Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This analysis is intended to assist you in understanding our results of operations for each of the past three years and financial condition for each of the past two years.
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, including substantial changes in the cost of fuel.
• Political instability, acts of war or terrorism, or cybersecurity threats.
• The spread of infectious diseases or pandemics.
• 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.
• The impact of climate change.
• 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.
• 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.
• 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.
16
Table of Contents
• 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, Finance and Risk 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. 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.
Additionally, we are required 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 the current environment presents challenges with increasing geopolitical uncertainty, elevated inflation, high interest rates, and persistently inverted yield curve. 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. 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.
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 review 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.”
17
Table of Contents
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.”
EARNINGS SUMMARY
Net income available to common shareholders in 2023 was $124.93 million, up from $120.51 million in 2022 and up from $118.53 million in 2021. Diluted net income per common share was $5.03 in 2023, $4.84 in 2022, and $4.70 in 2021. Return on average total assets was 1.48% in 2023 compared to 1.49% in 2022, and 1.53% in 2021. Return on average common shareholders’ equity was 13.48% in 2023 versus 13.81% in 2022, and 13.07% in 2021.
Net income in 2023, as compared to 2022, was positively impacted by a $15.18 million or 5.76% increase in net interest income and a $7.38 million decrease in the provision for credit losses which was offset by a $17.03 million or 9.22% increase in noninterest expense. 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 an $8.83 million or 8.82% decrease in noninterest income.
Dividends paid on common stock in 2023 amounted to $1.30 per share, compared to $1.26 per share in 2022, and $1.21 per share in 2021. 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. 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 3.51% in 2023, compared to 3.45% in 2022 and 3.23% in 2021. Net interest income was $278.65 million for 2023, compared to $263.47 million for 2022 and $236.64 million for 2021. Tax-equivalent net interest income totaled $279.39 million for 2023, up $15.29 million from the $264.10 million reported in 2022. Tax-equivalent net interest income for 2022 was up $27.00 million from the $237.10 million reported for 2021.
During 2023, average earning assets increased $295.44 million or 3.86% while average interest-bearing liabilities increased $520.63 million or 10.41% over the comparable period in 2022. The yield on average earning assets increased 141 basis points to 5.25% for 2023 from 3.84% for 2022 primarily due to higher rates on loans and leases, tax exempt investment securities and 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. Total cost of average interest-bearing liabilities increased 189 basis points to 2.50% during 2023 from 0.61% in 2022 as a result of the higher interest rate environment. The result to the fully taxable-equivalent net interest margin was an increase of six basis points.
18
Table of Contents
The largest contributor to the increase in the yield on average earning assets in 2023 was the 151 basis point improvement in the loan and lease portfolio yield primarily from rising interest rates. Average loans and leases increased $637.16 million or 11.45% in 2023 from 2022 while the yield increased to 6.25%. Strong growth primarily within our Auto and Light Truck, Construction Equipment and Commercial Real Estate portfolios drove total average loans and leases higher during the year. Net interest recoveries positively contributed three basis points to the yield on average loans and leases during 2023 and two basis points to the average loans and leases yield during 2022.
During 2023, the tax-equivalent yield on investment securities available-for-sale increased seven basis points to 1.57% while the average balance decreased $168.70 million or 9.14% with the largest decreases in U.S. treasury and federal agency securities and mortgage-backed securities. Average mortgages held for sale decreased $2.81 million or 54.27% during 2023 while the yield increased 236 basis points. Average other investments decreased $170.21 million or 69.78% during 2023 while the yield increased 391 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 $530.60 million or 11.35% during 2023 while the effective rate paid on those deposits increased 183 basis points. The increased average balance was primarily due to increases in time deposits, public fund, and brokered 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 change which began during 2022 carried over into 2023 with clients moving their funds from non-maturity accounts to certificates of deposit due to the rising interest rate environment. Average noninterest-bearing demand deposits decreased $284.73 million or 13.97% during 2023 due primarily to persistent rate competition for deposits and greater utilization of excess funds by our business customers.
Average short-term borrowings decreased $1.36 million or 0.63% during 2023 while the effective rate paid increased 259 basis points. The decrease in short-term borrowings was primarily the result of lower repurchase agreements offset by increased borrowings with the FHLB. Average long-term debt and mandatorily redeemable securities balances decreased $8.62 million or 15.68% during 2023 while the effective rate increased 827 basis points primarily due to higher rates on mandatorily redeemable securities from an improvement in book value per share during 2023. 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.
19
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.
2023 2022 2021
(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 $ 1,632,567 $ 24,501 1.50 % $ 1,805,041 $ 26,294 1.46 % $ 1,410,797 $ 17,767 1.26 %
Tax-exempt (1)
44,083 1,805 4.09 % 40,310 1,311 3.25 % 32,583 741 2.27 %
Mortgages held for sale 2,368 155 6.55 % 5,178 217 4.19 % 17,026 448 2.63 %
Loans and leases, net of unearned discount (1)
6,203,857 387,524 6.25 % 5,566,701 264,043 4.74 % 5,437,817 234,902 4.32 %
Other investments 73,729 3,663 4.97 % 243,938 2,579 1.06 % 440,416 1,373 0.31 %
Total earning assets (1)
7,956,604 417,648 5.25 % 7,661,168 294,444 3.84 % 7,338,639 255,231 3.48 %
Cash and due from banks 70,304 75,836 77,275
Allowance for loan and lease losses (144,183) (133,028) (139,141)
Other assets 532,072 469,135 454,374
Total assets $ 8,414,797 $ 8,073,111 $ 7,731,147
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing deposits $ 5,204,095 $ 123,162 2.37 % $ 4,673,494 $ 25,231 0.54 % $ 4,460,359 $ 12,276 0.28 %
Short-term borrowings:
Securities sold under agreements to repurchase 78,928 136 0.17 % 166,254 85 0.05 % 180,610 112 0.06 %
Other short-term borrowings 134,683 6,896 5.12 % 48,716 1,412 2.90 % 6,119 3 0.05 %
Subordinated notes 58,764 4,174 7.10 % 58,764 3,550 6.04 % 58,764 3,267 5.56 %
Long-term debt and mandatorily redeemable securities 46,323 3,892 8.40 % 54,940 69 0.13 % 78,845 2,476 3.14 %
Total interest-bearing liabilities 5,522,793 138,260 2.50 % 5,002,168 30,347 0.61 % 4,784,697 18,134 0.38 %
Noninterest-bearing deposits 1,753,149 2,037,882 1,882,168
Other liabilities 151,659 103,740 112,291
Shareholders’ equity 926,935 872,721 906,951
Noncontrolling interests 60,261 56,600 45,040
Total liabilities and equity $ 8,414,797 $ 8,073,111 $ 7,731,147
Less: Fully tax-equivalent adjustments (741) (628) (459)
Net interest income/margin (GAAP-derived) (1)
$ 278,647 3.50 % $ 263,469 3.44 % $ 236,638 3.22 %
Fully tax-equivalent adjustments 741 628 459
Net interest income/margin - FTE (1)
$ 279,388 3.51 % $ 264,097 3.45 % $ 237,097 3.23 %
(1) See “Reconciliation of Non-GAAP Financial Measures” for more information on this performance measure/ratio.
