owned under operating leases declined $3.67 million or 26.81% in 2022 from 2021, following a $6.51 million or 32.22% decrease in 2021 from 2020.

In 2022 and 2021, 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.

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.

Professional fees decreased $1.40 million or 16.09% in 2022 from 2021, compared to a $2.36 million or 37.34% increase in 2021 from 2020.

The lower expense in 2022 can primarily be attributed to a decline in legal fees offset by increased utilization of consulting services for technology projects and compliance services.

The higher expense in 2021 compared to 2020 was primarily due to a rise in legal fees and increased utilization of consulting services for technology projects.

FDIC and other insurance expense grew $0.95 million or 35.41% in 2022 from 2021 and increased $0.07 million or 2.72% in 2021 from 2020.

The increase in 2022 was mainly the result of higher assessments for FDIC premiums from a larger asset base and a one-time $0.38 million recovery of an incurred but not reported insurance reserve in 2021.

Business development and marketing expenses declined $2.19 million or 27.33% in 2022 from 2021 and rose $3.86 million or 92.76% in 2021 from 2020.

The decreased expense in 2022 was mainly the result of a one-time charitable contribution of $3.00 million made during 2021 offset by increased business development expense and marketing promotions.

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.

Other expenses increased by $3.39 million or 31.05% in 2022 as compared to 2021 and decreased $5.66 million or 34.18% in 2021 as compared to 2020.

The higher expense in 2022 was primarily the result of an increase in the provision for unfunded loan commitments, a rise in the provision for interest rate swaps with customers, and higher employee training expenses.

The reduction in 2021 was primarily the result of lower general collection and repossession expenses, fewer valuation adjustments on repossessed assets, a lower provision for interest rate swaps with customers, a decrease in the provision for unfunded loan commitments, and a reduction in postage and shipping expenses offset by reduced gains on the sale of operating lease equipment and higher employee training expenses due to fewer COVID-19 travel restrictions.

Income Taxes — 1st Source recognized income tax expense in 2022 of $36.26 million, compared to $36.33 million in 2021, and $24.88 million in 2020.

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Loans and leases, net of unearned discount, at December 31, 2022, were $6.01 billion and were 72.08% of total assets, compared to $5.35 billion and 66.03% of total assets at December 31, 2021.

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.

Average loans and leases, net of unearned discount, increased $128.88 million or 2.37% and decreased $25.62 million or 0.47% in 2022 and 2021, respectively.

PPP loans, net of unearned discount, at December 31, 2022 and 2021 were $0.90 million and $73.08 million, respectively, and were located in the Commercial and agricultural lending portfolio.

Commercial and agricultural lending, excluding those loans secured by real estate but including PPP loans, decreased $106.68 million or 11.61% in 2022 over 2021.

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.

Commercial and agricultural lending outstandings were $812.03 million and $918.71 million at December 31, 2022 and December 31, 2021, respectively.

Similar to 2021, the decrease during 2022 was largely due to PPP loan forgiveness and customer pay downs which amounted to $74.88 million during 2022.

Additionally, one-time reclassifications of loan outstandings from this portfolio into the commercial real estate portfolio of $32.66 million contributed to the balance reduction.

Excluding PPP loans, commercial and agricultural outstandings were $811.13 million and $845.63 million as of December 31, 2022 and 2021, respectively.

Solar loans and leases increased $32.86 million or 9.43% in 2022 over 2021.

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At December 31, 2022, auto and light truck loans had outstandings of $808.12 million and $603.78 million at December 31, 2021.

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.

This increase was primarily attributable to expanding relationships with existing clients and selectively adding new clients during a time of continued constrained fleet availability.

Medium and heavy duty truck loans and leases increased $54.12 million or 20.84% in 2022.

Medium and heavy duty truck financing at December 31, 2022 and 2021 had outstandings of $313.86 million and $259.74 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.