20
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) 2023 2022 2021
Calculation of Net Interest Margin
(A) Interest income (GAAP) $ 416,907 $ 293,816 $ 254,772
Fully tax-equivalent adjustments:
(B) - Loans and leases 381 366 319
(C) - Tax-exempt investment securities 360 262 140
(D) Interest income - FTE (A+B+C) 417,648 294,444 255,231
(E) Interest expense (GAAP) 138,260 30,347 18,134
(F) Net interest income (GAAP) (A-E) 278,647 263,469 236,638
(G) Net interest income - FTE (D-E) 279,388 264,097 237,097
(H) Total earning assets $ 7,956,604 $ 7,661,168 $ 7,338,639
Net interest margin (GAAP-derived) (F/H) 3.50 % 3.44 % 3.22 %
Net interest margin - FTE (G/H) 3.51 % 3.45 % 3.23 %
21
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
2023 compared to 2022
Interest earned on:
Investment securities available-for-sale:
Taxable $ (2,570) $ 777 $ (1,793)
Tax-exempt 131 363 494
Mortgages held for sale (150) 88 (62)
Loans and leases, net of unearned discount 32,763 90,718 123,481
Other investments (2,856) 3,940 1,084
Total earning assets $ 27,318 $ 95,886 $ 123,204
Interest paid on:
Interest-bearing deposits $ 3,179 $ 94,752 $ 97,931
Short-term borrowings:
Securities sold under agreements to repurchase (64) 115 51
Other short-term borrowings 3,823 1,661 5,484
Subordinated notes — 624 624
Long-term debt and mandatorily redeemable securities (13) 3,836 3,823
Total interest-bearing liabilities $ 6,925 $ 100,988 $ 107,913
Net interest income - FTE $ 20,393 $ (5,102) $ 15,291
2022 compared to 2021
Interest earned on:
Investment securities available-for-sale:
Taxable $ 5,463 $ 3,064 $ 8,527
Tax-exempt 203 367 570
Mortgages held for sale (412) 181 (231)
Loans and leases, net of unearned discount 5,674 23,467 29,141
Other investments (843) 2,049 1,206
Total earning assets $ 10,085 $ 29,128 $ 39,213
Interest paid on:
Interest-bearing deposits $ 613 $ 12,342 $ 12,955
Short-term borrowings:
Securities sold under agreements to repurchase (8) (19) (27)
Other short-term borrowings 151 1,258 1,409
Subordinated notes — 283 283
Long-term debt and mandatorily redeemable securities (578) (1,829) (2,407)
Total interest-bearing liabilities $ 178 $ 12,035 $ 12,213
Net interest income - FTE $ 9,907 $ 17,093 $ 27,000
22
Table of Contents
Noninterest Income — Noninterest income decreased $0.64 million or 0.70% in 2023 from 2022 following a $8.83 million or 8.82% decrease in 2022 from 2021. The following table shows the components of our noninterest income for the most recent three years ended December 31.
(Dollars in thousands) 2023 2022 2021
Noninterest income:
Trust and wealth advisory $ 23,706 $ 23,107 $ 23,782
Service charges on deposit accounts 12,749 12,146 10,589
Debit card 17,980 18,052 18,125
Mortgage banking 3,471 4,122 11,822
Insurance commissions 6,911 6,703 7,247
Equipment rental 8,837 12,274 16,647
Losses on investment securities available-for-sale (2,926) (184) (680)
Other 19,895 15,042 12,560
Total noninterest income $ 90,623 $ 91,262 $ 100,092
Trust and wealth advisory fees (which include investment management fees, estate administration fees, mutual fund fees, annuity fees, and fiduciary fees) increased $0.60 million or 2.59% in 2023 from 2022 compared to a $0.68 million or 2.84% decrease in 2022 over 2021. 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, 2023 and 2022 was $5.46 billion and $4.84 billion, respectively. The positive performance of the stock and bond markets primarily during the fourth quarter of 2023 resulted in an increase in the market value of trust assets under management compared to 2022. At December 31, 2023, these trust assets were comprised of $3.66 billion of personal and agency trusts and estate administration assets, $1.10 billion of employee benefit plan assets, $0.53 million of individual retirement accounts, and $0.17 million of custody assets.
Service charges on deposit accounts increased by $0.60 million or 4.96% in 2023 from 2022 compared to an increase of $1.56 million or 14.70% in 2022 from 2021. The growth in service charges on deposit accounts in 2023 was primarily due to increased consumer and business overdraft transactions. The increase during 2022 was primarily due to increased consumer and business nonsufficient fund transactions.
Debit card income declined slightly during 2023 following a similar slight decrease during 2022. The declines in 2023 to 2022 were mainly the result of decreased discretionary spending and a focus on core expenses by consumers. Additionally, regulatory changes to web commerce transactions implemented by the Federal Reserve during 2023 had a negative impact.
Mortgage banking income dropped $0.65 million or 15.79% in 2023 over 2022, compared to a $7.70 million or 65.13% decrease in 2022 from 2021. We had $0.81 million of MSR impairment recoveries in 2021. During 2023, 2022 and 2021, we determined that no permanent write-down was necessary for previously recorded impairment on MSRs. During 2023 and 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.
Insurance commissions increased $0.21 million or 3.10% in 2023 compared to 2022 and declined $0.54 million or 7.51% in 2022 compared to 2021. The rise in 2023 was primarily due to a larger book of business and more contingent commissions received. The decrease in 2022 was primarily due to a reduced book of business and fewer contingent commissions received.
Equipment rental income generated from operating leases decreased by $3.44 million or 28.00% during 2023 from 2022 compared to a reduction of $4.37 million or 26.27% during 2022 from 2021. The average equipment rental portfolio decreased 29.45% in 2023 over 2022 and decreased 21.27% in 2022 over 2021 as a result of reduced leasing volume primarily in the medium and heavy duty truck, construction equipment and the auto and light truck portfolios due to changing customer preferences and competitive pricing pressures for new business. In 2023 and 2022, 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 $2.93 million in 2023 compared to losses of $0.18 million and $0.68 million in 2022 and 2021, respectively. Losses during 2023 of $2.88 million were the result of repositioning the investment securities portfolio. In the repositioning, approximately $40 million of securities with an average yield of 1.10% were sold and used to purchase approximately $40 million of securities with an average yield of 4.80%. The remaining 2023 losses were the result of sales to support liquidity and fund loan growth during the first quarter. Losses during 2022 and 2021 were from the sale of Federal agency securities in 2022 and corporate securities in 2021 with the goal of managing portfolio risk and liquidity.
23
Table of Contents
Other income improved $4.85 million or 32.26% in 2023 from 2022 compared to an increase of $2.48 million or 19.76% in 2022 from 2021. The increase in 2023 was mainly a result of partnership investment gains on sale of renewable energy tax equity investments of $3.43 million, increased customer swap fees of $1.23 million and higher bank owned life insurance policy claims. 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.
Noninterest Expense — Noninterest expense increased $17.03 million or 9.22% in 2023 from 2022 following a $1.45 million or 0.78% decrease in 2022 from 2021. The following table shows the components of our noninterest expense for the most recent three years ended December 31.
(Dollars in thousands) 2023 2022 2021
Noninterest expense:
Salaries and employee benefits $ 115,612 $ 105,110 $ 105,808
Net occupancy 11,090 10,728 10,524
Furniture and equipment 5,653 5,448 5,977
Data Processing 25,055 22,375 19,877
Depreciation — leased equipment 7,093 10,023 13,694
Professional fees 6,705 7,280 8,676
FDIC and other insurance 5,926 3,625 2,677
Business development and marketing 7,157 5,823 8,013
Other 17,433 14,287 10,902
Total noninterest expense $ 201,724 $ 184,699 $ 186,148
Total salaries and employee benefits increased $10.50 million or 9.99% in 2023 from 2022, following a slight decrease in 2022 from 2021.
Employee salaries grew $7.17 million or 8.31% in 2023 from 2022 compared to an increase of $0.62 million or 0.73% in 2022 from 2021. The increase in 2023 was mainly a result of higher base salaries due to normal merit increases, the impact of wage inflation, and an increase in the number of employees from the filling of prior open positions and lower employee turnover. 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.
Employee benefits increased $3.33 million or 17.73% in 2023 from 2022, compared to a $1.32 million or 6.58% decrease in 2022 from 2021. During 2023, group insurance costs were higher due to a rise in claims experienced and increased company contributions to employee retirement accounts compared to levels in 2022. During 2022, group insurance costs were lower due to decreased claims experienced compared to levels in 2021.
Occupancy expense rose $0.36 million or 3.37% in 2023 from 2022, compared to an increase of $0.20 million or 1.94% in 2022 from 2021. The expense increase in 2023 was primarily the result of higher premises repairs. The elevated expense in 2022 was primarily the result of higher snow removal costs due to inclement weather conditions.
Furniture and equipment expense, including depreciation, increased by $0.21 million or 3.76% in 2023 from 2022 compared to a decrease of $0.53 million or 8.85% in 2022 from 2021. The higher expense in 2023 was primarily due to increased equipment replacement costs. The lower expense in 2022 was primarily due to a reduction in equipment rental and depreciation expenses.
Data processing expense rose by $2.68 million or 11.98% in 2023 from 2022, following a $2.50 million or 12.57% increase in 2022 from 2021. The increases in 2023 and 2022 were due to a rise in software maintenance costs and higher computer processing charges related to a variety of technology projects.
Depreciation on equipment owned under operating leases declined $2.93 million or 29.23% in 2023 from 2022, following a $3.67 million or 26.81% decrease in 2022 from 2021. In 2023 and 2022, depreciation on equipment owned under operating leases correlated with the change in equipment rental income.
Professional fees decreased $0.58 million or 7.90% in 2023 from 2022, compared to a $1.40 million or 16.09% decrease in 2022 from 2021. The lower expense in 2023 can primarily be attributed to a decline in the utilization of consulting services for technology projects and compliance services. 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.
24
Table of Contents
FDIC and other insurance expense grew $2.30 million or 63.48% in 2023 from 2022 and increased $0.95 million or 35.41% in 2022 from 2021. The increase in 2023 was mainly the result of higher assessments for FDIC premiums from a two basis point increase in assessment rates during the first quarter of 2023. 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 increased $1.33 million or 22.91% in 2023 from 2022 following a decline of $2.19 million or 27.33% in 2022 from 2021. The increased expense in 2023 was mainly the result of a charitable contribution of $1.00 million made during 2023 and higher marketing promotions. 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.