The increase at December 31, 2022 from December 31, 2021 can be mainly attributed to expanded relationships with existing clients while fleet availability continues to be constrained.

Aircraft financing at year-end 2022 increased $179.32 million or 19.96% from year-end 2021.

Aircraft financing at December 31, 2021 and 2020 had outstandings of $898.40 million and $861.46 million, respectively.

Aircraft financing at December 31, 2022 and 2021 had outstandings of $1.08 billion and $898.40 million, respectively.

The increase during 2022 was due to higher domestic outstandings of $75.17 million and foreign outstandings of $104.15 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 2022 balances increased as demand was bolstered by ongoing health safety concerns sparked by COVID-19 and increasingly less convenient commercial travel.

Those concerns as well as customers hoping to take advantage of bonus depreciation, which will begin phasing down during 2023, increased demand for private turbine aircraft especially amongst private business and high net worth market segments.

Our foreign outstandings increased 53.88% year over year.

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Construction equipment financing at December 31, 2022 had outstandings of $938.50 million, compared to outstandings of $754.27 million at December 31, 2021.

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.

The growth in this category was primarily due to significant new client relationships and continued growth with existing clients.

Commercial loans secured by real estate, of which approximately 57% is owner occupied, increased $14.40 million or 1.55% in 2022 over 2021.

Commercial loans secured by real estate outstanding at December 31, 2022 were $943.75 million and $929.34 million at December 31, 2021.

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.

The increase in 2022 was the result of one-time reclassifications from the commercial and agricultural portfolio of $32.66 million as well as by continued modest growth of owner occupied borrowings within certain business sectors of our markets.

Our non-owner occupied real estate portfolio again declined slightly as projects took advantage of low market rates and refinanced via the secondary markets.

In addition, some of our newer projects have seen continued delays due to labor and material shortages.

Residential real estate and home equity loans were $584.74 million at December 31, 2022 and $500.59 million at December 31, 2021.

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.

Residential real estate and home equity loans increased $84.15 million or 16.81% in 2022 from 2021.

Residential mortgage and home equity outstandings grew in 2022 as new adjustable-rate mortgage loans were retained rather than being sold into the secondary market along with high demand for home equity lines of credit.

The trends from 2021 shifted in 2022 as clients did not want to refinance their first mortgages to pull equity from their homes.

In addition, a slow housing market and low builder confidence tended to slow home purchases.

Consumer loans increased $18.20 million or 13.68% in 2022 over 2021.

Consumer loans outstanding at December 31, 2022, were $151.28 million and $133.08 million at December 31, 2021.

Volumes modestly increased as consumer spending improved as clients learned how to live with the COVID-19 pandemic.

Volumes increased as consumer spending improved as restrictions associated with the COVID-19 pandemic were relaxed.

In addition, an increase in new and used car prices resulted in an increase in average loan size.

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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.

Our liability for repurchases, included in Accrued Expenses and Other Liabilities on the Statements of Financial Condition, was $0.17 million and $0.22 million as of December 31, 2022 and 2021, respectively.

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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.

Our allowance for unfunded credit commitments is included 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.

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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.

Forecasts are difficult to establish and the current environment presents complexity with near 40-year high inflation, markedly higher interest rates, and heightened uncertainty from the protracted war in Ukraine.

Residual economic impacts from the pandemic remain an intermittent, but recurrent, headwind for global trade particularly in China and neighboring countries where spiking COVID-19 cases led to lockdown measures and travel restrictions.

Economic growth prospects entering the new year are discouraging, with widespread calls for recession in the U.S.

GDP forecasts continue to trend downward as persistent inflation, continued hawkishness of the Federal Reserve, and the ongoing war in Ukraine heavily weigh on the outlook.

Current political turmoil in Brazil, growing tensions between China and the U.S., and longstanding turmoil in the Middle East, also 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.

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.

The outlook for world economies is weak, with decades-high inflation, geopolitical uncertainty, lingering pandemic activity and a consequent slowdown in China impacting the outlook.

Current concerns include corruption scandals and political unrest in Latin American countries, the competitive and complex nature of U.S.-China relations, the geopolitical tensions with Russia, and persistent threats of terrorist attacks.

In Brazil and Mexico where we have a presence with our aircraft lending, we remain concerned with significant inflation, high interest rates and their resultant economic impact, political unrest most prominently evident in Brazil, and the likelihood of economic weakness in future periods that would parallel an expected slowdown in the U.S.

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.

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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.

Loan outstandings have fluctuated in recent years as two rounds of Paycheck Protection Program loans entered and exited the portfolio with loan forgiveness.

Our customers have benefited from the monetary and fiscal stimulus, which provided a lifeline during a period of unprecedented market undercurrents.

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.

Small business confidence remains below the long term average as fewer business owners expect the economy to improve in the next six months.

Wholesalers and manufacturers have generally performed well and most were able to navigate the supply chain difficulties while passing along rising costs to their consumers.

The recreational vehicle industry, which is centered in our footprint, is slowing from record high shipment levels with supply and demand dynamics reversing in recent months.

Our business customers engaged in manufacturing for, and supplying the industry, performed very well during the recent years.

There has been broad consolidation within the industry over the last two decades and industry suppliers and manufacturers are generally stronger and better capitalized than past cycles to navigate a downturn.

The outlook in our agricultural portfolio remains cautiously optimistic as commodity prices remain high, although an expiring Farm Bill is cause for uncertainty.

Input prices are expected to remain elevated and along with higher borrowing costs and cash rents, will likely result in thin, but still profitable margins on our agricultural business clients next year.

Our customers experienced favorable growing and harvesting conditions during the year which resulted in strong crop yields.

In the commercial and agricultural portfolio, we have experienced generally stable credit quality trends with low delinquencies and minimal charge-offs.

As of the end of 2022, 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 six years ago continues to gain momentum in terms of the performance of existing projects financed, loan growth opportunities and overall credit quality.

Financing is provided to qualified borrowers throughout the continental United States with an emphasis on the region east of the Rocky Mountains.

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.

To date, we have not incurred any losses in this portfolio and qualitative adjustments were lowered in the portfolio with the current year-end analysis given continued favorable credit performance.

Auto and light truck – The primary auto rental segment of the auto and light truck portfolio experienced a strong year with sizable loan growth as demand for rental vehicles was high and revenue per unit reached a record for the industry.

Semiconductor shortages restrained new vehicle production and manufacturers dramatically reduced fleet sales in response.

With limited new vehicle availability, used prices skyrocketed and forced operators to forego typical fleet cycles and hold existing inventory for longer periods.

The significant increase in vehicle values generally benefited our customers however, elevated valuations increase risk with new fundings which we have attempted to mitigate by maintaining appropriate terms and limiting funding on used units.

Wholesale used vehicle prices have declined in nine of the last twelve months and are 15% off the prior year peak, although used values remain well above the historical trendline.

Loan growth is strong with operators holding vehicles longer thereby extending fleet cycles.

The auto leasing segment also performed well in 2022 and the portfolio exhibits stable credit quality and low delinquency.

Leasing customers lease to auto rental companies as well as other commercial entities.

We have some concern that increasing vehicle prices and higher borrowing costs could lead to leasing companies stretching for yield by lowering credit quality standards on sub-lessees.

We remain diligent in setting our terms and residual value appropriately and monitoring fleet mix given the recent volatility in vehicle prices.

The portfolio reported a net recovery position for the year in both the auto rental and specialty vehicle portfolios which include the bus, step van, and funeral car segments.

The bus segment experienced losses in the prior two years due to the pandemic and collateral values for motor coaches decreasing substantially during that time.

Values are showing signs of stabilization, particularly in late-model motor coaches.

There remains concern with repossessing bus units should credit quality deteriorate as outlets for repossessed inventory are not well established and markets are limited.