Other expenses increased by $3.15 million or 22.02% in 2023 as compared to 2022 and increased $3.39 million or 31.05% in 2022 as compared to 2021. The higher expense in 2023 was primarily the result of an increase in the provision for unfunded credit commitments, higher postage and shipping costs, and a rise in data communication line charges as bandwidth is improved. 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.
Income Taxes — 1st Source recognized income tax expense in 2023 of $36.75 million, compared to $36.26 million in 2022, and $36.33 million in 2021. The effective tax rate in 2023 was 22.73% compared to 23.12% in 2022, and 23.45% in 2021.
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) 2023 2022
Commercial and agricultural $ 766,223 $ 812,031
Renewable energy 399,708 381,163
Auto and light truck 966,912 808,117
Medium and heavy duty truck 311,947 313,862
Aircraft 1,078,172 1,077,722
Construction equipment 1,084,752 938,503
Commercial real estate 1,129,861 943,745
Residential real estate and home equity 637,973 584,737
Consumer 142,957 151,282
Total loans and leases $ 6,518,505 $ 6,011,162
At December 31, 2023, 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, 2023, were $6.52 billion and were 74.69% of total assets, compared to $6.01 billion and 72.08% of total assets at December 31, 2022. Average loans and leases, net of unearned discount, increased $637.16 million or 11.45% and increased $128.88 million or 2.37% in 2023 and 2022, respectively.
Commercial and agricultural lending, excluding those loans secured by real estate, decreased $45.81 million or 5.64% in 2023 over 2022. Commercial and agricultural lending outstandings were $766.22 million and $812.03 million at December 31, 2023 and December 31, 2022, respectively. The reduction in balances during 2023 can be attributed to reduced borrowings within our working capital and line of credit products as borrowers utilized excess deposits to reduce their line of credit borrowings fueled by elevated interest rates.
Renewable energy loans and leases increased $18.55 million or 4.87% in 2023 over 2022. Renewable energy loan and lease outstandings were $399.71 million and $381.16 million at December 31, 2023 and 2022, respectively. The increase during 2023 was due to continued positive momentum from the addition of new clients and repeat business from existing clients.
Auto and light truck loans increased $158.80 million or 19.65% in 2023 over 2022. At December 31, 2023, auto and light truck loans had outstandings of $966.91 million and $808.12 million at December 31, 2022. This increase was primarily attributable to expanding and selectively adding vehicle rental and commercial lessor client relationships as fleet availability continues to improve.
25
Table of Contents
Medium and heavy duty truck loans and leases decreased $1.92 million or 0.61% in 2023. Medium and heavy duty truck financing at December 31, 2023 and 2022 had outstandings of $311.95 million and $313.86 million, respectively. The decrease at December 31, 2023 from December 31, 2022 can be mainly attributed to competitive factors and a selective credit approach to maintain yield with existing clients while fleet availability continues to improve.
Aircraft financing at year-end 2023 was relatively flat from year-end 2022. Aircraft financing at December 31, 2023 and 2022 had outstandings of $1.08 billion and $1.08 billion, respectively. Our 2023 domestic balances remained flat while increasing aircraft inventories and fewer transactions took place in the market. Bonus depreciation-motivated purchases are phasing down resulting in lower demand for private turbine aircraft especially amongst private business and high net worth market segments. Higher usage of cash for purchases and increased caution with large capital spending was normalizing after the record COVID-era transaction activity. We continue to exercise a consistent disciplined approach to aircraft types and client credit profiles. Our foreign outstandings, all denominated in U.S. dollars, increased 1.66% during 2023 and were $302.41 million and $297.46 million as of December 31, 2023 and 2022, respectively. Loan and lease outstandings to borrowers in Brazil and Mexico were $119.38 million and $147.61 million as of December 31, 2023, respectively, compared to $129.98 million and $136.68 million as of December 31, 2022, respectively. Outstanding balances to other borrowers in other countries were insignificant.
Construction equipment financing increased $146.25 million or 15.58% in 2023 compared to 2022. Construction equipment financing at December 31, 2023 had outstandings of $1.08 billion, compared to outstandings of $938.50 million at December 31, 2022. 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 increased $186.12 million or 19.72% in 2023 over 2022. Commercial loans secured by real estate outstanding at December 31, 2023 were $1.13 billion and $943.75 million at December 31, 2022. Approximately 55% of loans were owner occupied at December 31, 2023. The majority of our non-owner occupied commercial real estate projects are located within our primary market area. The increase in 2023 was the result of selective growth within our markets. We have financed a minimal amount of commercial real estate secured by non-owner occupied office property where third-party tenant rents are the primary source of repayment and all are performing as agreed.
Residential real estate and home equity loans were $637.97 million at December 31, 2023 and $584.74 million at December 31, 2022. Residential real estate and home equity loans increased $53.24 million or 9.10% in 2023 from 2022. Residential mortgage and home equity outstandings grew in 2023 as new adjustable-rate mortgage loans were retained rather than being sold into the secondary market. Additionally, reduced homeowner liquidity drove continued high demand for home equity lines of credit and loans. The trends from 2022 continued in 2023 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 decreased $8.33 million or 5.50% in 2023 over 2022. Consumer loans outstanding at December 31, 2023, were $142.96 million and $151.28 million at December 31, 2022. During 2023, higher vehicle prices, increased interest rates, reduced inventory levels and consumer’s lack of liquidity contributed to the decrease in consumer loans.
26
Table of Contents
The following table shows the contractual maturities of loans and leases outstanding as of December 31, 2023 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 $ 78,555 $ 193,681 $ 14,931 $ — $ 287,167
Variable rate 306,946 132,775 39,332 3 479,056
Total commercial and agricultural 385,501 326,456 54,263 3 766,223
Renewable energy
Fixed rate 8,912 28,001 28,437 13,940 79,290
Variable rate 125,986 97,175 88,956 8,301 320,418
Total renewable energy 134,898 125,176 117,393 22,241 399,708
Auto and light truck
Fixed rate 156,900 302,199 4,911 — 464,010
Variable rate 163,638 333,191 6,073 — 502,902
Total auto and light truck 320,538 635,390 10,984 — 966,912
Medium and heavy duty truck
Fixed rate 90,252 207,586 10,547 — 308,385
Variable rate 1,293 2,269 — — 3,562
Total medium and heavy duty truck 91,545 209,855 10,547 — 311,947
Aircraft
Fixed rate 133,613 603,982 13,654 — 751,249
Variable rate 73,836 154,908 98,179 — 326,923
Total aircraft 207,449 758,890 111,833 — 1,078,172
Construction equipment
Fixed rate 314,640 719,932 9,979 — 1,044,551
Variable rate 8,264 22,099 9,838 — 40,201
Total construction equipment 322,904 742,031 19,817 — 1,084,752
Commercial real estate
Fixed rate 93,073 450,802 73,730 280 617,885
Variable rate 21,079 317,669 138,882 34,346 511,976
Total commercial real estate 114,152 768,471 212,612 34,626 1,129,861
Residential real estate and home equity
Fixed rate 56,559 166,941 164,437 21,826 409,763
Variable rate 45,333 117,769 63,603 1,505 228,210
Total residential real estate and home equity 101,892 284,710 228,040 23,331 637,973
Consumer
Fixed rate 60,755 71,521 123 — 132,399
Variable rate 8,521 2,015 22 — 10,558
Total consumer 69,276 73,536 145 — 142,957
Total loans and leases
Fixed rate 993,259 2,744,645 320,749 36,046 4,094,699
Variable rate 754,896 1,179,870 444,885 44,155 2,423,806
Total loans and leases $ 1,748,155 $ 3,924,515 $ 765,634 $ 80,201 $ 6,518,505
During 2023, approximately 29% of the Bank’s residential mortgage originations were sold into the secondary market. Mortgage loans held for sale were $1.44 million at December 31, 2023 and were $3.91 million at December 31, 2022.
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.
27
Table of Contents
Our liability for repurchases, included in Accrued Expenses and Other Liabilities on the Statements of Financial Condition, was $0.15 million and $0.17 million as of December 31, 2023 and 2022, respectively. Our recovery for repurchase losses, included in Loan and Lease Collection and Repossession expense on the Statements of Income, was $0.07 million in 2023 compared to $0.05 million in 2022 and $0.09 million in 2021. 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 — 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 the Current Expected Credit Losses (CECL) methodology, we use a broad range of 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 and slow recovery which supports full lifetime losses. CECL requires our loan portfolio to be segregated into pools based on similar risk characteristics.
Pooled loans and leases are collectively evaluated using either a cohort cumulative loss rate methodology or a transition matrix-based probability of default (PD)/loss given default (LGD) methodology. 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, considering 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 current and historical conditions, including consideration of economic risk which is generally reflected in a forecast adjustment, specific industry risk and concentration risk, all of which may be susceptible to significant and unforeseen changes. We review the loan and lease portfolios to identify borrowers that might develop financial problems and to mitigate losses. Our allowance for loan and lease losses is provided for by direct charges to the provision for credit losses on the Consolidated Statements of Income. Losses on loans and leases are charged against the allowance and likewise, recoveries during the period for prior losses are credited to the allowance. We utilize similar processes to estimate our liability for credit losses on unfunded loan commitments which is included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Position and is provided for 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 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 based on analysis of environmental factors, principally specific industry risk, collateral risk, and concentration risk, along with global economic and political issues. Our forecast adjustment includes key economic factors affecting our portfolios such as growth in gross domestic product, unemployment rates, housing market trends, commodity prices, and inflation. Forecasts are difficult to establish and the current environment presents challenges with high interest rates and a persistently inverted yield curve, generally tighter lending conditions, growing signs of consumer stress, and heightened uncertainty from ongoing conflicts around the world. Economic growth prospects entering the new year remain below trend, with varied calls ranging from soft landing to recession for the domestic economy. GDP forecasts have improved slightly but substantial headwinds remain, and uncertainty is high with growing risks of widening global conflicts, and global supply chain disruption. 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.
We include a factor for global risk in our analysis. While difficult to predict with precision, global risks may adversely impact our borrowers impairing their ability to repay their financial obligations. The global outlook calls for slowing growth, high sovereign debt levels and continued high interest rates in developing countries pressure growth prospects. Rising global geopolitical uncertainty impacts the outlook and the escalation of various ongoing foreign conflicts. Global shipping routes are under threat of attack. Terrorism remains a persistent concern and risks of a catastrophic event are elevated. In Brazil and Mexico where we have a presence with our aircraft lending, we remain concerned with high interest rates and their resultant economic impact, upcoming elections in Mexico, and slowing growth forecasts for both countries.
28
Table of Contents
The following discussion focuses on relevant economic conditions and various circumstances impacting the December 31, 2023 allowance for loan and lease losses of each of our loan and lease segments.
Commercial and agricultural – Multiple industries are represented in the commercial and agricultural portfolio and the outlook for the portfolio is guarded. Small businesses are challenged to absorb higher interest rates, higher cost of capital, compete for labor, and control expenses. In our underlying industries, wholesalers have generally performed well and have been able to pass along rising costs. Manufacturers remain under pressure as demand for durable goods remains soft. The recreational vehicle industry, which is centered in our footprint, has slowed rapidly from record high shipment levels reached in 2022 with supply and demand dynamics reversing sharply. The outlook for 2024 remains weak; marginally improved from 2023. The outlook in our agricultural portfolio remains cautiously optimistic. Crop prices remain comparatively high but are slipping and elevated input prices and borrowing costs could squeeze margins of our agricultural clients. We experienced higher charge-offs in the commercial and agricultural portfolio during 2023 after a sustained period of low credit losses. Credit quality remains acceptable, but we expect to see some deterioration in the portfolio during the coming year as the impact of higher rates are fully realized.
Renewable energy – Our renewable energy (predominately solar) portfolio continues to perform well. Growth opportunities abound and overall credit quality remains solid. Risks include construction and developer related risks and delays, site issues, climate and weather risks, regulatory problems and permitting issues, as well as utility interconnection delays. To date, we have not incurred any losses in this portfolio and credit performance continues to be favorable.
Auto and light truck – The primary auto rental segment of the auto and light truck portfolio reported strong loan growth for a third straight year as demand for rental vehicles and revenue per unit remains elevated. Credit quality is generally stable, with limited weakness exhibited with a few smaller operators. Used asset valuations have softened but remain above the long-term trend line as constrained original equipment manufacturer (OEM) production volumes have likely provided some pricing support. Clients are slowly returning to more normalized fleet cycles, but cycles remain longer than historical norms. Increased vehicle values generally benefited our customers however, elevated valuations increase new funding risk which we have attempted to mitigate by maintaining appropriate terms and limiting funding on used units. Wholesale used vehicle prices continue to soften, particularly within electric vehicle segments of which we have limited exposure, although overall vehicle values remain above the longer-term trend line. The auto leasing segment also performed well in 2023 and the portfolio exhibits stable credit quality and low delinquency. Leasing customers lease to auto rental companies as well as other commercial entities. Our auto leasing portfolio is concentrated in larger client exposures. We remain diligent in setting our terms and residual values appropriately and monitoring fleet mix given recent volatility in vehicle prices. The auto and light truck portfolio reported a net recovery position for the year. We modestly adjusted qualitative factors in the portfolio due to substantial loan growth and the corresponding increase in concentration risk of overall bank capital.
Medium and heavy duty truck – The industry has weakened as it deals with overcapacity and declining freight rates. This portfolio has historically been a barometer for overall economic weakness and 2024 is expected to be a difficult year for the industry. In previous downturns, small companies and independent owner-operators have been hit the hardest and asset valuations could be pressured should consolidation accelerate. The portfolio exhibited no material loan growth for the year and has decreased as a percentage of capital, comparably to our other portfolios. At year-end, we adjusted qualitative factors in our allowance analysis to account for the industry’s increasing risk profile and expected credit deterioration.
Aircraft – Loan growth in our domestic and foreign aircraft segments was essentially flat after both segments exhibited strong growth in the previous year. Aircraft collateral values, particularly those in our niche, strengthened considerably during this economic cycle and are generally holding, although there are signs of softening valuations with select models and increased available inventory. OEM backlogs for new units remain healthy and have supported used prices. The portfolio has been relatively stable lately, 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 high losses. In this portfolio, we have $302 million of foreign exposure, primarily domiciled in Mexico and Brazil. Brazil’s economy outperformed expectations during 2023, but forecasts are moderating for the coming year as growth in the agricultural sector slows. The Mexican economy also fared better than expectations in 2023, although growth is anticipated to moderate in the coming year given heavy dependence on the U.S. economy which forecasts slower growth. Heavy indebtedness and financial problems with state-owned oil firm Pemex indicate ongoing concern for Mexico’s broader economy.
29
Table of Contents
Construction equipment – Our construction equipment portfolio has shown strong growth in recent periods and experienced stable credit quality in the years between the Great Recession and the pandemic. In recent years, there have been credit quality concerns with unanticipated downgrades to special attention. The portfolio recognized the largest single charge off in both 2021 and 2022; one of which was subsequently fully recovered during 2023. Higher interest rates and a slowed housing market have weakened the outlook for site developers. Certain industry segments are experiencing stress and we continue to monitor for credit weaknesses. The portfolio remains vulnerable to volatility and regulation in the oil and gas sector. The general nature of bidding on construction projects can also have unanticipated costs or delays. Volatile energy costs have been harmful to portfolio clients which often operate under long-term contracts that may lack adequate cost escalators. 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 modestly adjusted qualitative factors for concentration risk of overall bank capital due to substantial loan growth, while also easing an adjustment for elevated problem loan activity in the segment given reduced special attention volume.
Commercial real estate – Similar to the commercial portfolio, our commercial real estate loans are concentrated in our local market with local customers although we do fund select projects outside our market with multi-state developers that are headquartered in our footprint. Approximately 55% of the Bank’s exposure in this portfolio is from owner occupied facilities where we are the primary relationship bank for our clients. We reviewed our qualitative adjustments as of year-end and made adjustments to address interest rate maturity risk and added a factor for construction risk in select segments as the loan volume of projects under construction is much higher than prior periods. We continue to be concerned about higher interest and capitalization rates within the segment and the potential negative impact on both real estate valuations and projected cash flows.
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 immaterial since 2013. Qualitative factors in the portfolio are primarily for reasonable and supportable forecasts, although we made an adjustment at the end of 2023 to account for an increase of non-salable adjustable-rate mortgages in the loan mix with repricing risk at maturity.
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 increase when there is deterioration in local economic factors and employment rates. Loss rates have been modest since 2013, but we experienced higher write-downs within the portfolio during the year. We reviewed our qualitative adjustments at the end of the 2023 which primarily consist of reasonable and supportable forecasts and made an adjustment to account for increasing delinquency and nonperforming activity within the portfolio.
The allowance for loan and lease losses at December 31, 2023, totaled $147.55 million and was 2.26% of loans and leases, compared to $139.27 million or 2.32% of loans and leases at December 31, 2022 and $127.49 million or 2.38% of loans and leases at December 31, 2021. 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, 2023.
Charge-offs for loan and lease losses were $6.65 million for 2023, compared to $3.41 million for 2022 and $12.52 million for 2021. Reflective of our strong loan and lease growth, partially offset by a net recovery position, we added $5.87 million to the provision for credit losses for 2023, compared to a provision of $13.25 million for 2022 and a recovery of provision of $4.30 million for 2021.
30
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) 2023 2022 2021
Amounts of loans and leases outstanding at end of period $ 6,518,505 $ 6,011,162 $ 5,346,214
Average amount of net loans and leases outstanding during period
$ 6,203,857 $ 5,566,701 $ 5,437,817
Balance of allowance for loan and lease losses at beginning of period $ 139,268 $ 127,492 $ 140,654
Charge-offs:
Commercial and agricultural 4,305 625 2,930
Renewable energy — — —
Auto and light truck 729 118 7,797
Medium and heavy duty truck — — —
Aircraft — — —
Construction equipment 54 1,114 856
Commercial real estate 248 538 —
Residential real estate and home equity 101 284 228
Consumer 1,211 730 712
Total charge-offs 6,648 3,409 12,523
Recoveries:
Commercial and agricultural 243 56 812
Renewable energy — — —
Auto and light truck 5,591 417 1,316
Medium and heavy duty truck 12 — —
Aircraft 967 785 687
Construction equipment 1,656 17 473
Commercial real estate 11 45 19
Residential real estate and home equity 334 160 16
Consumer 252 460 341
Total recoveries 9,066 1,940 3,664
Net (recoveries) charge-offs (2,418) 1,469 8,859
Provision (recovery of provision) for loan and lease losses 5,866 13,245 (4,303)
Balance at end of period $ 147,552 $ 139,268 $ 127,492
Ratio of net (recoveries) charge-offs to average net loans and leases outstanding (0.04) % 0.03 % 0.16 %
Ratio of allowance for loan and lease losses to net loans and leases outstanding end of period 2.26 % 2.32 % 2.38 %
Coverage ratio of allowance for loan and lease losses to nonperforming loans and leases 627.08 % 526.06 % 327.28 %
The following table shows net (recoveries) charge-offs as a percentage of average loans and leases by portfolio type:
2023 2022 2021
Commercial and agricultural 0.52 % 0.07 % 0.19 %
Renewable energy — — —
Auto and light truck (0.55) (0.04) 1.11
Medium and heavy duty truck — — —
Aircraft (0.09) (0.08) (0.08)
Construction equipment (0.16) 0.13 0.05
Commercial real estate 0.02 0.05 —
Residential real estate and home equity (0.04) 0.02 0.04
Consumer 0.66 0.19 0.28
Total net (recoveries) charge-offs to average portfolio loans and leases (0.04) % 0.03 % 0.16 %
31
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.
2023 2022
(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 $ 17,385 11.76 % $ 14,635 13.51 %
Renewable energy 6,610 6.13 7,217 6.34
Auto and light truck 16,858 14.83 18,634 13.44
Medium and heavy duty truck 8,965 4.79 7,566 5.22
Aircraft 37,653 16.54 41,093 17.93
Construction equipment 26,510 16.64 24,039 15.61
Commercial real estate 23,690 17.33 17,431 15.70
Residential real estate and home equity 7,698 9.79 6,478 9.73
Consumer 2,183 2.19 2,175 2.52
Total $ 147,552 100.00 % $ 139,268 100.00 %
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 $24.24 million at December 31, 2023, compared to $26.93 million at December 31, 2022, and $41.33 million at December 31, 2021. During 2023, interest income on nonaccrual loans and leases would have increased by approximately $1.47 million compared to $2.68 million in 2022 if these loans and leases had earned interest at their full contractual rate.
Nonperforming assets at December 31, 2023 decreased from December 31, 2022, mainly due to declines in nonaccrual loans and leases in the auto and light truck and construction equipment portfolios offset by an increase in the commercial and agricultural portfolio. Repossessions consisted mainly of units in the specialty finance segments of the auto and light truck portfolio. There were no properties held in other real estate.
32
Table of Contents
Nonperforming assets at December 31 (Dollars in thousands)
2023 2022
Loans past due over 90 days $ 149 $ 54
Nonaccrual loans and leases:
Commercial and agricultural 13,267 864
Renewable energy — —
Auto and light truck 4,666 14,153
Medium and heavy duty truck — 15
Aircraft — 571
Construction equipment 176 5,469
Commercial real estate 2,970 3,229
Residential real estate and home equity 1,812 1,785
Consumer 490 334
Total nonaccrual loans and leases 23,381 26,420
Total nonperforming loans and leases 23,530 26,474
Other real estate — 104
Repossessions:
Commercial and agricultural — —
Auto and light truck 689 311
Medium and heavy duty truck — —
Aircraft — —
Construction equipment — —
Consumer 16 16
Total repossessions 705 327
Operating leases — 22
Total nonperforming assets $ 24,235 $ 26,927
Nonperforming loans and leases to loans and leases, net of unearned discount
0.36 % 0.44 %
Nonperforming assets to loans and leases and operating leases, net of unearned discount
0.37 % 0.45 %
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 potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. As of December 31, 2023 and 2022, we had $34.04 million and $7.83 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, 2023, potential problem loans consisted of five relationships; one relationship in the commercial and agricultural portfolio, one relationship in the aircraft portfolio, one relationship in the medium and heavy duty truck portfolio, and two relationships in the construction portfolio. Weakness in the borrowers’ operating performance have caused us to give heighten attention to these credits.
INVESTMENT PORTFOLIO
The amortized cost of securities available-for-sale at year-end 2023 decreased 10.50% from 2022, following a 4.96% increase from year-end 2021 to year-end 2022. The amortized cost of securities available-for-sale at December 31, 2023 was 20.19% of total assets, compared to 23.61% of total assets at December 31, 2022.
The following table shows the amortized cost of investment securities available-for-sale as of December 31.
(Dollars in thousands) 2023 2022
U.S. Treasury and Federal agencies securities $ 979,530 $ 1,090,743
U.S. States and political subdivisions securities 97,522 130,670
Mortgage-backed securities — Federal agencies 676,257 730,672
Corporate debt securities 8,448 16,486
Foreign government securities 600 600
Total investment securities available-for-sale $ 1,762,357 $ 1,969,171
33
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, 2023, 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 $ 257,225 0.93 %
1 – 5 years 722,305 0.94
5 – 10 years — —
Over 10 years — —
Total U.S. Treasury and Federal agencies securities 979,530 0.94
U.S. States and political subdivisions securities
Under 1 year 14,181 2.40
1 – 5 years 54,241 1.50
5 – 10 years 9,396 3.88
Over 10 years 19,704 5.87
Total U.S. States and political subdivisions securities 97,522 2.74
Corporate debt securities
Under 1 year 8,448 2.32
1 – 5 years — —
5 – 10 years — —
Over 10 years — —
Total Corporate debt securities 8,448 2.32
Foreign government securities
Under 1 year 600 2.12
1 – 5 years — —
5 – 10 years — —
Over 10 years — —
Total Foreign government securities 600 2.12
Mortgage-backed securities — Federal agencies 676,257 1.97
Total investment securities available-for-sale $ 1,762,357 1.44 %
At December 31, 2023, 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, 2023, the vintage (years originated) of the underlying loans comprising our securities are: 5% in the year 2023; 12% in the year 2022; 67% in the years 2020 and 2021; 7% in the years 2018 and 2019; 5% in the years 2016 and 2017; 4% in the years 2015 prior.
DEPOSITS
The following table shows the average daily amounts of deposits and rates paid on such deposits.
2023 2022 2021
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
Noninterest bearing demand $ 1,753,149 — % $ 2,037,882 — % $ 1,882,168 — %
Interest bearing demand 2,481,362 2.33 2,554,945 0.69 2,278,498 0.13
Savings 1,181,314 0.68 1,283,143 0.08 1,172,411 0.07
Time 1,541,419 3.73 835,406 0.79 1,009,450 0.84
Total deposits $ 6,957,244 $ 6,711,376 $ 6,342,527
34
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 $ 129,952
4 – 6 Months 82,534
7 – 12 Months 234,223
Over 12 Months 458,854
Total $ 905,563
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 Federal Reserve Advances Other
Short-Term Borrowings Total Borrowings
2023
Balance at December 31, 2023 $ 55,809 $ — $ 155,000 $ 100,000 $ 1,550 $ 312,359
Maximum amount outstanding at any month-end 189,138 3,491 225,000 100,000 1,694 519,323
Average amount outstanding 81,904 2,373 121,003 7,123 1,208 213,611
Weighted average interest rate during the year 0.36 % 0.09 % 5.28 % 4.98 % — % 3.29 %
Weighted average interest rate for outstanding amounts at December 31, 2023 0.37 % — % 5.51 % 4.83 % — % 4.35 %
2022
Balance at December 31, 2022 $ 141,432 $ 3,096 $ 70,000 $ — $ 1,001 $ 215,529
Maximum amount outstanding at any month-end 193,798 4,072 250,000 — 1,746 449,616
Average amount outstanding 169,600 3,838 40,123 — 1,409 214,970
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, 2022 0.05 % 0.03 % 4.16 % — % — % 1.39 %
During December 2023, we borrowed $100.00 million from the Federal Reserve’s Bank Term Funding Program based on the economics of the borrowing relative to our other funding sources.
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 2023, average core deposits equaled 73.77% of average total assets, compared to 79.60% in 2022 and 78.04% in 2021. The effective rate of core deposits in 2023 was 1.45%, compared to 0.32% in 2022 and 0.12% in 2021.
Average noninterest bearing core deposits decreased 13.97% in 2023 compared to an increase of 8.27% in 2022. These represented 28.24% of total core deposits in 2023, compared to 31.71% in 2022, and 31.20% in 2021.
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 which includes Federal Home Loan Bank and Federal Reserve Bank borrowings. Purchased funds are raised from customers seeking short-term investments and are used to manage the Bank’s interest rate sensitivity. During 2023, our reliance on purchased funds increased to 11.45% of average total assets from 6.19% in 2022.
35
Table of Contents
Shareholders’ Equity — Average shareholders’ equity equated to 11.02% of average total assets in 2023, compared to 10.81% in 2022. Shareholders’ equity was 11.34% of total assets at year-end 2023, compared to 10.36% at year-end 2022. 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 on available-for-sale securities, net of income taxes, were $106.32 million and $147.69 million at December 31, 2023 and 2022, 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. 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 $1.23 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. 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, 2023, 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.
36
Table of Contents
We maintain prudent strategies to support a strong liquidity position. The following table represents our sources of liquidity as of December 31, 2023.
(Dollars in thousands) Available
Internal Sources
Unencumbered securities $ 1,211,222
External Sources
FHLB advances (1)
450,143
FRB borrowings (2)
498,394
Fed funds purchased (3)
335,000
Brokered deposits (4)
252,746
Listing services deposits (4)
424,870
Total liquidity $ 3,172,375
% of Total deposits net brokered and listing services certificates of deposit 49.51 %
(1) Availability is shown net of required stock purchases under the FHLB activity-based stock ownership requirement, which is currently 4.50%, and may vary
(2) Includes access to discount window and Bank Term Funding Program
(3) Availability contingent on correspondent bank approvals at time of borrowing
(4) Availability contingent on internal borrowing guidelines
External sources as listed in the table above are managed to approved guidelines by our Board of Directors. Total net available liquidity was $3.17 billion at December 31, 2023, which accounted for approximately 50% of total deposits net of brokered and listing services certificates of deposits.
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.
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, 2023 December 31, 2022
Basis Point Interest Rate Change 12 Months 24 Months 12 Months 24 Months
Up 200 (1.40)% 3.01% (2.32)% 2.99%
Up 100 (0.66)% 1.52% (1.15)% 1.52%
Down 100 (0.18)% (2.42)% (2.39)% (5.10)%
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, 2023 and 2022, 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.
37
Table of Contents
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.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.