Long-term, there remains uncertainty as some bus portfolio customers may struggle 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 removed the majority of qualitative factors in the bus segment as we believe historical loss rates are sufficient to cover remaining risk in the portfolio as we recognized charge-offs during 2022 and 2021 and our expectation is that future losses will be lower than recent experience.

We believe we appropriately recognized the losses in our portfolio and that peak charge-offs occurred in 2021.

Special attention balances decreased from $26.26 million at the end of 2021 to $14.56 million at the end of 2022.

Credit quality in the auto rental and leasing portions of the portfolio remain stable and we modestly reduced qualitative factors in those segments.

Medium and heavy duty truck – Credit quality remains stable in the medium and heavy duty truck portfolio.

The industry continues to struggle with driver shortages.

However, the highly limited inventory of Class 8 tractors experienced in 2021 due to a semiconductor chip shortage appears to have largely been rectified – inventory levels are rebounding and auction valuations are softening.

Loan growth opportunities were improved during 2022 as more equipment became available.

We believe our reserve ratios for this portfolio are appropriate.

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.

Aircraft – Our domestic and foreign aircraft segments both experienced strong loan growth during the year as high asset valuations and demand for private aircraft increased lending opportunities.

The portfolio has been a relatively stable performer of late, but was among the sectors affected most by the sluggish economy following the Great Recession.

Our portfolio loss history has been volatile, characterized by lengthy periods of minimal losses or modest recoveries followed by short intervals of higher losses.

Aircraft collateral values, particularly those in our niche, have strengthened considerably in this economic cycle.

Long, often multi-year, delays for new aircraft have in some instances driven used valuations beyond the price of new aircraft given their immediate availability.

In this portfolio we have $297 million of foreign exposure, primarily in Mexico and Brazil.

Brazil’s economy continues to struggle to sustain growth and is further hampered by increased inflation fears and political uncertainties.

The Mexican economy has fared better of late as its manufacturing rebounded with recovering automotive production.

Growth continues to be threatened by drug trafficking and related violence with widespread poverty and income inequality remaining significant concerns.

Qualitative adjustments are assigned to Brazil and Mexico’s economic risk as the bulk of foreign aircraft outstandings are domiciled in those markets.

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 adjusted the historical ratios for current conditions, principally, a small increase in collateral concentration risk as we are currently lending into an abnormally strong used aircraft market with increased downside valuation risk on new fundings.

Additionally, we increased the qualitative forecast factor adjustment for cohort based pools which is commensurate to the impact of the forecast adjustment in the PD/LGD (probability of default/loss given default) model analysis.

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.

however, there have been credit quality concerns in recent periods with a steady undercurrent of unanticipated downgrades to special attention during the last two years.

The portfolio recognized the largest singular charge-off in both 2021 and 2022.

The construction industry benefited from growth in private residential construction over the last several years, but higher interest rates and a rapidly slowing housing market have weakened the outlook for site developers.

Certain sectors are experiencing stress and we continue to monitor for credit weaknesses.

Construction equipment remains vulnerable due to volatility and regulation in the oil and gas sector.

The general nature of bidding on construction projects can also have unknown costs or delays.

Increased energy costs have been harmful to portfolio clients which often operate under long-term contracts that may lack adequate cost escalators.

Diesel prices remain elevated and will be a hardship for clients in the construction industry and have impacted margins.

Historically, we have experienced less volatility in this portfolio than the broader industry as losses have been mitigated by appropriate underwriting and a global market for used construction equipment.

Continued infrastructure spending is expected to have a positive impact for many contractors within the segment and for the industry’s used equipment markets.

We modified our qualitative factors as of 2021 year-end to recognize the increased volume of accounts moving into special attention, and qualitative factors were largely maintained with the 2022 portfolio review given continued special attention activity.

Commercial real estate – Similar to the commercial portfolio, our commercial real estate loans are concentrated in our local market with local customers.

Approximately 57% of the Bank’s exposure in this portfolio is from owner occupied facilities where we are the primary relationship bank for our customers.

We reviewed our qualitative adjustments as of year-end, and made some modifications as we are concerned about higher interest and capitalization rates within the segment and the potential negative impact on real estate valuations.

We believe our ratios as adjusted are appropriate and adequate as of December 31, 2022.

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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.

Losses in these portfolios have been immaterial since 2013, but we did experience losses during the housing crises and recognized one loss of $0.23 million during 2022 which is related to a commercial special attention account.

We reviewed our qualitative adjustments at the end of 2022 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.

Losses are stable during good economic times and tend to increase when there is deterioration in local economic factors and employment rates.

We reviewed our qualitative adjustments at the end of the 2022 which are primarily for reasonable and supportable forecasts, and believe they are appropriate.

The allowance for loan and lease losses at December 31, 2022, totaled $139.27 million and was 2.32% of loans and leases, compared to $127.49 million or 2.38% of loans and leases at December 31, 2021 and $140.65 million or 2.56% of loans and leases at December 31, 2020.

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Charge-offs for loan and lease losses were $3.41 million for 2022, compared to $12.52 million for 2021 and $13.97 million for 2020.

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.

In order to accommodate net charge offs and strong loan and lease growth, we added $13.25 million to the provision for credit losses for 2022, compared to a recovery of provision of $(4.30) million for 2021 and a provision of $36.00 million for 2020.

The following table summarizes our loan and lease loss experience for each of the last three years ended December 31.

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Net charge-offs (recoveries) 1,469 8,859 9,185

(Recovery of) provision for loan and lease losses (4,303) 36,001 15,833

Provision (recovery of provision) for loan and lease losses 13,245 (4,303) 36,001

Balance at end of period $ 139,268 $ 127,492 $ 140,654

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During 2022, interest income on nonaccrual loans and leases would have increased by approximately $2.68 million compared to $2.62 million in 2021 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.

Nonperforming assets at December 31, 2022 decreased from December 31, 2021, mainly due to declines in nonaccrual loans and leases in the bus segment of the auto and light truck portfolio along with modestly lower nonaccrual loans in construction equipment.

Repossessions consisted mainly of units in the bus and step van segments of the auto and light truck portfolio.

Other real estate consists of one residential real estate property.

Nonperforming assets at December 31 (Dollars in thousands)

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Medium and heavy duty truck — —

Aircraft — 750

Construction equipment — 757

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As of December 31, 2022 and 2021, we had $7.83 million and $1.23 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.

At December 31, 2022, potential problem loans consisted of one credit relationship in the commercial and agricultural portfolio.

Weakness in the borrower’s operating performance have caused us to heighten attention given to this credit.

INVESTMENT PORTFOLIO

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2% in the years 2015 and 2016;

and 6% in years 2013 and prior.

4% in the years 2014 prior.

The following table shows the average daily amounts of deposits and rates paid on such deposits.

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Weighted average interest rate during the year 0.12 % 0.04 % 3.22 % — % 0.70 %

Weighted average interest rate for outstanding amounts at December 31, 2021 0.04 % 0.04 % N/A — % 0.04 %

Weighted average interest rate for outstanding amounts at December 31, 2022 0.05 % 0.03 % 4.16 % — % 1.39 %

Balance at December 31, 2021 $ 194,727 $ 3,967 $ — $ 1,333 $ 200,027

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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.

The unrealized losses on available-for-sale securities, net of income taxes, were $147.69 million and $9.86 million at December 31, 2022 and 2021, respectively.

The unrealized losses occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase.

Additionally, we do not intend to sell these investments and it is more likely than not that we will not be required to sell these investments before recovery of the amortized cost basis, which may be the maturity dates of the securities.

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.

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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.

Our potential liquidity exposure if we must pledge collateral is approximately $1.15 billion.

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.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis