UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31 , 2021
OR
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-11487
| (State of incorporation) | (I.R.S. Employer Identification No.) | ||||
(Address of principal executive offices)
Telephone: (574 ) 267-6144
Securities registered pursuant to Section 12(b) of the Act:
| (Title of class) | (Trading symbol) | (Name of each exchange on which registered) | ||||||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No__
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes __No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such other period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No __
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No __
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| ☒ | Accelerated filer [ ] | Non-accelerated filer [ ] | Smaller reporting company | Emerging growth company | |||||||||||||||||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes __ No ☒
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the last sales price quoted on the Nasdaq Global Select Market on June 30, 2021, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $1,482,067,229 .
Number of shares of common stock outstanding at February 16, 2022: 25,344,231
DOCUMENTS INCORPORATED BY REFERENCE
LAKELAND FINANCIAL CORPORATION
Annual Report on Form 10-K
Table of Contents
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PART I
ITEM 1. BUSINESS
The Company
Lakeland Financial Corporation (“Lakeland Financial”), an Indiana corporation incorporated in 1983, is a bank holding company headquartered in Warsaw, Indiana that provides, through its wholly owned subsidiary Lake City Bank (the “Bank” and together with Lakeland Financial, the “Company”), a broad array of financial products and services throughout its Northern and Central Indiana markets. The Company offers commercial and consumer banking services, as well as trust and wealth management, brokerage, and treasury management commercial services. The Company serves a diverse customer base, including commercial customers across a wide variety of industries including, among others, commercial real estate, manufacturing, agriculture, construction, retail, wholesale, finance and insurance, accommodation and food services and health care. The Company is not dependent upon any single industry or customer. At December 31, 2021, Lakeland Financial had consolidated total assets of $6.6 billion and was the sixth largest independent bank holding company headquartered in the State of Indiana.
Company’s Business. Lakeland Financial is a bank holding company as defined in the Bank Holding Company Act of 1956, as amended. Lakeland Financial owns all of the outstanding stock of the Bank, a full-service commercial bank organized under Indiana law. Lakeland Financial conducts no business except that which is incident to its ownership of the outstanding stock of the Bank and the operation of the Bank. Although Lakeland Financial is a corporate entity, legally separate and distinct from its affiliates, bank holding companies such as Lakeland Financial are required to act as a source of financial strength for their subsidiary banks. The principal source of Lakeland Financial’s income is dividends from the Bank. There are certain regulatory restrictions on the extent to which subsidiary banks can pay dividends or otherwise supply funds to their holding companies. See “Supervision and Regulation of the Company” below for further discussion of these matters. Lakeland Financial’s executive offices are located at 202 East Center Street, Warsaw, Indiana 46580, and its telephone number is (574) 267-6144.
Bank’s Business. The Bank was originally organized in 1872 and has continuously operated under the laws of the State of Indiana since its organization. As of December 31, 2021, the Bank had 51 offices in fifteen counties, including 45 offices in northern Indiana and six offices in central Indiana, in the Indianapolis market. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) to the maximum extent provided under federal law and FDIC regulations. The Bank’s activities cover all traditional facets of commercial banking, including deposit products, commercial and consumer lending, retail and merchant credit card services, corporate treasury management services, and wealth advisory, trust and brokerage services. On January 31, 2022, the Bank opened its 52nd branch in downtown Elkhart.
The Bank’s business strategy is focused on building long-term relationships with its customers based on top quality service, high ethical standards and safe and sound lending. The Bank operates as a community-based financial services organization augmented by experienced, centralized support in select critical areas. The Bank’s local market orientation is reflected in its regional management, which divides the Bank’s market area into five distinct geographic regions, each headed by a retail and commercial regional manager. This arrangement allows decision making to be as close to the customer as possible and enhances responsiveness to local banking needs. Despite this local-market, community-based focus, the Bank offers many of the products and services available at much larger regional and national competitors. While our strategy encompasses all phases of traditional community banking, including consumer lending and wealth advisory and trust services, we focus on building expansive commercial relationships and developing retail and commercial deposit gathering strategies through relationship-based client services. Substantially all of the Bank’s assets and income are located in and derived from the United States.
The Company is not a party to any collective bargaining agreements, and employee relations are considered good.
Operating Segment. While the Company has assigned certain management responsibilities by region and business line, the Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. The majority of the Company’s revenue is from the business of banking and the Company’s assigned regions have similar economic characteristics, products, services and customers. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable operating segment.
Expansion Strategy. Since 1990, the Company has expanded from 17 offices in four Indiana counties to 51 offices in fifteen Indiana counties primarily through de novo branching. During this period, the Company has grown its assets from $286 million to $6.6 billion, a compound annual growth rate of 11%. Mergers and acquisitions have not played a role in this growth
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as the Company’s expansion strategy has been driven by organic growth. The Company has opened seven de novo branches in the past seven years and plans to continue expansion in the Indianapolis market.
Over the past twenty years, the Company has primarily targeted growth in the larger cities located in Northern Indiana and the Indianapolis market in Central Indiana and areas that are two hours from a Lake City Bank branch. The Company believes these areas offer above average growth potential with attractive demographics and potential for commercial lending and deposit gathering opportunities. The Company considers expanding into a market when the Company believes that market would be receptive to its strategic plan to deliver broad-based financial services to businesses with a commitment to local communities. When entering new markets, the Company believes it is critical to attract experienced local management and staff with a similar philosophy in order to provide a basis for success.
Competition. The financial services industry is highly competitive. Competition is based on a number of factors including, among others, customer service, quality and range of products and services offered, price, reputation, interest rates on loans and deposits, lending limits and customer convenience. Our competitors include national, regional and community banks, e-commerce and other Fintech or nonbanking companies offering financial services, as well as thrifts, credit unions, farm credit services, finance companies, personal loan companies, brokerage firms, investment companies, insurance companies, mortgage banking companies, credit card issuers and mutual fund companies. Many of these competitors enjoy fewer regulatory constraints and some may have lower cost structures.
Human Capital. The Bank is committed to being the acknowledged and recognized leader in Indiana Community Banking. We achieve this mission only through the hard work and dedication of our employees. The Bank team is 616 people strong, including 567 full-time, 37 part-time, and 12 seasonal/temporary employees as of December 31, 2021.
Diversity and Inclusiveness. The Bank is committed to social and governance responsibility, and in 2020, the management team added “inclusivity” as the eighth core value defining our organizational culture. The Bank’s employee Code of Conduct supports diversity and inclusion efforts in our workplace, and we established a Diversity and Inclusion Task Force to develop and promote initiatives throughout the corporation. The Task Force developed and is carrying out a plan to further inclusivity at the bank, creating opportunities for education, awareness, and ongoing discussion of these important issues. Eighty-four percent of our employees identify as women or people of color. At present, women comprise 59% of the Bank’s officers (253 officers – 150 women), 33% (8 of 24 members) of Senior Leadership Council (which includes those with the title of “Senior Vice President” and above) and 44% (4 of 9 members) of the executive Management Committee. Additionally, three of our 13 board members identify as women or people of color.
Employee Engagement and Development. A positive workplace culture is vital to the Bank’s success. By supporting, respecting, engaging, and appreciating employees, the Bank has built a team well-equipped to show the same commitment to its customers. Building and strengthening this positive workplace culture starts with Lake City University. Founded in 1999, Lake City University is dedicated to helping employees thrive professionally and personally. In 2021, the Bank employees averaged 19.64 hours per employee of instruction through the program. From courses to improve technical skills, product knowledge, and customer service to classes focused on an employee’s well-being, like personal financial planning and benefits education, Lake City University supports and promotes the personal and professional growth of all the Bank employees. In 2021, 144 employees were promoted and 125 employees were hired externally, demonstrating a commitment to professional development of Lake City Bank employees.
In addition to the substantial investment in employee professional development, the Bank’s benefit and compensation programs are designed to ensure we recruit and retain top talent. The Bank offers employees a comprehensive health benefits package, provides a 401(k) match of up to 6% of an employee’s salary to encourage retirement savings, tuition reimbursement that 17 employees took advantage of in 2021, and structures its bonus program for officers to create meaningful performance-based incentives. These programs, combined with an intentional focus to create a positive, values-based culture ensures the Bank team will continue as the acknowledged and recognized leader in Indiana community banking.
Impact of Strong Labor Market. Indiana has a strong labor market, with an unemployment rate of 2.7% as of December 31, 2021. The U.S. Census Bureau announced Indiana's population grew by 4.7% between 2010 and 2020, and manufacturing jobs increased 1.5% from December 2019 to December 2021. In this tight labor market, the Company has focused on hiring and retaining talented employees, which has increased compensation expense during 2021.
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Forward-looking Statements
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the federal securities law. Forward-looking statements are not historical facts and are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “project,” “possible,” “continue,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain and, accordingly, the reader is cautioned not to place undue reliance on any forward-looking statement made by the Company. Actual results could differ materially from those addressed in the forward-looking statements as a result of numerous factors, including, without limitation:
•the effects of future economic, business and market conditions and changes, including in connection with the COVID-19 pandemic, both domestic and foreign;
•governmental monetary and fiscal policies and the impact the current economic environment will have on these;
•the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities and other interest sensitive assets and liabilities;
•changes in borrowers’ credit risks and payment behaviors;
•the failure of assumptions and estimates used in our reviews of our loan portfolio, underlying the establishment of reserves for possible credit losses, our analysis of our capital position and other estimates;
•changes in the prices, values and sales volumes of residential and commercial real estate;
•the effects of disruption and volatility in capital markets on the value of our investment portfolio;
•the risk of labor availability, trade policy and tariffs, as well as supply chain constraints could impact loan demand from the manufacturing sector;
•changes in the scope and cost of FDIC insurance, the state of Indiana’s Public Deposit Insurance Fund and other coverages;
•changes in the availability and cost of credit and capital in the financial markets;
•the anticipated phase out of most LIBOR tenors by mid-2023 and establishment of a new reference rate or rates;
•the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
•the timing and scope of any legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators;
•risk of cyber-security attacks that could result in damage to the Company’s or third-party service providers' networks or data of the Company;
•changes in technology or products that may be more difficult or costly, or less effective than anticipated;
•the effects of any employee or customer fraud;
•the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;
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•changes in accounting policies, rules and practices;
•the effects of war or other conflicts, acts of terrorism or other catastrophic events, including storms, droughts, tornados and flooding, that may affect general economic conditions, including agricultural production and demand and prices for agricultural goods and land used for agricultural purposes, generally and in our markets; and
•the risks noted in the Risk Factors discussed under Item 1A of Part 1 of this Annual Report on Form 10-K, as well as other risks and uncertainties set forth from time to time in the Company’s other filings with the Securities and Exchange Commission (the “SEC”).
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
Internet Website
The Company maintains an internet site at www.lakecitybank.com. The Company makes available free of charge, in the Investor Relations section on this site, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K and other statements and reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC. All such documents filed with the SEC are also available for free on the SEC’s website (www.sec.gov). The Company’s Articles of Incorporation, Bylaws, Code of Conduct and the charters of the various committees of the Company’s board of directors are also available on the Investor Relations section of the website.
SUPERVISION AND REGULATION
General
FDIC-insured institutions, like the Bank, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, our growth and earnings performance may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory agencies, including the Indiana Department of Financial Institutions (the “DFI”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the FDIC and the Consumer Financial Protection Bureau (the “CFPB”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed by the Financial Accounting Standards Board, securities laws administered by the SEC and state securities authorities, and anti-money laundering laws enforced by the U.S. Department of the Treasury (“Treasury”) have an impact on our business. The effect of these statutes, regulations, regulatory policies and accounting rules are significant to our operations and results.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of FDIC-insured institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than shareholders. These laws, and the regulations of the bank regulatory agencies issued under them, affect, among other things, the scope of our business, the kinds and amounts of investments we may make, required capital levels relative to our assets, the nature and amount of collateral for loans, the establishment of branches, our ability to merge, consolidate and acquire, dealings with our insiders and affiliates and our payment of dividends. In reaction to the global financial crisis and particularly following passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), we experienced heightened regulatory requirements and scrutiny. Although the reforms primarily targeted systemically important financial service providers, their influence filtered down in varying degrees to community banks over time and caused our compliance and risk management processes, and the costs thereof, to increase. Then, in May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (“Regulatory Relief Act”) was enacted by Congress in part to provide regulatory relief for community banks and their holding companies. To that end, the law eliminated questions about the applicability of certain Dodd-Frank Act reforms to community bank systems, including relieving us of any requirement to engage in mandatory stress tests, maintain a risk committee or comply with the Volcker Rule’s complicated prohibitions on proprietary trading and ownership of private funds. We believe these reforms are favorable to our operations.
The supervisory framework for U.S. banking organizations subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that are not publicly available and that can impact the conduct and growth of their business. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings,
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liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
The following is a summary of the material elements of the supervisory and regulatory framework applicable to the Company and the Bank, beginning with a discussion of the impact of the COVID-19 pandemic on the banking industry. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.
COVID-19 Pandemic
The federal bank regulatory agencies, along with their state counterparts, issued a steady stream of guidance responding to the COVID-19 pandemic and took a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the Community Reinvestment Act ("CRA") for certain pandemic-related loans, investments and public service. Because of the need for social distancing measures, the agencies revamped the manner in which they conducted periodic examinations of their regulated institutions, including making greater use of off-site reviews.
Moreover, the Federal Reserve issued guidance encouraging banking institutions to utilize its discount window for loans and intraday credit extended by its Reserve Banks to help households and businesses impacted by the pandemic and announced numerous funding facilities. The FDIC also acted to mitigate the deposit insurance assessment effects of participating in the Paycheck Protection Program ("PPP") and the Federal Reserve's PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.
Reference is made to the discussion of Risks Relating to General Economic Conditions in the Risk Factors section below for information on the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), PPP program and the Federal Reserve’s lending facilities and for discussions of the economic impact of the COVID-19 pandemic. In addition, information as to selected topics, such as the impact on capital requirements, dividend payments, reserves and CRA, is contained in the relevant sections of this Supervision and Regulation discussion.
The Role of Capital
Regulatory capital represents the net assets of a banking organization available to absorb losses. Because of the risks attendant to their business, FDIC-insured institutions are generally required to hold more capital than other businesses, which directly affects our earnings capabilities. While capital has historically been one of the key measures of the financial health of both bank holding companies and banks, its role became fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish capital standards for banks and bank holding companies that are meaningfully more stringent than those in place previously.
Capital Levels. Banks have been required to hold minimum levels of capital based on guidelines established by the bank regulatory agencies since 1983. The minimums have been expressed in terms of ratios of "capital" divided by "total assets". The capital guidelines for U.S. banks beginning in 1989 have been based upon international capital accords (known as “Basel" rules) adopted by the Basel Committee on Banking Supervision, a committee of central banks and bank supervisors that acts as the primary global standard-setter for prudential regulation, as implemented by the U.S. bank regulatory agencies on an interagency basis. The accords recognized that bank assets for the purpose of the capital ratio calculations needed to be risk weighted (the theory being that riskier assets should require more capital) and that off-balance sheet exposures needed to be factored in the calculations.
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Following the global financial crisis, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital requirements for banking organizations around the world, known as Basel III, to address deficiencies recognized in connection with the global financial crisis.
The Basel III Rule. In July 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to capital requirements historically, which were in the form of guidelines, Basel III was released in the form of binding regulations by each of the regulatory agencies. The Basel III Rule increased the required quantity and quality of capital and required more detailed categories of risk weighting of riskier, more opaque assets. For nearly every class of assets, the Basel III Rule requires a more complex, detailed and calibrated assessment of risk in the calculation of risk weightings. The Basel III Rule is applicable to all banking organizations that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies, other than “small bank holding companies” (generally holding companies with consolidated assets of less than $3 billion) and certain qualifying banking organizations that may elect a simplified framework (which we have not done). Thus, the Company and the Bank are each currently subject to the Basel III Rule as described below.
Not only did the Basel III Rule increase most of the required minimum capital ratios in effect prior to January 1, 2015, but, in requiring that forms of capital be of higher quality to absorb loss, it introduced the concept of Common Equity Tier 1 Capital, which consists primarily of common stock, related surplus (net of Treasury stock), retained earnings, and Common Equity Tier 1 minority interests subject to certain regulatory adjustments. The Basel III Rule also changed the definition of capital by establishing more stringent criteria that instruments must meet to be considered Additional Tier 1 Capital (primarily non-cumulative perpetual preferred stock that meets certain requirements) and Tier 2 Capital (primarily other types of preferred stock and subordinated debt, subject to limitations). The Basel III Rule also constrained the inclusion of minority interests, mortgage-servicing assets, and deferred tax assets in capital and required deductions from Common Equity Tier 1 Capital in the event that such assets exceeded a percentage of a banking institution’s Common Equity Tier 1 Capital.
The Basel III Rule requires minimum capital ratios as follows:
•A ratio of minimum Common Equity Tier 1 Capital equal to 4.5% of risk-weighted assets;
•A ratio of minimum Tier 1 Capital equal to 6% of risk-weighted assets;
•A continuation of the minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8% of risk-weighted assets; and
•A minimum leverage ratio of Tier 1 Capital to total quarterly average assets equal to 4% in all circumstances.
In addition, institutions that seek the freedom to make capital distributions (including for dividends and repurchases of stock) and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% in Common Equity Tier 1 Capital attributable to a capital conservation buffer. The purpose of the conservation buffer is to ensure that banking institutions maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. Factoring in the conservation buffer increases the minimum ratios depicted above to 7% for Common Equity Tier 1 Capital, 8.5% for Tier 1 Capital and 10.5% for Total Capital. The federal bank regulators released a joint statement in response to the COVID-19 pandemic reminding the industry that capital and liquidity buffers were meant to give banks the means to support the economy in adverse situations, and that the agencies would support banks that use the buffers for that purpose if undertaken in a safe and sound manner.
Well-Capitalized Requirements. The ratios described above are minimum standards in order for banking organizations to be considered “adequately capitalized.” Bank regulatory agencies uniformly encourage banks to hold more capital and be “well-capitalized” and, to that end, federal law and regulations provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is well-capitalized may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept, roll-over or renew brokered deposits. Higher capital levels could also be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating
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significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible assets), well above the minimum levels.
Under the capital regulations of the Federal Reserve, in order to be well-capitalized, a banking organization must maintain:
•A Common Equity Tier 1 Capital ratio to risk-weighted assets of 6.5% or more;
•A ratio of Tier 1 Capital to total risk-weighted assets of 8% or more;
•A ratio of Total Capital to total risk-weighted assets of 10% or more; and
•A leverage ratio of Tier 1 Capital to total adjusted average quarterly assets of 5% or greater.
It is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation buffer discussed above.
As of December 31, 2021: (i) the Bank was not subject to a directive from the Federal Reserve to increase its capital and (ii) the Bank was well-capitalized, as defined by Federal Reserve regulations. As of December 31, 2021, the Company had regulatory capital in excess of the Federal Reserve’s requirements and met the Basel III Rule requirements to be well-capitalized. We are also in compliance with the capital conservation buffer.
Prompt Corrective Action. The concept of an institution being “well-capitalized” is part of a regulatory enforcement regime that provides the federal banking regulators with broad power to take “prompt corrective action” to resolve the problems of institutions based on the capital level of each particular institution. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
Community Bank Capital Simplification. Community banks have long raised concerns with bank regulators about the regulatory burden, complexity, and costs associated with certain provisions of the Basel III Rule. In response, Congress provided an “off-ramp” for institutions, like us, with total consolidated assets of less than $10 billion. Section 201 of the Regulatory Relief Act instructed the federal banking regulators to establish a single "Community Bank Leverage Ratio" (“CBLR”) of between 8 and 10%. Under the final rule, a community banking organization is eligible to elect the new framework if it has: less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a CBLR greater than 9%. The bank regulatory agencies temporarily lowered the CBLR to 8% as a result of the COVID-19 pandemic. We may elect the CBLR framework at any time but have not currently determined to do so.
Supervision and Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, we are registered with, and subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (“BHCA”). We are legally obligated to act as a source of financial and managerial strength to the Bank and to commit resources to support the Bank in circumstances where we might not otherwise do so. Under the BHCA, we are subject to periodic examination by the Federal Reserve and are required to file with the Federal Reserve periodic reports of our operations and such additional information regarding us and the Bank as the Federal Reserve may require.
Acquisitions and Activities. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding
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company and its FDIC-insured institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or acquisitions. For a discussion of the capital requirements, see “The Role of Capital” above.
The BHCA generally prohibits us from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit us to engage in a variety of banking-related businesses, including the ownership and operation of a savings association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage services. The BHCA does not place territorial restrictions on the domestic activities of nonbank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of FDIC-insured institutions or the financial system generally. We have elected to operate as a financial holding company. In order to maintain our status as a financial holding company, the Company and the Bank must be well-capitalized, well-managed, and the Bank must have at least a satisfactory CRA rating. If the Federal Reserve determines that a financial holding company or any bank subsidiary is not well-capitalized or well-managed, the Federal Reserve will provide a period of time in which to achieve compliance, but, during the period of noncompliance, the Federal Reserve may place any additional limitations on the Company that it deems appropriate. Furthermore, if non-compliance is based on the failure of the Bank to achieve a satisfactory CRA rating, we would not be able to commence any new financial activities or acquire a company that engages in such activities.
Change in Control. Federal law prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership.
Capital Requirements. As a bank holding company, we are required to maintain capital in accordance with Federal Reserve capital adequacy requirements. For a discussion of capital requirements, see “The Role of Capital” above.
Dividend Payments. Our ability to pay dividends to our shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As an Indiana corporation, we are subject to the limitations of Indiana General Business Corporations Law, which prohibit us from paying dividends if we are, or by payment of the dividend would become, insolvent, or if the payment of dividends would render us unable to pay its debts as they become due in the usual course of business. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5% in Common Equity Tier 1 Capital attributable to the capital conservation buffer.
As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer or significantly reduce dividends to shareholders if: (i) the company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. These factors have come into consideration in the industry as a result of the COVID-19 pandemic. The Federal Reserve also possesses enforcement powers over bank holding companies and their nonbank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank holding companies and their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market transactions in U.S. government securities and changes in the discount rate on bank borrowings.
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These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
Federal Securities Regulation. Our common stock is registered with the SEC under the Exchange Act. Consequently, we are subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Corporate Governance. The Dodd-Frank Act addressed many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. It increased shareholder influence over boards of directors by requiring companies to give stockholders a nonbinding vote on executive compensation and so-called “golden parachute” payments, and authorizing the SEC to promulgate rules that would allow shareholders to nominate and solicit voters for their own candidates using a company’s proxy materials. The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.
Supervision and Regulation of the Bank
General. The Bank is an Indiana-chartered bank. The deposit accounts of the Bank are insured by the FDIC's Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations, currently $250,000 per insured depositor category. The Bank is also a member of the Federal Reserve System (a “member bank”). As an Indiana-chartered FDIC- insured member bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the DFI, the chartering authority for Indiana banks, the Federal Reserve, as the primary federal regulator of member banks, and the FDIC, as administrator of the DIF.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured institutions pay insurance premiums at rates based on their risk classification. For institutions like the Bank that are not considered large and highly complex banking organizations, assessments are based on examination ratings and financial ratios. The total base assessment rates currently range from 1.5 basis points to 30 basis points. At least semi-annually, the FDIC updates its loss and income projections for the DIF and, if needed, increases or decreases the assessment rates, following notice and comment on proposed rulemaking.
The reserve ratio is the FDIC insurance fund balance divided by estimated insured deposits. The Dodd-Frank Act altered the minimum reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits. The reserve ratio reached 1.36% as of September 30, 2018, exceeding the statutory required minimum. As a result, the FDIC provided assessment credits to insured depository institutions, like the Bank, with total consolidated assets of less than $10 billion for the portion of their regular assessments that contributed to growth in the reserve ratio between 1.15% and 1.35%. The FDIC applied the small bank credits for quarterly assessment periods beginning July 1, 2019. However, the reserve ratio then fell to 1.30% in 2020 as a result of extraordinary insured deposit growth caused by an unprecedented inflow of more than $1 trillion in estimated insured deposits in the first half of 2020, stemming mainly from the COVID-19 pandemic stimulus programs. On September 15, 2020, the FDIC adopted a Restoration Plan to restore the reserve ratio to at least 1.35% within eight years. Although the FDIC could have ceased the small bank credits, it waived the requirement that the reserve ratio be at least 1.35% for full remittance of the remaining assessment credits, and it refunded all small bank credits as of September 30, 2020.
Supervisory Assessments. All Indiana banks are required to pay supervisory assessments to the DFI to fund the operations of that agency. The amount of the assessment is calculated on the basis of the Bank’s total assets. During the year ended December 31, 2021, the Bank paid supervisory assessments to the DFI totaling approximately $294,000.
Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital requirements, see “The Role of Capital” above.
Liquidity Requirements. Liquidity is a measure of the ability and ease with which bank assets may be converted to cash. Liquid assets are those that can be converted to cash quickly if needed to meet financial obligations. To remain viable, FDIC-insured institutions must have enough liquid assets to meet their near-term obligations, such as withdrawals by depositors. Because the global financial crisis was in part a liquidity crisis, Basel III also includes a liquidity framework that requires FDIC-insured institutions to measure their liquidity against specific liquidity tests. One test, referred to as the Liquidity Coverage Ratio, or LCR, is designed to ensure that the banking entity has an adequate stock of unencumbered high-quality liquid assets that can be converted easily and immediately in private markets into cash to meet liquidity needs for a 30-calendar
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day liquidity stress scenario. The other test, known as the Net Stable Funding Ratio, or NSFR, is designed to promote more medium- and long-term funding of the assets and activities of FDIC-insured institutions over a one-year horizon. These tests provide an incentive for banks and holding companies to increase their holdings in Treasury securities and other sovereign debt as a component of assets, increase the use of long-term debt as a funding source and rely on stable funding like core deposits (in lieu of brokered deposits). While these rules do not, and will not, apply to the Bank, we continue to review our liquidity risk management policies in light of developments.
Dividend Payments. Our primary source of funds is dividends from the Bank. Indiana law prohibits the Bank from paying dividends in an amount greater than its undivided profits. The Bank is required to obtain the approval of the DFI for the payment of any dividend if the total of all dividends declared by the Bank during the calendar year, including the proposed dividend, would exceed the sum of the Bank's net income for the year-to-date combined with its retained net income for the previous two years. Indiana law defines "retained net income" to mean the net income of a specified period, calculated under the consolidated report of income instructions, less the total amount of all dividends declared for the specified period. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by state member banks, such as the Bank. Without Federal Reserve approval, a state member bank may not pay dividends in any calendar year that, in the aggregate, exceed that bank's calendar year-to-date net income plus the bank's retained net income for the two preceding calendar years. Moreover, the payment of dividends by any FDIC- insured institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and an FDIC-insured institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its capital requirements under applicable guidelines as of December 31, 2021. Notwithstanding the availability of funds for dividends, however, the Federal Reserve and the DFI may prohibit the payment of dividends by the Bank if either or both determine such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Rule, institutions that seek the freedom to pay unrestricted dividends will have to maintain 2.5% in Common Equity Tier 1 Capital attributable to the capital conservation buffer. See “The Role of Capital” above.
State Bank Investments and Activities. The Bank is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Indiana law. However, under federal law, FDIC-insured institutions are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount that are not permissible for a national bank. Federal law also prohibits FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the DIF. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank and its “affiliates.” The Company is an affiliate of the Bank for purposes of these restrictions, and covered transactions subject to the restrictions include extensions of credit to the Company, investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank. The Dodd-Frank Act enhanced the requirements for certain transactions with affiliates, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.
Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiaries, to principal shareholders of the Company and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or the Bank, or a principal shareholder of the Company, may obtain credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted operational and managerial standards to promote the safety and soundness of FDIC-insured institutions. The standards apply to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness standards prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. While regulatory standards do not have the force of law, if an institution operates in an unsafe and unsound manner, the FDIC-insured institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an FDIC-insured institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the FDIC-insured institution’s rate of growth, require
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the FDIC-insured institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with safety and soundness may also constitute grounds for other enforcement action by the federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal controls when evaluating the activities of the FDIC-insured institutions they supervise. Properly managing risks has been identified as critical to the conduct of safe and sound banking activities and has become even more important as new technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational, legal and reputational risk. Bank regulators have identified key risk themes for 2022 as: credit risk management given protracted economic conditions, cybersecurity risk, and commercial and residential real estate concentration risk management. The agencies will also be monitoring banks for their transition away from LIBOR (London Interbank Offered Rate) as a reference rate, compliance risk management related to COVID-19 pandemic-related activities, Bank Secrecy Act/anti-money laundering (“AML”) compliance, cybersecurity, third-party and change management, climate and environmental, social and governance initiatives, digital assets and CRA performance. The Bank is expected to have active board and senior management oversight; adequate policies, procedures and limits; adequate risk measurement, monitoring and management information systems; and comprehensive internal controls.
Privacy and Cybersecurity. The Bank is subject to many U.S. federal and state laws and regulations governing requirements for maintaining policies and procedures to protect non-public confidential information of their customers. These laws require the Bank to periodically disclose its privacy policies and practices relating to sharing such information and permit consumers to opt out of their ability to share information with unaffiliated third parties under certain circumstances. They also impact the Bank’s ability to share certain information with affiliates and non-affiliates for marketing and/or non-marketing purposes, or to contact customers with marketing offers. In addition, as a part of its operational risk mitigation, the Bank is required to implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of customer records and information and to require the same of its service providers. These security and privacy policies and procedures are in effect across all business lines and geographic locations.
Branching Authority. Indiana banks, such as the Bank, have the authority under Indiana law to establish branches anywhere in the State of Indiana, subject to receipt of all required regulatory approvals. Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches has historically been permitted only in those states the laws of which expressly authorize such expansion. The Dodd-Frank Act permits well-capitalized and well-managed banks to establish new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) without impediments.
Transaction Account Reserves. Federal law required FDIC-insured institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts) to provide liquidity. Reserves were maintained on deposit at the Federal Reserve Banks. However, in March 2020, in an unprecedented move, the Federal Reserve announced that the banking system had ample reserves, and, as reserve requirements no longer played a significant role in this regime, it reduced all reserve tranches to zero percent, thereby freeing banks from the reserve maintenance requirement. The action permits the Bank to loan or invest funds that were previously unavailable. The Federal Reserve has indicated that it expects to continue to operate in an ample reserves regime for the foreseeable future.
Community Reinvestment Act Requirements. CRA requires the Bank to have a continuing and affirmative obligation in a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. Federal regulators regularly assess the Bank’s record of meeting the credit needs of its communities. Applications for additional acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its CRA requirements. In a joint statement responding to the COVID-19 pandemic, the bank regulatory agencies announced favorable CRA consideration for banks providing retail banking services and lending activities in their assessment areas, consistent with safe and sound banking practices, that are responsive to the needs of low- and moderate-income individuals, small businesses, and small farms affected by the pandemic. Those activities include waiving certain fees, easing restrictions on out-of-state and non-customer checks, expanding credit products, increasing credit limits for creditworthy borrowers, providing alternative service options, and offering prudent payment accommodations. The joint statement also provided favorable CRA consideration for certain pandemic-related community development activities.
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Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”) is designed to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for FDIC-insured institutions, brokers, dealers and other businesses involved in the transfer of money. The USA PATRIOT Act, along with other legal authority, mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between FDIC-insured institutions and law enforcement authorities.
Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any one industry or segment. A concentration in commercial real estate is one example of regulatory concern. The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (“CRE Guidance”) provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land development loans exceeding 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. On December 18, 2015, the federal banking agencies issued a statement to reinforce prudent risk-management practices related to CRE lending, having observed substantial growth in many CRE asset and lending markets, increased competitive pressures, rising CRE concentrations in banks, and an easing of CRE underwriting standards. The federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management practices to identify, measure, monitor, and manage the risks arising from CRE lending. In addition, FDIC-insured institutions must maintain capital commensurate with the level and nature of their CRE concentration risk.
Based on the Bank’s loan portfolio as of December 31, 2021, it did not exceed the 300% guideline for commercial real estate loans.
Consumer Financial Services. The historical structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply to all providers of consumer products and services, including the Bank, as well as the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over providers with more than $10 billion in assets. FDIC-insured institutions with $10 billion or less in assets, like the Bank, continue to be examined by their applicable bank regulators.
Because abuses in connection with residential mortgages were a significant factor contributing to the financial crisis, many new rules issued by the CFPB and required by the Dodd-Frank Act addressed mortgage and mortgage-related products, their underwriting, origination, servicing and sales. The Dodd-Frank Act significantly expanded underwriting requirements applicable to loans secured by 1-4 family residential real property and augmented federal law combating predatory lending practices. In addition to numerous disclosure requirements, the Dodd-Frank Act imposed new standards for mortgage loan originations on all lenders, including banks and savings associations, in an effort to strongly encourage lenders to verify a borrower’s ability to repay, while also establishing a presumption of compliance for certain “qualified mortgages.” The Regulatory Relief Act provided relief in connection with mortgages for banks with assets of less than $10 billion, and, as a result, mortgages the Bank makes are now considered to be qualified mortgages if they are held in portfolio for the life of the loan. The CFPB has from time to time released additional rules as to qualified mortgages and the borrower’s ability to repay, most recently in July of 2021. The CFPB’s rules have not had a significant impact on the Bank’s operations, except for higher compliance costs.
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ITEM 1A. RISK FACTORS
In addition to the other information in this Annual Report on Form 10-K, stockholders or prospective investors should carefully consider the following risk factors:
Risks Relating to General Economic Conditions
A downturn in general economic or business conditions, nationally or in markets where our business is concentrated, could have an adverse effect on our business, results of operations and financial condition.
Our success depends upon the business activity, population, employment rates, income levels, deposits and real estate activity in our markets in northern and central Indiana. Although our customers’ business and financial interests may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce our growth rate, diminish the ability of our customers to repay their loans to us, decrease the value of any collateral securing our loans and generally adversely affect our financial condition and results of operations. Moreover, because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.
The COVID-19 pandemic, including the spread of new variants, has had and may continue to have an adverse impact on our business and results of operations, and could have an adverse impact on our financial condition or capital levels, any of which could be material.
The COVID-19 pandemic has had a significant economic impact on the communities in which we operate, our borrowers and depositors, and the national economy generally. Even as efforts to contain the pandemic, including vaccinations, have made progress and some restrictions have relaxed, new variants of the virus have and may continue to have significant economic effects. The impact of these variants cannot be predicted. As a result, we expect the impact of COVID-19 could continue to be volatile, and last for a significant and indeterminate period. These developments could adversely affect our business, results of operations, financial condition and capital levels, the amounts of which cannot be determined and could be material. In particular, certain of our borrowers and depositors are in or have exposure to industries, such as hotel and accommodations, entertainment and recreation and full-service restaurants, which have been significantly adversely affected by the pandemic and its effects on the economy. Additionally, supply chain constraints and labor availability is adversely impacting our manufacturing clients. See "Note 25 - COVID-19 and Current Economic Conditions" for additional information.
Continued elevated levels of inflation could adversely impact our business and results of operations.
The United States has recently experienced elevated levels of inflation, with the consumer price index climbing approximately 7.0% in 2021. Continued levels of inflation could have complex effects on our business and results of operations, some of which could be materially adverse. For example, if interest rates were to rise in response to, or as a result of, elevated levels of inflation, the value of our securities portfolio would be negatively impacted. In addition, while we generally expect any inflation-related increases in our interest expense to be offset by increases in our interest revenue, inflation-driven increases in our levels of non-interest expense could negatively impact our results of operations. Continued elevated levels of inflation could also cause increased volatility and uncertainty in the business environment, which could adversely affect loan demand and our clients' ability to repay indebtedness. It is also possible that governmental responses to the current inflation environment could adversely affect our business, such as changes to monetary and fiscal policy that are too strict, or the imposition or threatened imposition of price controls. The duration and severity of the current inflationary period cannot be estimated with precision.
Labor shortages and failure to attract and retain qualified employees could negatively impact our business, results of operations and financial condition.
A number of factors may adversely affect the labor force available to us or increase labor costs, including high employment levels, decreased labor force size and participation rates as a result of the COVID-19 pandemic, expanded unemployment benefits offered in response to the ongoing COVID-19 pandemic, and other government actions. Although we have not experienced any material labor shortage to date, we have recently observed an overall tightening and increasingly competitive local labor market. As of December 31, 2021, Indiana's unemployment rate was 2.7%. A sustained labor shortage or increased turnover rates within our employee base could lead to increased costs, such as increased compensation expense to attract and retain employees.
In addition, if we are unable to hire and retain employees capable of performing at a high-level, or if mitigation measures we may take to respond to a decrease in labor availability have unintended negative effects, our business could be
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adversely affected. An overall labor shortage, lack of skilled labor, increased turnover or labor inflation, caused by COVID-19 or as a result of general macroeconomic factors, could have a material adverse impact on our operations, results of operations, liquidity or cash flows.
Interest rate shifts may reduce net interest income and otherwise negatively impact our financial condition and results of operations.
Shifts in short-term interest rates may reduce net interest income, which is the principal component of our earnings. Net interest income is the difference between the amounts received by us on our interest bearing assets and the interest paid by us on our interest bearing liabilities. When interest rates rise, as is expected to happen in 2022, the rate of interest we pay on our liabilities may rise more quickly than the rate of interest that we receive on our interest bearing assets, which may cause our profits to decrease. Conversely, when interest rates fall our interest bearing assets reprice more quickly than our interest bearing liabilities, given our asset-sensitive balance sheet, which may cause our net interest income to decrease. The impact on earnings is more adverse when the slope of the yield curve flattens, i.e. when short-term interest rates increase more than corresponding changes in long-term interest rates or when long-term interest rates decrease more than corresponding changes in short-term interest rates.
Interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default. At the same time, the marketability of any underlying assets securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on the loans as borrowers refinance their mortgages at lower rates.
Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have a material adverse effect on our results of operations and cash flows. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income.
Risks Relating to Our Business
If we do not effectively manage our credit risk, we may experience increased levels of nonperforming loans, charge offs and delinquencies, which could require further increases in our provision for credit losses.
There are risks inherent in making any loan, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. In general, these risks have increased as a result of the COVID-19 pandemic, which has disrupted business trends that we evaluate when making credit decisions, and changed the short- and long-term outlook for businesses and individuals in our markets. We cannot assure you that our loan application approval procedures, use of loan concentration limits, credit monitoring, use of independent reviews of outstanding loans or other procedures will reduce these credit risks. If the overall economic climate in the United States, generally, and our market areas, specifically, does not perform in the manner we expect, or even if it does, our borrowers may experience difficulties in repaying their loans, and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the provision for credit losses, which would cause our net income and return on equity to decrease.
If our allowance for credit losses is not sufficient to absorb losses that may occur in our loan portfolio, our financial condition and liquidity could suffer.
We establish our allowance for credit losses and maintain it at a level considered adequate by management to absorb expected credit losses within the portfolio. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management's judgment, should be charged against the allowance. Additions to the allowance for credit losses, which are charged to earnings through the provision for credit losses, are determined based on a variety of factors, including an analysis of the loan portfolio, historical loss experience and an evaluation of current economic conditions in our market areas. The actual amount of credit losses is affected by changes in economic, operating and other conditions within our markets, which may be beyond our control, and such losses may exceed current estimates.
At December 31, 2021, our allowance for credit losses as a percentage of total loans was 1.58% and as a percentage of total nonperforming loans was 449%. Because of the nature of our loan portfolio and our concentration in commercial and industrial loans, which tend to be larger loans, the movement of a small number of loans to nonperforming status can have a significant impact on these ratios. Although a formal evaluation of the adequacy of the credit loss allowance is conducted
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monthly, we cannot predict credit losses with certainty and we cannot provide assurance that our allowance for credit losses will prove sufficient to cover actual credit losses in the future. Credit losses in excess of our reserves may adversely affect our business, results of operations and financial condition.
Commercial and industrial loans make up a significant portion of our loan portfolio.
Commercial and industrial loans were $1.389 billion, or approximately 32% of our total loan portfolio, as of December 31, 2021. Commercial and industrial loans are often larger and involve greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation of the borrower involved, repayment of such loans is often more sensitive than other types of loans to adverse conditions in the general economy. For example, decreased economic activity, labor availability shortages and supply chain constraints as a result of the COVID-19 pandemic have adversely affected commercial and industrial loans, and we expect this trend to continue for certain portions of our loan portfolio, depending on the strength and speed of economic recovery and other factors.
Our commercial and industrial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral is accounts receivable, inventory, machinery or real estate. Whenever practical, we require a personal guarantee on commercial and industrial loans. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Due to the larger average size of each commercial loan as compared with other loans such as residential loans, as well as collateral that is generally less readily-marketable, losses incurred on a small number of commercial loans could adversely affect our business, results of operations and growth prospects. Historically, the Bank's largest charge offs have been in this segment of the loan portfolio.
Our loan portfolio includes commercial real estate loans, which involve risks specific to real estate value.
Commercial real estate loans were $1.955 billion, or approximately 46% of our total loan portfolio as of December 31, 2021. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located, and, as a general matter, some of these values have been significantly and negatively affected by the COVID-19 pandemic.
Although a significant portion of such loans are secured by real estate as a secondary form of collateral, these developments and any future adverse developments affecting real estate values in one or more of our markets could increase the credit risk associated with our loan portfolio. Additionally, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.
If the loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time of originating the loan, which could cause us to increase our provision for credit losses and adversely affect our operating results and financial condition.
Our loan portfolio has a notable concentration in agri-business, which has a higher level of uncontrolled risk.
Our agri-business loans, which totaled $445.8 million, or approximately 10% of our total loan portfolio as of December 31, 2021, are subject to risks outside of our or the borrower’s control. These risks, specific to the agricultural industry, include decreases in livestock and crop prices, increases in labor and input prices, increase in stockpiles of agricultural commodities, the strength of the U.S. dollar, the potential impact of tariffs on commodities and the nature of climate and weather conditions. To the extent these or other factors affect the performance or financial condition of our agri-business borrowers, our results of operations and financial performance could suffer.
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Our consumer loans generally have a higher degree of risk of default than our other loans.
At December 31, 2021, consumer loans totaled $82.8 million, or 2% of our total loan portfolio. Consumer loans typically have shorter terms and lower balances with higher yields as compared to commercial loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans.
Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition and could result in further losses in the future.
Our nonperforming assets adversely affect our net income in various ways. We do not record interest income on nonaccrual loans or other real estate owned, which adversely affects our net income and returns on assets and equity, increases our loan administration costs and adversely affects our efficiency ratio. When we take collateral in foreclosure and similar proceedings, we are required to mark the collateral to its current fair market value at the time of transfer, which may result in a loss. These nonperforming loans and other real estate owned also increase our risk profile and our regulatory capital requirements may increase in light of such risks. The resolution of nonperforming assets requires significant time commitments from management and can be detrimental to the performance of their other responsibilities. If we experience increases in nonperforming loans and other nonperforming assets, our net interest income and provision expense may be negatively impacted and our loan administration costs could increase, each of which could have an adverse effect on our net income and related ratios, such as return on assets and equity.
Liquidity risks could affect operations and jeopardize our business, results of operations and financial condition.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial, negative effect on our liquidity. Our primary sources of funds consist of deposits, cash from operations and investment maturities and sales. Additional liquidity is provided by brokered deposits, CD Option of IntraFi Network Deposits (“CD Option”, formerly known as CDARS), American Financial Exchange overnight borrowings, IntraFi Network’s insured cash sweep program, as well as our ability to borrow from federal funds lines at correspondent banks, the Federal Reserve and the Federal Home Loan Bank (the “FHLB”). Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. In addition, increased competition with the largest banks and Fintechs for retail deposits may impact our ability to raise funds through deposits and could have a negative effect on our liquidity.
During the last recession, the financial services industry and the credit markets generally were materially and adversely affected by significant declines in asset values and historically depressed levels of liquidity. The liquidity issues were also particularly acute for regional and community banks, as many of the larger financial institutions curtailed their lending to regional and community banks to reduce their exposure to the risks of other banks. In addition, many of the larger correspondent lenders reduced or even eliminated federal funds lines for their correspondent customers. Furthermore, regional and community banks generally have less access to the capital markets than national and super-regional banks because of their smaller size and limited analyst coverage. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our stockholders, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.
Any action or steps to change coverages or eliminate Indiana’s Public Deposit Insurance Fund could require us to find alternative, higher-cost funding sources to replace public fund deposits or to provide for collateralization of these deposits.
At December 31, 2021, approximately 22% of our deposits are concentrated in public funds from a small number of municipalities and government agencies located in the Bank’s geographic footprint. A shift in funding away from public fund deposits would impact liquidity availability and could increase our cost of funds, as the alternate funding sources, such as brokered certificates of deposit, can be higher-cost, are less favorable deposits and could require additional collateral to be pledged. The inability to maintain these public funds on deposit could result in a material adverse effect on the Bank’s liquidity and could materially impact our ability to grow and remain profitable.
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Declines in asset values may result in impairment charges and adversely affect the value of our investments, financial performance and capital.
We maintain an investment portfolio that includes, but is not limited to, mortgage-backed securities and municipal securities. The market value of investments may be affected by factors other than the underlying performance of the servicer of the securities or the mortgages underlying the securities, such as ratings downgrades, the effects of the COVID-19 pandemic on the financial condition of state and local governments, adverse changes in the business climate and a lack of liquidity in the secondary market for certain investment securities. On a quarterly basis, we evaluate investments and other assets for credit and other impairment indicators. We may be required to record additional credit reserve charges if our investments suffer a decline in fair value that has resulted from credit losses or other factors. If we determine that a significant reserve is needed, we would be required to charge against earnings the credit-related portion, which could have a material adverse effect on our results of operations in the periods in which the write-offs occur.
We may be adversely impacted by the discontinuance of LIBOR as a short-term interest rate utilized for loans and other financing agreements.
In July 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. In March 2021, the ICE Benchmark Administration, which administers LIBOR, announced that it would stop publishing all LIBOR tenors by June 30, 2023. The Alternative Reference Rates Committee ("ARRC") has proposed that the Secured Overnight Financing Rate ("SOFR") is the rate that represents best practice as the alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a paced market transition plan to SOFR from USD-LIBOR and organizations are continuing to work on industry wide and company-specific transition plans as it relates to derivatives and cash markets exposed to USD-LIBOR. The Company has material contracts that are indexed to USD-LIBOR and is monitoring this activity and evaluating the related risks. This includes identifying outstanding USD-LIBOR-based loans without ARRC recommended fallback language, internal training and education, and working with our core provider to ensure proper integration once an alternative reference is implemented. The Company has formed a cross-functional project team to lead the transition from LIBOR to adoption of alternative reference rates which include Secured Overnight Financing Rate (“SOFR”), American Interbank Offered Rate ("Ameribor"), and Bloomberg Short-Term Bank Yield Index ("BSBY"). Management is monitoring ARRC publications for best practices as the Company transitions legacy LIBOR loans by the June 30, 2023 deadline.
Risks Relating to Our Corporate Strategy
We may need to raise additional capital in the future to achieve our growth plans, but that capital may not be available when it is needed.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Accordingly, we may need to raise additional capital to support our future growth plans. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and on our financial condition and performance. Accordingly, we cannot make assurances of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our financial condition and our ability to further expand our operations through internal growth or acquisitions could be materially impaired.
We may experience difficulties in managing our growth, and our growth strategy involves risks that may negatively impact our net income.
In addition to our continuing expansion in Indianapolis and larger cities in Northern Indiana, we may expand into additional communities or attempt to strengthen our position in our current markets through opportunistic acquisitions of all or part of other financial institutions, or by opening new branches in or within two hours of our contiguous geographic footprint. To the extent that we undertake acquisitions or new branch openings, we are likely to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business.
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To the extent that we grow through acquisitions and branch openings, we cannot assure that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses will involve similar risks to those commonly associated with branching but may also involve additional risks, including:
•potential exposure to unknown or contingent liabilities of banks and businesses we acquire;
•exposure to potential asset quality issues of the acquired bank or related business;
•difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and
•the possible loss of key employees and customers of the banks and businesses we acquire.
We face intense competition in all phases of our business from other banks, financial institutions and nonbank financial service providers.
The banking and financial services business in our market is highly competitive. Our competitors include large national, regional and local community banks, credit unions, Fintech and nonbank financial service providers, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds and farm credit services. Many of these competitors are not subject to the same operating costs or regulatory restrictions as we are and are able to provide customers with a feasible alternative to traditional banking services.
Increased competition in our market may also result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower. Any of these results could have a material adverse effect on our ability to grow and remain profitable. If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted. If increased competition causes us to relax our underwriting standards, we could be exposed to higher losses from lending activities. Moreover, we rely on deposits to be a low-cost source of funding, and a loss in our deposit base could cause us to incur higher funding costs.
The financial services industry is constantly undergoing rapid technological changes with frequent introductions of new technology-driven products and services. We invest from time to time in investment funds that seek to promote the development of such new and emerging financial technologies.
Additionally, many of our competitors are much larger in total assets and capitalization, have greater access to capital markets, possess larger lending limits and offer a broader range of financial services than we can offer.
Attractive acquisition opportunities may not be available to us in the future.
We expect that other banking and financial service companies, many of which have significantly greater resources than us, will compete with us in acquiring other financial institutions if we pursue such acquisitions. This competition could increase prices for potential acquisitions that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and stockholders’ equity per share of our common stock.
Risks Relating to Regulation, Tax and Accounting
We may be materially and adversely affected by the highly regulated environment in which we operate.
We are subject to extensive federal and state regulation, supervision and examination. A more detailed description of the primary federal and state banking laws and regulations that affect us is contained in the section of this Annual Report on Form 10-K captioned “Supervision and Regulation.” Banking regulations are primarily intended to protect depositors’ funds, FDIC funds, customers and the banking system as a whole, rather than our shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things.
As a bank holding company, we are subject to extensive regulation and supervision and undergo periodic examinations by our regulators, who have extensive discretion and authority to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies. Failure to comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil monetary penalties and/or damage to our reputation, which could have a material adverse
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effect on us. Although we have policies and procedures designed to mitigate the risk of any such violations, there can be no assurance that such violations will not occur.
The laws, regulations, rules, standards, policies and interpretations governing us are constantly evolving and may change significantly over time. For example, on July 21, 2010, the Dodd-Frank Act was signed into law, which significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act, together with the regulations to be developed thereunder, includes provisions affecting large and small financial institutions alike, including several provisions that affect how community banks, thrifts and small bank and thrift holding companies will be regulated. In addition, the Federal Reserve, in recent years, has adopted numerous new regulations addressing banks’ overdraft and mortgage lending practices. Further, the CFPB has broad powers to supervise and enforce consumer protection laws, and additional consumer protection legislation and regulatory activity is anticipated in the near future.
In addition, in July 2013, the U.S. federal banking authorities approved the implementation of the Basel III Rule, defined previously. The Basel III Rule is applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $3 billion).
These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, may impact the profitability of our business activities and may change certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads and could expose us to additional costs, including increased compliance costs. Although we are currently compliant with the Basel III Rule, these changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply and could therefore also materially and adversely affect our business, financial condition and results of operations.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. Declining federal funds rate lowers short-term rates and the interest earned from floating rate loans. The bank may not be able to lower deposit rates fast enough to offset the effect of declining short-term rates on loan interest income.
The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.
We may be adversely affected by changes in U.S. tax laws and regulations.
Any change in federal or state tax laws or regulations, including any increase in the federal corporate income tax rate from the current level of 21%, could negatively affect our business and results of operations, including as a result of our income tax expense and any impact to the profitability of our loan customers.
We are required to maintain capital to meet regulatory requirements, and, if we fail to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, our financial condition, liquidity and results of operations, as well as our ability to maintain regulatory compliance, would be adversely affected.
The Company, on a consolidated basis, and the Bank, on a stand-alone basis, must meet certain regulatory capital requirements and maintain sufficient liquidity. We face significant capital and other regulatory requirements as a financial institution, which were heightened with the implementation of the Basel III Rule and the phase-in of capital conservation buffer requirement. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities and on our financial condition and performance. Accordingly, we cannot assure you that we will be able to raise additional capital if needed or on terms acceptable to us. If we fail to maintain capital to meet regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected.
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We may be subject to a higher consolidated effective tax rate if there is a change in tax laws relating to LCB Investments II, Inc. or if LCB Funding, Inc. fails to qualify as a real estate investment trust.
The Bank holds certain investment securities in its wholly owned subsidiary LCB Investments II, Inc., which is incorporated in Nevada. Pursuant to the State of Indiana’s current tax laws and regulations, we are not subject to Indiana income tax for income earned through that subsidiary. If there are changes in Indiana’s tax laws or interpretations thereof requiring us to pay state taxes for income generated by LCB Investments II, Inc., the resulting tax consequences could increase our effective tax rate or cause us to have a tax liability for prior years.
The Bank also holds certain commercial real estate loans, residential real estate loans and other loans in a real estate investment trust through LCB Investments II, Inc., which is incorporated in Maryland. Qualification as a real estate investment trust involves application of specific provisions of the Internal Revenue Code relating to various asset tests. If LCB Funding, Inc. fails to meet any of the required provisions for real estate investment trusts, it could no longer qualify as a real estate investment trust and the resulting tax consequences would increase our effective tax rate or cause us to have a tax liability for prior years.
Our accounting policies and methods are the basis for how we prepare our consolidated financial statements and how we report our financial condition and results of operations, and they require management to make estimates about matters that are inherently uncertain.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure they comply with GAAP and reflect management’s judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances. The application of that chosen accounting policy or method might result in the Company reporting different amounts than would have been reported under a different alternative. If management’s estimates or assumptions are incorrect, the Company may experience material losses.
Management has identified one accounting policy as being “critical” to the presentation of the Company’s financial condition and results of operations because they require management to make particularly subjective and complex 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. This critical accounting policy relates to the allowance for credit losses. Because of the inherent uncertainty of this estimate, no assurance can be given that the application of alternative policies or methods might not result in the reporting of a different amount of the allowance for credit losses and, accordingly, net income.
From time to time, the FASB and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be difficult to predict and could materially impact how we report our financial condition and results of operations. Changes in these standards are continuously occurring, and given the current economic environment, more drastic changes may occur. The implementation of such changes could have a material adverse effect on our financial condition and results of operations.
We may experience increases to, and volatility in, the balance of the allowance for credit losses and related provision expense due to the adoption of the CECL methodology.
We adopted CECL, effective as of January 1, 2021, following the delayed adoption period permitted by the CARES Act and extended by the Consolidated Appropriations Act, 2021. The CECL methodology differs substantially from the incurred loss methodology previously used in that it is forward-looking, requiring measurement to occur when a financial asset is first added to the balance sheet and periodically thereafter. These measurements require significant use of management judgments as well as forward-looking information and forecasts. Any failure of these judgments or forecasts to be correct could negatively affect our results of operations and financial condition.
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Risks Relating to our Operations
Our ability to attract and retain management and key personnel and any damage to our reputation may affect future growth and earnings.
Much of our success and growth has been influenced strongly by our ability to attract and retain management experienced in banking and financial services and familiar with the communities in our market areas. Our ability to retain the executive officers, management teams, branch managers and loan officers at the Bank will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our community-based operating strategy. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, results of operations and financial condition.
In addition, our business depends on earning and maintaining the trust of our customers and communities. Harm to our reputation could arise from numerous sources, including employee misconduct, compliance failures, litigation or our failure to deliver appropriate levels of service. If any events or circumstances occur which could undermine our reputation, there can be no assurance that the additional costs and expenses we may incur as a result would not have an adverse impact on our business.
We have a continuing need to adapt to technological change and we may not have the resources to effectively implement new technology.
The financial services industry is constantly undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand our market areas. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that we will be able to offer, which would put us at a competitive disadvantage. Accordingly, we cannot provide assurances that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.
The Company’s information systems may experience an interruption or breach in security and cyber-attacks, all of which could have a material adverse effect on the Company’s business.
The Company relies heavily on internal and outsourced technologies, communications, and information systems to conduct its business. Additionally, in the normal course of business, the Company collects, processes and retains sensitive and confidential information regarding our customers. As the Company’s reliance on technology has increased, so have the potential risks of a technology-related operation interruption (such as disruptions in the Company’s core provider, general ledger, deposit, loan, digital banking or other systems) or the occurrence of a cyber-attack (such as unauthorized access to the Company’s systems). These risks have increased for all financial institutions as new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others have increased. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks against financial institutions, particularly denial of service attacks, which are designed to disrupt key business services, such as customer-facing web sites and social engineering attacks that could influence an employee of the Company to click on a link that downloads malware or ransomware to the Company’s system. The Company is not able to anticipate or implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently and because attacks can originate from a wide variety of sources. In addition, it is possible that we may not be able to detect security breaches on a timely basis, or at all, which could increase the costs and risks associated with any such breach.
The Company also faces risks related to cyber-attacks and other security breaches in connection with credit card and debit card transactions that typically involve the transmission of sensitive information regarding the Company’s customers through various third parties, including merchant acquiring banks, payment processors, payment card networks and its processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments such as the point of sale that the Company does not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact the Company through no fault of its own, and in some cases it may have exposure and suffer losses for breaches or attacks relating to them. In addition, the Company
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offers its customers protection against fraud and certain losses for unauthorized use of debit cards in order to stay competitive with other financial institutions. Offering such protection exposes the Company to losses that could adversely affect its business, financial condition and results of operations. Further cyber-attacks or other breaches in the future, whether affecting the Company or others, could intensify consumer concern and regulatory focus and result in reduced use of payment cards and increased costs, all of which could have a material adverse effect on the Company’s business. To the extent we are involved in any future cyber-attacks or other breaches, the Company’s reputation could be affected, which could also have a material adverse effect on the Company’s business, financial condition or results of operations.
We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.
Employee errors and misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding their own unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence, among others.
In addition, as a bank, we are susceptible to fraudulent activity that may be committed against us, third parties or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. For example, as previously disclosed, in the third quarter of 2019, the Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks. In the context of resulting bankruptcy proceedings involving the former client, the liquidating trustee has filed a complaint against the Bank, focused on a series of business transactions among the former client, related entities and the Bank. See "Note 1 - Summary of Significant Accounting Policies" for additional information.
We maintain a system of internal controls and insurance coverage to mitigate operational risks, including data processing system failures and errors, cyber-attacks, and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, results of operations and financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
We have no unresolved SEC staff comments.
ITEM 2. PROPERTIES
The Company is headquartered in the main office building of the Bank at 202 E. Center Street, Warsaw, Indiana 46580. The Company operates in 57 locations, 51 of which are owned by the Bank and six of which are leased from third parties.
None of the Company’s real property assets are the subject of any material encumbrances.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Company, to which Lakeland Financial or the Bank is a party or to which any of their property is subject.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The quarterly high and low prices for the Company’s common stock and the cash dividends declared and paid on that common stock are set forth in the table below.
| 2021 | 2020 | ||||||||||||||||||||||||||||||||||
| High* | Low* | Cash Dividend | High* | Low* | Cash Dividend | ||||||||||||||||||||||||||||||
| Fourth quarter | $ | 80.77 | $ | 69.51 | $ | 0.34 | $ | 56.28 | $ | 40.57 | $ | 0.30 | |||||||||||||||||||||||
| Third quarter | $ | 73.04 | $ | 56.06 | $ | 0.34 | $ | 53.00 | $ | 39.38 | $ | 0.30 | |||||||||||||||||||||||
| Second quarter | $ | 70.25 | $ | 57.02 | $ | 0.34 | $ | 47.49 | $ | 33.92 | $ | 0.30 | |||||||||||||||||||||||
| First quarter | $ | 77.05 | $ | 53.02 | $ | 0.34 | $ | 49.85 | $ | 30.49 | $ | 0.30 | |||||||||||||||||||||||
The common stock of the Company was first quoted on The Nasdaq Stock Market under the symbol “LKFN” on August 14, 1997. Currently, the Company’s common stock is listed for trading on the Nasdaq Global Select Market under the symbol “LKFN.” On February 16, 2022, the Company had approximately 311 stockholders of record.
The Company paid dividends on its common stock as set forth in the table above. The Company’s ability to pay dividends to stockholders is largely dependent upon the dividends it receives from the Bank, and the Bank is subject to regulatory limitations on the amount of cash dividends it may pay. See “Supervision and Regulation – Dividend Payments” for additional information.
Equity Compensation Plan Information
The table below sets forth the following information as of December 31, 2021 for (i) all compensation plans previously approved by the Company’s stockholders and (ii) all compensation plans not previously approved by the Company’s stockholders:
(a)the number of securities to be issued upon the exercise of outstanding options, warrants and rights;
(b)the weighted-average exercise price of such outstanding options, warrants and rights; and
(c)other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the number of securities remaining available for future issuance under the plans.
EQUITY COMPENSATION PLAN INFORMATION
| Plan category | Number of securities to be issued upon exercise of outstanding options | Weighted-average exercise price of outstanding options | Number of securities remaining available for future issuance under equity compensation plans | ||||||||||||||
Equity compensation plans approved by security holders(1) | 0 | $ | 0 | 454,308 | |||||||||||||
| Equity compensation plans not approved by security holders | 0 | 0 | 0 | ||||||||||||||
| Total | 0 | $ | 0 | 454,308 | |||||||||||||
(1)Lakeland Financial Corporation 2017 Equity Incentive Plan was adopted on April 12, 2017 by the board of directors.
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STOCK PRICE PERFORMANCE GRAPH
The graph below compares the cumulative total return of the Company, the Nasdaq Market Index, the KBW Nasdaq Bank Index, and the S&P U.S. BMI Banks Index.
| Lakeland Financial Corporation | ||||||||
| Period Ending | |||||||||||||||||||||||||||||||||||
| Index | 12/31/16 | 12/31/17 | 12/31/18 | 12/31/19 | 12/31/20 | 12/31/21 | |||||||||||||||||||||||||||||
| Lakeland Financial Corporation | 100.00 | 104.31 | 88.23 | 110.29 | 124.13 | 189.58 | |||||||||||||||||||||||||||||
| NASDAQ Composite Index | 100.00 | 129.34 | 125.96 | 172.18 | 249.51 | 304.85 | |||||||||||||||||||||||||||||
| SNL U.S. Bank NASDAQ Index | 100.00 | 118.59 | 97.58 | 132.84 | 119.14 | 164.80 | |||||||||||||||||||||||||||||
| S&P U.S. BMI Banks Index | 100.00 | 118.21 | 98.75 | 135.64 | 118.33 | 160.89 | |||||||||||||||||||||||||||||
The above returns assume that $100 invested on December 31, 2016 and that all dividends were reinvested.
ISSUER PURCHASES OF EQUITY SECURITIES
On January 8, 2019, the Company's board of directors approved a share repurchase program, under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, shares of the Company's common stock with an aggregate purchase price of up to $30 million. Repurchases may be made in the open market, through block trades or otherwise, and in privately negotiated transactions. On April 13, 2021, the Company's board of directors reauthorized and extended the share repurchase program through April 30, 2023. As extended, the repurchase program has an aggregate purchase price cap of $30 million. The repurchase program does not obligate the Company to repurchase any dollar amount or number of shares, and the program may be extended, modified, suspended or discontinued at any time. There were no repurchases under this plan during the year ended December 31, 2021.
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The following table provides information about purchases by the Company and its affiliates during the quarter ended December 31, 2021 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
| Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Appropriate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs | |||||||||||||||||||
| 10/01/21 - 10/31/21 | 0 | $ | 0.00 | 0 | $ | 30,000,000 | |||||||||||||||||
| 11/01/21 - 11/30/21 | 861 | 73.76 | 0 | 30,000,000 | |||||||||||||||||||
| 12/01/21 - 12/31/21 | 0 | 0.00 | 0 | 30,000,000 | |||||||||||||||||||
| Total | 861 | $ | 73.76 | 0 | $ | 30,000,000 | |||||||||||||||||
The shares purchased during the quarter were held as treasury stock and credited to the deferred share accounts of ten non-employee directors under the Company’s directors’ deferred compensation plan.
ITEM 6. SELECTED FINANCIAL DATA
The information previously required by Item 6 of this Form 10-K has been intentionally omitted, as permitted by the SEC in connection with its adoption of its final rules regarding the amendments to modernize, simplify, and enhance identified disclosure requirements of registrants.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Net income in 2021 was $95.7 million, up 13.5% from $84.3 million in 2020. Net income for 2020 was 3.1% lower than $87.0 million in 2019.
Diluted net income per common share was $3.74 in 2021, $3.30 in 2020 and $3.38 in 2019. Return on average total assets was 1.56% in 2021 versus 1.55% in 2020 and 1.76% in 2019. Return on average total equity was 14.19% in 2021 versus 13.51% in 2020 and 15.47% in 2019. The dividend payout ratio, with respect to diluted earnings per share, was 36.36% in 2021, 36.36% in 2020 and 34.32% in 2019. The average equity to average assets ratio was 10.96% in 2021 compared to 11.51% in 2020 and 11.38% in 2019.
Net income in 2021 was positively impacted by a $15.1 million increase in net interest income and a $13.7 million decrease in provision for credit losses. Offsetting these positive impacts were a $13.1 million increase in noninterest expense and a $2.1 million decrease in noninterest income.
Net income in 2020 was $84.3 million, down 3.1% from $87.0 million in 2019 and up 4.9% from $80.4 million in 2018. Diluted net income per common share was $3.30 in 2020 and $3.38 in 2019. Return on average total assets was 1.55% in 2020 versus 1.76% in 2019. Return on average total equity was 13.51% in 2020 versus 15.47% in 2019. The dividend payout ratio, with respect to diluted earnings per share, was 36.36% in 2020 and 34.32% in 2019. The average equity to average assets ratio was 11.51% in 2020 compared to 11.38% in 2019.
Net income in 2020 was positively impacted by an $8.0 million, or 5.1% increase, in net interest income and an $1.8 million, or 4.1% increase, in noninterest income. Offsetting these positive impacts was an $11.5 million, or 356.6% increase, in the provision for credit losses and an $1.8 million, or 2.0%, increase in noninterest expense.
Total assets were $6.557 billion as of December 31, 2021 versus $5.830 billion as of December 31, 2020, an increase of $726.9 million or 12.5%. This increase was primarily due to a $663.7 million increase in available-for-sale investment securities and an increase in short-term investments of $455.9 million. The increase of investment securities reflects the deployment of $652 million in excess liquidity that resulted from deposit growth. Deposit growth was impacted by PPP and economic stimulus. Total average assets increased $729.0 million primarily due to a $434.4 million increase in available-for-sale investment securities and a $313.6 million increase in interest bearing deposits.
CRITICAL ACCOUNTING POLICIES
Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for credit losses.
Allowance for Credit Losses
The Company maintains an allowance for credit losses to provide for expected credit losses. Losses are charged against the allowance when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management’s judgment, should be charged against the allowance. A provision for credit losses is taken based on management’s ongoing evaluation of the appropriate allowance balance. A formal evaluation of the adequacy of the credit loss allowance is conducted monthly. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control.
The level of credit loss provision is influenced by growth in the overall loan portfolio, emerging market risk, emerging concentration risk, commercial loan focus and large credit concentration, new industry lending activity, general economic conditions and historical loss analysis. In addition, management gives consideration to changes in the facts and circumstances of watch list credits, which includes the security position of the borrower, in determining the appropriate level of the credit loss provision. Furthermore, management’s overall view on credit quality is a factor in the determination of the provision.
The determination of the appropriate allowance is inherently subjective, as it requires significant estimates by management. The Company has an established process to determine the adequacy of the allowance for credit losses that generally includes consideration of changes in the nature and volume of the loan portfolio and overall portfolio quality, along with current and forecasted economic conditions that may affect borrowers’ ability to repay. Consideration is not limited to
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these factors although they represent the most commonly cited factors. To determine the specific allocation levels for individual credits, management considers the current valuation of collateral and the amounts and timing of expected future cash flows as the primary measures. Management also considers trends in adversely classified loans based upon an ongoing review of those credits. With respect to pools of similar loans, an appropriate level of general allowance is determined by portfolio segment using a probability of default-loss given default (“PD/LGD”) model, subject to a floor. A default can be triggered by one of several different asset quality factors, including past due status, nonaccrual status, TDR status or if the loan has had a charge-off. This PD is then combined with a LGD derived from historical charge-off data to construct a default rate. This loss rate is then supplemented with adjustments for reasonable and supportable forecasts of relevant economic indicators, particularly the unemployment rate forecast from the Federal Open Market Committee’s Summary of Economic Projections, and other environmental factors based on the risks present for each portfolio segment. These environmental factors include consideration of the following: levels of, and trends in, delinquencies and nonperforming loans; trends in volume and terms of loans; changes in collateral strength; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedure, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. It is also possible that these factors could include social, political, economic, and terrorist events or activities. All of these factors are susceptible to change, which may be significant. As a result of this detailed process, the allowance results in two forms of allocations, specific and general. These two components represent the total allowance for credit losses deemed adequate to cover expected losses inherent in the loan portfolio.
Commercial loans are subject to a dual standardized grading process administered by the credit administration function. These grade assignments are performed independent of each other and a consensus is reached by credit administration and the loan review officer. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that indicate it should be evaluated on an individual basis. Considerations with respect to specific allocations for these individual credits include, but are not limited to, the following: (a) the sufficiency of the customer’s cash flow or net worth to repay the loan; (b) the adequacy of the discounted value of collateral relative to the loan balance; (c) whether the loan has been criticized in a regulatory examination; (d) whether the loan is nonperforming; (e) any other reasons the ultimate collectability of the loan may be in question; or (f) any unique loan characteristics that require special monitoring.
Allocations are also applied to categories of loans considered not to be individually analyzed, but for which the rate of loss is expected to be consistent with or greater than historical averages. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. These general pooled loan allocations are performed for portfolio segments of commercial and industrial; commercial real estate, multi-family, and construction; agri-business and agricultural; other commercial loans; and consumer 1-4 family mortgage and other consumer loans. General allocations of the allowance are determined by a historical loss rate based on the calculation of each pool’s probability of default-loss given default, subject to a floor. The length of the historical period for each pool is based on the average life of the pool. The historical loss rates are supplemented with consideration of economic conditions and portfolio trends.
Due to the imprecise nature of estimating the allowance for credit losses, the Company’s allowance for credit losses includes an unallocated component. The unallocated component of the allowance for credit losses incorporates the Company’s judgmental determination of potential expected losses that may not be fully reflected in other allocations, including factors such as the level of classified credits, economic uncertainties, industry trends impacting specific portfolio segments, broad portfolio quality trends, and trends in the composition of the Company’s large commercial loan portfolio and related large dollar exposures to individual borrowers. As a practical expedient, the Company has elected to state accrued interest separately from loan principal balances on the consolidated balance sheet. Additionally, when a loan is placed on non-accrual, interest payments are reversed through interest income.
For off balance sheet credit exposures outlined in the ASU at 326-20-30-11, it is the Company’s position that nearly all of the unfunded amounts on lines of credit are unconditionally cancellable, and therefore not subject to having a liability set up.
The allowance is inherently uncertain as it represents the Company’s expectation of the future collectability of loans in its portfolio; actual collections may be greater than or less than expectations. Actual collections may be impacted by wider economic conditions such as changes in the competitive environment or in the levels of business investment or consumer spending, or by the quality of borrowers’ management teams and the success of their strategy execution. Borrowers’ ability to repay may also change due to the effects of government monetary or fiscal policy, which could affect the level of demand for borrowers’ products or services.
The Company’s allowance for credit losses is subject to changes in the inputs to the model, including the following: the numbers of delinquent loans, nonaccrual loans, troubled debt restructuring, or charge offs; the levels of charge offs and recoveries; projected unemployment rates and other economic indicators; the Company’s collateral position on adversely classified loans; or management’s qualitative judgment of the implication of trends in its loan portfolio or in the broader economy.
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RESULTS OF OPERATIONS
Overview
In 2021 and 2020, the Company continued to grow loans and deposits organically, in its geographic footprint of northern Indiana and in central Indiana in the Indianapolis market. In addition, during 2021 and 2020 the Company was an active participant in the PPP. The Company had 51 branches as of December 31, 2021. The Company’s profitability has been positively impacted by growth in loans and deposits and a reduction in provision for credit losses. In addition, asset quality has remained stable. The core banking contributions to noninterest income of loan, wealth management, and merchant card interchange fee income increased in 2021. Overall, expense growth has reflected our continued investment in people, technology and our branch infrastructure. The outlook for 2022 includes plans for continued organic loan growth and expanding our lending radius, a disciplined credit philosophy, continued investment in the Company in the form of staff additions, continued expansion in our geographic footprint, and continued investments in customer-facing technology and cybersecurity risk management tools.
Selected income statement information for the years ended December 31, 2021, 2020 and 2019 is presented in the following table.
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Income Statement Summary: | |||||||||||||||||
| Net interest income | $ | 178,088 | $ | 163,008 | $ | 155,047 | |||||||||||
| Provision for credit losses | 1,077 | 14,770 | 3,235 | ||||||||||||||
| Noninterest income | 44,720 | 46,843 | 44,997 | ||||||||||||||
| Noninterest expense | 104,287 | 91,205 | 89,424 | ||||||||||||||
| Other Data: | |||||||||||||||||
| Efficiency ratio (1) | 46.81 | % | 43.46 | % | 44.70 | % | |||||||||||
| Dilutive EPS | $ | 3.74 | $ | 3.30 | $ | 3.38 | |||||||||||
| Total equity | $ | 704,906 | $ | 657,184 | $ | 598,100 | |||||||||||
| Tangible capital ratio (2) | 10.70 | % | 11.21 | % | 12.02 | % | |||||||||||
| Net charge-offs (recoveries) to average loans | 0.09 | % | 0.09 | % | 0.03 | % | |||||||||||
| Net interest margin | 3.07 | % | 3.19 | % | 3.38 | % | |||||||||||
| Net interest margin excluding PPP loans (3) | 2.95 | % | 3.19 | % | 3.38 | % | |||||||||||
| Noninterest income to total revenue | 20.07 | % | 22.32 | % | 22.49 | % | |||||||||||
| Pretax Pre-Provision Earnings (4) | $ | 118,521 | $ | 118,646 | $ | 110,620 | |||||||||||
(1)Noninterest expense/Net interest income plus Noninterest income.
(2)Non-GAAP financial measure. Calculated by subtracting intangible assets, net of deferred tax, from total assets and total equity. Management believes this is an important measure because it is useful for planning and forecasting purposes. See reconciliation on the next page.
(3)Non-GAAP financial measure. Calculated by subtracting the impact PPP loans had on average earnings assets, loan interest income, average interest bearing liabilities, and interest expense. Management believes this is an important measure because it provide for better comparability to prior periods, given the expectation that PPP represents a limited governmental intervention in the lending market, designed to support small businesses through the pandemic, its low fixed interest rate of 1.0% and because the accretion of net loan fee income can be accelerated upon borrower forgiveness and repayment by the SBA. Management is actively monitoring net interest margin on a fully tax equivalent basis with and without PPP loan impact for the duration of this program. See reconciliation on the next page.
(4)Non-GAAP financial measure. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Management believes this is an important measure because it may enable investors to identify the trends in the Company's earnings exclusive of the effects of tax and provision expense, which may vary significantly from period to period. See reconciliation on the next page.
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The Company believes that providing non-GAAP financial measures provides investors with information useful to understanding the company's financial performance. A reconciliation of these non-GAAP financial measures is provided below (dollars in thousands, except per share data).
| Year Ended | |||||||||||||||||
| Dec. 31, 2021 | Dec. 31, 2020 | Dec. 31, 2019 | |||||||||||||||
| Total Equity | $ | 704,906 | $ | 657,184 | $ | 598,100 | |||||||||||
| Less: Goodwill | (4,970) | (4,970) | (4,970) | ||||||||||||||
| Plus: Deferred tax assets related to goodwill | 1,176 | 1,176 | 1,181 | ||||||||||||||
| Tangible Common Equity | 701,112 | 653,390 | 594,311 | ||||||||||||||
| Assets | $ | 6,557,323 | $ | 5,830,435 | $ | 4,946,745 | |||||||||||
| Less: Goodwill | (4,970) | (4,970) | (4,970) | ||||||||||||||
| Plus: Deferred tax assets related to goodwill | 1,176 | 1,176 | 1,181 | ||||||||||||||
| Tangible Assets | 6,553,529 | 5,826,641 | 4,942,956 | ||||||||||||||
| Ending Common Shares Issued | 25,488,508 | 25,424,307 | 25,623,016 | ||||||||||||||
| Tangible Book Value Per Common Share | $ | 27.50 | $ | 25.70 | $ | 23.19 | |||||||||||
| Tangible Capital Ratio | 10.70 | % | 11.21 | % | 12.02 | % | |||||||||||
| Net Interest Income | $ | 178,088 | $ | 163,008 | $ | 155,047 | |||||||||||
| Plus: Noninterest income | 44,720 | 46,843 | 44,997 | ||||||||||||||
| Minus: Noninterest expense | (104,287) | (91,205) | (89,424) | ||||||||||||||
| Pretax Pre-Provision Earnings | $ | 118,521 | $ | 118,646 | $ | 110,620 | |||||||||||
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The impact of the Paycheck Protection Program on Net Interest Margin FTE is provided below (dollars in thousands).
| Year Ended | |||||||||||||||||
| Dec. 31, 2021 | Dec. 31, 2020 | Dec. 31, 2019 | |||||||||||||||
| Total Average Earnings Assets | $ | 5,906,640 | $ | 5,184,836 | $ | 4,656,707 | |||||||||||
| Less: Average Balance of PPP Loans | (237,951) | (376,785) | 0 | ||||||||||||||
| Total Adjusted Earning Assets | 5,668,689 | 4,808,051 | 4,656,707 | ||||||||||||||
| Total Interest Income FTE | $ | 196,806 | $ | 195,549 | $ | 217,339 | |||||||||||
| Less: PPP Loan Income | (14,945) | (12,832) | 0 | ||||||||||||||
| Total Adjusted Interest Income FTE | 181,861 | 182,717 | 217,339 | ||||||||||||||
| Adjusted Earning Asset Yield, net of PPP Impact | 3.21 | % | 3.80 | % | 4.67 | % | |||||||||||
| Total Average Interest Bearing Liabilities | $ | 3,761,520 | $ | 3,437,338 | $ | 3,390,512 | |||||||||||
| Less: Average Balance of PPP Loans | (237,951) | (376,785) | 0 | ||||||||||||||
| Total Adjusted Interest Bearing Liabilities | 3,523,569 | $ | 3,060,553 | $ | 3,390,512 | ||||||||||||
| Total Interest Expense FTE | $ | 15,131 | $ | 30,095 | $ | 60,163 | |||||||||||
| Less: PPP Cost of Funds | (595) | (956) | 0 | ||||||||||||||
| Total Adjusted Interest Expense FTE | 14,536 | 29,139 | 60,163 | ||||||||||||||
| Adjusted Cost of Funds, net of PPP Impact | 0.26 | % | 0.61 | % | 1.29 | % | |||||||||||
| Net Interest Margin FTE, net of PPP Impact | 2.95 | % | 3.19 | % | 3.38 | % | |||||||||||
Net Income
Net income was $95.7 million in 2021, an increase of $11.4 million, or 13.5%, versus net income of $84.3 million in 2020. The increase in net income from 2020 to 2021 was primarily due to an increase in net interest income of $15.1 million, or 9.3%, and a decrease in the provision for credit losses of $13.7 million, or 92.7%. Noninterest expense increased $13.1 million, or 14.3%, and noninterest income decreased $2.1 million, or 4.5%. Net interest income for 2021 included $14.9 million in PPP interest and fee income compared to $12.8 million for 2020. The decrease in provision expense for 2021 was driven by improved economic conditions, which were supported by government stimulus programs and accommodative FOMC monetary policy.
Net income was $84.3 million in 2020, a decrease of $2.7 million, or 3.1%, versus net income of $87.0 million in 2019. The decrease in net income from 2019 to 2020 was primarily due to an increase in the provision for credit losses of $11.5 million, or 356.6%, as well as an increase of $1.8 million, or 2.0%, in noninterest expense. Net interest income increased $8.0 million, or 5.1%, and noninterest income increased $1.8 million, or 4.1%. Net interest income for 2020 included $12.8 million in PPP interest and fee income. The increase in provision for credit losses was driven by the potential negative impact to the Company's borrowers due to the economic impact of the COVID-19 pandemic.
Net Interest Income
The following table presents a three-year average balance sheet and, for each major asset and liability category, its related interest income and yield or its expense and rate for the years ended December 31, 2021, 2020 and 2019.
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THREE YEAR AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
| 2021 | 2020 | 2019 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| (fully tax equivalent basis, dollars in thousands) | Average Balance | Interest Income | Yield (1)/ Rate | Average Balance | Interest Income | Yield (1)/ Rate | Average Balance | Interest Income | Yield (1)/ Rate | ||||||||||||||||||||||||||||||||||||||||||||
| Earning Assets | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Taxable (1)(2) | $ | 4,406,456 | $ | 170,081 | 3.86 | % | $ | 4,405,994 | $ | 176,538 | 4.01 | % | $ | 3,950,130 | $ | 196,733 | 4.98 | % | |||||||||||||||||||||||||||||||||||
| Tax exempt (3) | 14,638 | 594 | 4.06 | 18,478 | 813 | 4.40 | 24,402 | 1,186 | 4.86 | ||||||||||||||||||||||||||||||||||||||||||||
| Investments: (3) | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale | 1,068,325 | 25,582 | 2.39 | 633,956 | 17,830 | 2.81 | 603,580 | 17,930 | 2.97 | ||||||||||||||||||||||||||||||||||||||||||||
| Short-term investments | 2,254 | 2 | 0.09 | 25,046 | 67 | 0.27 | 18,771 | 339 | 1.81 | ||||||||||||||||||||||||||||||||||||||||||||
| Interest bearing deposits | 414,967 | 547 | 0.13 | 101,362 | 301 | 0.30 | 59,824 | 1,151 | 1.92 | ||||||||||||||||||||||||||||||||||||||||||||
| Total earning assets | $ | 5,906,640 | $ | 196,806 | 3.33 | % | $ | 5,184,836 | $ | 195,549 | 3.77 | % | $ | 4,656,707 | $ | 217,339 | 4.67 | % | |||||||||||||||||||||||||||||||||||
| Less: Allowance for credit losses | (72,083) | (56,824) | (50,062) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Nonearning Assets | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Cash and due from banks | 70,035 | 62,242 | 119,450 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Premises and equipment | 59,667 | 60,492 | 59,147 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other nonearning assets | 189,521 | 174,050 | 156,662 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total assets | $ | 6,153,780 | $ | 5,424,796 | $ | 4,941,904 | |||||||||||||||||||||||||||||||||||||||||||||||
| Interest Bearing Liabilities | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Savings deposits | $ | 360,915 | $ | 278 | 0.08 | % | $ | 270,010 | $ | 219 | 0.08 | % | $ | 240,293 | $ | 260 | 0.11 | % | |||||||||||||||||||||||||||||||||||
| Interest bearing checking accounts | 2,392,220 | 6,759 | 0.28 | 1,862,077 | 9,268 | 0.50 | 1,669,045 | 26,006 | 1.56 | ||||||||||||||||||||||||||||||||||||||||||||
| Time deposits: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| In denominations under $100,000 | 218,624 | 2,038 | 0.93 | 262,040 | 4,361 | 1.66 | 277,896 | 5,337 | 1.92 | ||||||||||||||||||||||||||||||||||||||||||||
| In denominations over $100,000 | 714,353 | 5,752 | 0.81 | 946,569 | 15,494 | 1.64 | 1,111,172 | 25,545 | 2.30 | ||||||||||||||||||||||||||||||||||||||||||||
| Miscellaneous short-term borrowings | 408 | 7 | 1.72 | 34,347 | 506 | 1.47 | 61,347 | 1,311 | 2.14 | ||||||||||||||||||||||||||||||||||||||||||||
| Long-term borrowings and subordinated debentures | 75,000 | 297 | 0.40 | 62,295 | 247 | 0.40 | 30,759 | 1,704 | 5.54 | ||||||||||||||||||||||||||||||||||||||||||||
| Total interest bearing liabilities | $ | 3,761,520 | $ | 15,131 | 0.40 | % | $ | 3,437,338 | $ | 30,095 | 0.88 | % | $ | 3,390,512 | $ | 60,163 | 1.77 | % | |||||||||||||||||||||||||||||||||||
| Noninterest Bearing Liabilities | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Demand deposits | 1,671,172 | 1,309,901 | 944,118 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other liabilities | 46,451 | 53,384 | 44,673 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Stockholders' Equity | 674,637 | 624,173 | 562,601 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total liabilities and stockholders' equity | $ | 6,153,780 | $ | 5,424,796 | $ | 4,941,904 | |||||||||||||||||||||||||||||||||||||||||||||||
| Interest Margin Recap | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest income/average earning assets | 196,806 | 3.33 | 195,549 | 3.77 | 217,339 | 4.67 | |||||||||||||||||||||||||||||||||||||||||||||||
| Interest expense/average earning assets | 15,131 | 0.26 | 30,095 | 0.58 | 60,163 | 1.29 | |||||||||||||||||||||||||||||||||||||||||||||||
| Net interest income and margin | $ | 181,675 | 3.07 | % | $ | 165,454 | 3.19 | % | $ | 157,176 | 3.38 | % | |||||||||||||||||||||||||||||||||||||||||
(1)Loan fees are included as taxable loan interest income. Net loan fees attributable to PPP loans were $12.5 million and $9.0 million for the years ended December 31, 2021 and 2020, respectively. All other loan fees were immaterial in relation to total taxable loan interest income for the periods presented.
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(2)Nonaccrual loans are included in the average balance of taxable loans.
(3)Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $3.6 million, $2.4 million and $2.1 million for the years ended December 31, 2021, 2020 and 2019, respectively.
The following table shows fluctuations in net interest income attributable to changes in the average balances of assets and liabilities and the yields earned or rates paid for the years ended December 31.
NET INTEREST INCOME – RATE/VOLUME ANALYSIS (fully tax equivalent basis, dollars in thousands)
| 2021 Over (Under) 2020 (1) | 2020 Over (Under) 2019 (1) | ||||||||||||||||||||||||||||||||||
| Attributable to | Total Change | Attributable to | Total Change | ||||||||||||||||||||||||||||||||
| Volume | Rate | Volume | Rate | ||||||||||||||||||||||||||||||||
| Interest Income (2) | |||||||||||||||||||||||||||||||||||
| Loans: | |||||||||||||||||||||||||||||||||||
| Taxable | $ | 18 | $ | (6,475) | $ | (6,457) | $ | 21,056 | $ | (41,251) | $ | (20,195) | |||||||||||||||||||||||
| Tax exempt | (158) | (61) | (219) | (268) | (105) | (373) | |||||||||||||||||||||||||||||
| Investments: | |||||||||||||||||||||||||||||||||||
| Available-for-sale | 10,724 | (2,972) | 7,752 | 879 | (979) | (100) | |||||||||||||||||||||||||||||
| Short-term investments | (37) | (28) | (65) | 86 | (358) | (272) | |||||||||||||||||||||||||||||
| Interest bearing deposits | 493 | (247) | 246 | 494 | (1,344) | (850) | |||||||||||||||||||||||||||||
| Total interest income | 11,040 | (9,783) | 1,257 | 22,247 | (44,037) | (21,790) | |||||||||||||||||||||||||||||
| Interest Expense | |||||||||||||||||||||||||||||||||||
| Savings deposits | 71 | (12) | 59 | 29 | (70) | (41) | |||||||||||||||||||||||||||||
| Interest bearing checking accounts | 2,186 | (4,695) | (2,509) | 2,710 | (19,448) | (16,738) | |||||||||||||||||||||||||||||
| Time deposits: | |||||||||||||||||||||||||||||||||||
| In denominations under $100,000 | (636) | (1,687) | (2,323) | (292) | (684) | (976) | |||||||||||||||||||||||||||||
| In denominations over $100,000 | (3,172) | (6,570) | (9,742) | (3,414) | (6,637) | (10,051) | |||||||||||||||||||||||||||||
| Miscellaneous short-term borrowings | (571) | 72 | (499) | (472) | (333) | (805) | |||||||||||||||||||||||||||||
| Long-term borrowings and | |||||||||||||||||||||||||||||||||||
| subordinated debentures | 50 | 0 | 50 | 896 | (2,353) | (1,457) | |||||||||||||||||||||||||||||
| Total interest expense | (2,072) | (12,892) | (14,964) | (543) | (29,525) | (30,068) | |||||||||||||||||||||||||||||
| Net Interest Income (tax equivalent) | $ | 13,112 | $ | 3,109 | $ | 16,221 | $ | 22,790 | $ | (14,512) | $ | 8,278 | |||||||||||||||||||||||
(1)The earning assets and interest bearing liabilities used to calculate interest differentials are based on average daily balances for 2021, 2020 and 2019. The changes in net interest income are created by changes in interest rates and changes in the volumes of loans, investments, deposits and borrowings. In the table above, changes attributable to volume are computed using the change in volume from the prior year multiplied by the previous year’s rate, and changes attributable to rate are computed using the change in rate from the prior year multiplied by the previous year’s volume. The change in interest or expense due to both rate and volume has been allocated between factors in proportion to the relationship of the absolute dollar amounts of the change in each.
(2)Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the TEFRA adjustment applicable to nondeductible interest expense.
Net interest income increased by $15.1 million to $178.1 million in 2021 compared to 2020, primarily due to a $721.8 million, or 13.9%, increase in average earning assets, driven by a $434.4 million increase in average available-for-sale investment securities and a $313.6 million increase in interest bearing deposits. The yield on average earning assets decreased 44 basis points to 3.33% in 2021 from 3.77% in 2020. The net interest margin decreased to 3.07% in 2021 versus 3.19% in 2020, driven by continued margin compression and excess liquidity on the Company's balance sheet. The net interest margin decreased to 3.19% in 2020 versus 3.38% in 2019, driven by the Federal Reserve Bank decreasing the target Federal Funds
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Rate by 225 basis points since the second half of 2019, inclusive of two emergency cuts during March 2020, in response to the economic challenges from the COVID-19 pandemic.
Growth in the commercial loan portfolio accounted for most of the growth in loans. Management believes that the growth in the loan portfolio, excluding the PPP loan program, will likely continue in a measured and prudent fashion as a result of our continued strategic focus on commercial and industrial lending, as well as commercial real estate lending. Average total loans were flat at $4.421 billion at December 31, 2021 compared to $4.424 billion at December 31, 2020. Average total loans, excluding PPP loans, were $4.183 billion at December 31, 2021 and represented growth of $135.5 million, or 3.3%, during 2021. Loan growth, excluding PPP loans, was slower in 2021 and 2020 as compared to prior years due to excess liquidity on our customers' balance sheets and a slowdown in demand for manufacturing and industrial loans. The utilization of commercial lines of credit has dropped in 2021 and 2020, due to softened loan demand, to 42% at December 31, 2021 from 43% at December 31, 2020 and 46% at December 31, 2019. However, available lines of credit have increased by a record $557 million to $4.101 billion at December 31, 2021 compared to $3.544 billion at December 31, 2020. Management believes that tepid loan demand has impacted the decrease in commercial line utilization and believes its organic growth strategy of continued expansion in its current geographic footprint and in Indianapolis will provide continued loan growth opportunities.
During 2021 a reduction in average loans of $3.4 million, growth in average available-for-sale investment securities of $434.4 million and growth in average short-term investments and interest bearing deposits of $290.8 million was funded through an increase in deposits. Average demand deposits increased $361.3 million in 2021 and average interest bearing deposit accounts increased $345.4 million. The increase in deposits for 2021 resulted from excess liquidity on our customers’ balance sheets resulting from a combination of PPP and economic stimulus. As a result of this excess liquidity on the Company's balance sheet, management deployed $652 million into the available-for-sale investment securities portfolio during 2021.
Provision for Credit Losses
On December 27, 2020, President Trump signed into law the Consolidated Appropriations Act, 2021. This law extended relief for troubled debt restructurings and provided the opportunity to further delay CECL adoption originally provided under the CARES Act. The Company elected to defer adoption of CECL until January 1, 2021. Prior to this, provision expense was recorded under the incurred loss methodology. The day one impact of the adoption was an increase in the allowance for credit losses of $9.1 million, with an offset, net of taxes, to beginning stockholders' equity.
The Company recorded a provision for credit losses of $1.1 million in 2021 compared to $14.8 million in 2020 and $3.2 million in 2019. The lower provision in 2021 was driven by improvement in the financial condition and outlook of the Company's borrowers. The Company’s allowance for credit losses as of December 31, 2021 was $67.8 million compared to $61.4 million as of December 31, 2020 and $50.7 million as of December 31, 2019. The allowance for credit losses represented 1.58% of total loans as of December 31, 2021 versus 1.32% at December 31, 2020 and 1.25% at December 31, 2019. CECL adoption included a one-time increase to the allowance for credit losses of $9.1 million. The company’s credit loss reserve to total loans, excluding PPP loans, was 1.59% at December 31, 2021 compared to 1.45% at December 31, 2020 and 1.25% at December 31, 2019. PPP loans are guaranteed by the United States SBA and have not been allocated for within the allowance for credit losses. Net charge-offs of $3.8 million, or 0.09% of average loans, and net charge-offs of $4.0 million, or 0.09% of average loans, were recorded in 2021 and 2020, respectively. The charge offs for 2021 and 2020 resulted primarily from a single commercial credit each year. Management believes the charge offs were one-off instances and are not reflective of deteriorating trends in the loan portfolio. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions including the impact of the COVID-19 pandemic and other factors that may influence the assessment of the collectability of loans.
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Noninterest Income
The following table presents changes in the components of noninterest income for the years ended December 31.
| % Change From Prior Year | |||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2019 | 2021 | 2020 | ||||||||||||||||||||||||
| Wealth advisory fees | $ | 8,750 | $ | 7,468 | $ | 6,835 | 17.2 | % | 9.3 | % | |||||||||||||||||||
| Investment brokerage fees | 1,975 | 1,670 | 1,687 | 18.3 | % | (1.0) | % | ||||||||||||||||||||||
| Service charges on deposit accounts | 10,608 | 10,110 | 15,717 | 4.9 | % | (35.7) | % | ||||||||||||||||||||||
| Loan and service fees | 11,922 | 10,085 | 9,911 | 18.2 | % | 1.8 | % | ||||||||||||||||||||||
| Merchant and interchange fee income | 3,023 | 2,408 | 2,641 | 25.5 | % | (8.8) | % | ||||||||||||||||||||||
| Bank owned life insurance income | 2,467 | 2,105 | 1,890 | 17.2 | % | 11.4 | % | ||||||||||||||||||||||
| Interest rate swap fee income | 1,035 | 5,089 | 1,691 | (79.7) | % | 200.9 | % | ||||||||||||||||||||||
| Mortgage banking income | 1,418 | 3,911 | 1,626 | (63.7) | % | 140.5 | % | ||||||||||||||||||||||
| Net securities gains | 797 | 433 | 142 | 84.1 | % | 204.9 | % | ||||||||||||||||||||||
| Other income | 2,725 | 3,564 | 2,857 | (23.5) | % | 24.7 | % | ||||||||||||||||||||||
| Total noninterest income | $ | 44,720 | $ | 46,843 | $ | 44,997 | (4.5) | % | 4.1 | % | |||||||||||||||||||
| Noninterest income to total revenue | 20.1 | % | 22.3 | % | 22.5 | % | |||||||||||||||||||||||
Noninterest income was $44.7 million in 2021 versus $46.8 million in 2020, a decrease of $2.1 million, or 4.5%. The decrease was primarily driven by a $4.1 million decrease in interest rate swap fees generated from commercial lending transactions, as well as a $2.5 million decrease in mortgage banking income. Demand for interest rate swap arrangements decreased in 2021. The carrying value of mortgage servicing rights was negatively impacted by increased prepayment speeds, resulting from the low interest rate environment. Offsetting these decreases were an increase in loan service fees of $1.8 million, an increases in wealth advisory and investment brokerage fees of $1.6 million, an increase in merchant and interchange fees of $615,000, and an increase in service charges on deposit accounts of $498,000. The increases in fee income were driven by growth in fee-based businesses including from the wealth advisory group, merchant services, debit card interchange and institutional services areas due to higher transaction volumes and increased economic activity.
Noninterest income was $46.8 million in 2020 versus $45.0 million in 2019, an increase of $1.8 million, or 4.1% higher. The increase was primarily driven by a record $3.4 million increase in interest rate swap fees generated from commercial lending transactions, as well as a $2.3 million increase in mortgage banking income. Noninterest income was also positively impacted by increase in wealth advisory fees due to continued growth of client relationships. Offsetting these increases was a decrease in service charges on deposit accounts driven primarily by lower treasury management fees as well as reduced levels of overdraft fee income.
Noninterest Expense
The following table presents changes in the components of noninterest expense for the years ended December 31.
| % Change From Prior Year | |||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2019 | 2021 | 2020 | ||||||||||||||||||||||||
| Salaries and employee benefits | $ | 57,882 | $ | 49,413 | $ | 48,742 | 17.1 | % | 1.4 | % | |||||||||||||||||||
| Net occupancy expense | 5,728 | 5,851 | 5,295 | (2.1) | % | 10.5 | % | ||||||||||||||||||||||
| Equipment costs | 5,530 | 5,766 | 5,521 | (4.1) | % | 4.4 | % | ||||||||||||||||||||||
| Data processing fees and supplies | 12,674 | 11,864 | 10,407 | 6.8 | % | 14.0 | % | ||||||||||||||||||||||
| Corporate and business development | 4,262 | 3,093 | 4,371 | 37.8 | % | (29.2) | % | ||||||||||||||||||||||
| FDIC insurance and other regulatory fees | 2,242 | 1,707 | 638 | 31.3 | % | 167.6 | % | ||||||||||||||||||||||
| Professional fees | 7,064 | 5,314 | 4,644 | 32.9 | % | 14.4 | % | ||||||||||||||||||||||
| Other expense | 8,905 | 8,197 | 9,806 | 8.6 | % | (16.4) | % | ||||||||||||||||||||||
| Total noninterest expense | $ | 104,287 | $ | 91,205 | $ | 89,424 | 14.3 | % | 2.0 | % | |||||||||||||||||||
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Noninterest expense increased by $13.1 million, or 14.3%, to $104.3 million for the year ended December 31, 2021 as compared to $91.2 million for 2020. Salaries and employee benefits increased by $8.5 million due primarily to increased performace-based compensation, increased salaries and increased health insurance expense. Additionally, increased legal fees and costs associated with the digital platform conversion to LCB Digital contributed to an overall increase of $1.8 million in professional fees. Corporate and business development expenses increased as the 2021 economy re-opened, and client events and contributions increased in 2021.
Noninterest expense was $91.2 million in 2020 versus $89.4 million in 2019, an increase of $1.8 million, or 2.0%. Data processing fees increased $1.5 million in 2020 primarily due to the Company's continued investment in customer focused, technology-based solutions and ongoing cybersecurity and data management enhancements. FDIC insurance and other regulatory fees increased $1.1 million due to the expiration of insurance assessment credits and growth of the balance sheet. Professional fees increased by $670,000 primarily due to higher legal expenses, increased fees to accounting firms and professional fees for innovative project implementations. Salaries and employee benefits increased primarily due to an increase in staffing at revenue producing and risk management areas as well as higher health insurance expenses. Offsetting these increases were decreases in corporate and business development as the COVID-19 pandemic forced the cancellation and postponement of events, in-person trainings and face-to-face customer and prospect meetings due to COVID-19 safety protocols. The Company spent approximately $640,000 since the pandemic began on personal protective equipment, protective barriers and enhanced social distancing measures for the safety of bank customers and employees.
As previously disclosed, in the third quarter of 2019, the Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks. The former client subsequently filed several related bankruptcy cases, captioned In re Interlogic Outsourcing, Inc., et al., which are pending in the United States Bankruptcy Court for the Western District of Michigan. On April 27, 2021, the bankruptcy court entered an order approving an amended plan of liquidation, which was filed by the former client, other debtors and bankruptcy plan proponents, and approving the consolidation of the assets in the aforementioned cases under the Khan IOI Consolidated Estate Trust. On August 9, 2021, the liquidating trustee for the bankruptcy estates filed a complaint against the Bank and the Company, and has agreed to stay prosecution of the action through March 31, 2022. The action is focused on a series of business transactions among the client, related entities, and the Bank, which the liquidating trustee alleges are voidable under applicable federal bankruptcy and state law. The complaint also addresses treatment of the Bank’s claims filed in the bankruptcy cases. Based on current information, we have determined that a material loss is neither probable nor estimable at this time, and the Bank and the Company intend to vigorously defend themselves against all allegations asserted in the complaint.
Future noninterest expense may continue to be impacted due to the COVID-19 pandemic. For example, continued economic reopening and growth may impact balance sheet growth and resulting revenue growth which could increase the amount the Company pays in incentive-based compensation. In addition, prolonged supply chain disruptions, labor availability shortages and increased infection rates due to COVID-19 variants could halt the economic recovery and resulting elevated provision expense which may reduce net income and diluted earnings per share, a key performance metric that impacts incentive-based compensation targets.
Income Taxes
The Company recognized income tax expense in 2021 of $21.7 million, compared to $19.5 million in 2020 and $20.3 million in 2019. The effective tax rate in 2021 was 18.5% compared to 18.8% in 2020, and 18.9% in 2019. For a detailed analysis of the Company’s income taxes see Note 13 – Income Taxes.
CERTAIN STATISTICAL DISCLOSURES BY BANK HOLDING COMPANIES
We are required to provide certain statistical disclosures as a bank holding company under the SEC's Industry Guide 3. The following table provides certain of those disclosures.
| Year ended December 31, | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Return on average assets | 1.56 | % | 1.55 | % | 1.76 | % | |||||||||||
| Return on equity | 14.19 | % | 13.51 | % | 15.47 | % | |||||||||||
| Average equity to average assets | 10.96 | % | 11.51 | % | 11.38 | % | |||||||||||
| Dividend payout ratio | 36.36 | % | 36.36 | % | 34.32 | % | |||||||||||
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Return on average assets is computed by dividing net income by average assets for each indicated fiscal year. Average assets is computed by adding total assets as of each date during the indicated fiscal year and dividing by the number of days in the fiscal year.
Return on average total equity is computed by dividing net income by average equity for each indicated fiscal year. Average equity is computed by adding the total equity attributable to the Company as of each date during the indicated fiscal year and dividing by the number of days in the fiscal year.
Average equity to average assets is computed by dividing average equity by average assets for each indicated fiscal year, as calculated in accordance with the previous explanation.
Dividend payout ratio is computed by dividing dividends declared per common share by earnings per diluted common share for each indicated fiscal year.
Refer to the "Financial Condition - Loan Portfolio", "Financial Condition - Sources of Funds" and "Risk Management - Loan Portfolio" sections of this MD&A and to the Notes to Consolidated Financial Statements of this Form 10-K for the other required disclosures.
FINANCIAL CONDITION
Overview
Total assets of the Company were $6.557 billion as of December 31, 2021, an increase of $726.9 million, or 12.5%, when compared to $5.830 billion as of December 31, 2020. Total loans, excluding PPP loans, increased by $24.5 million, or 0.6%, as of December 31, 2021 from $4.237 billion at December 31, 2020. Total loans outstanding decreased by $361.3 million, or 7.8%, to $4.288 billion at December 31, 2021 from $4.649 billion at December 31, 2020. PPP loans outstanding were $26.2 million as of December 31, 2021, compared to $412.0 million at December 31, 2020. The company received PPP forgiveness proceeds and borrowers' repayment of $709.5 million from the SBA for loans since the program's inception. Cash and cash equivalents increased by $433.3 million and available-for-sale securities increased by $663.7 million. Funding for the investment securities portfolio and organic loan growth came from a $698.6 million increase in total deposits as well as a $54.1 million increase in retained earnings, offset by an $10.5 million decrease in total borrowings.
Uses of Funds
Investment Portfolio
At year end 2021, 2020 and 2019, there were no holdings of securities of any one issuer, other than the U.S. government, government agencies and government sponsored agencies, in an amount greater than 10% of stockholders’ equity. See Note 2 – Securities for more information on these investments.
Purchases of securities available-for-sale totaled $835.0 million in 2021, $216.5 million in 2020 and $129.5 million in 2019. Growth of the investment portfolio during the past three years serves to provide liquidity for the Company and provide longer duration as an offset to the short duration of the loan portfolio. The Company deployed $652 million in excess liquidity into the investment securities portfolio during 2021 and $100 million in 2020 in order to preserve net interest income in the current rate and economic environment. Investment securities represented 21% of total assets on December 31, 2021 compared to 13% on December 31, 2020 and 12% on December 31, 2019. Management expects the investment portfolio as a percent of total assets to normalize once core loan growth demand increases and investment security repayments are deployed into loan growth. Securities sales totaled $14.0 million in 2021, $8.0 million in 2020 and $57.1 million in 2019. Paydowns from prepayments and scheduled payments of $113.1 million, $90.4 million and $53.0 million were received in 2021, 2020 and 2019, and the amortization of premiums, net of the accretion of discounts, was $5.0 million, $4.0 million and $3.9 million, respectively. Maturities and calls of securities totaled $24.7 million, $7.6 million and $14.8 million in 2021, 2020 and 2019, respectively. No provision for allowance for credit loss was recorded in connection with the investment securities portfolio in 2021, and no other-than-temporary impairment was recognized in 2020 or 2019. The investment portfolio is managed to provide for an appropriate balance between liquidity, credit risk and investment return and to limit the Company’s exposure to risk to an acceptable level. The longer duration of the investment security portfolio serves to balance the shorter duration of the loan portfolio.
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The weighted average yields and maturity distribution for the securities portfolio at December 31, 2021, were as follows:
| Within One Year | After One Within Five Years | After Five Years Within Ten years | After Ten Years | ||||||||||||||||||||||||||||||||||||||||||||
| (fully tax equivalent basis, dollars in thousands) | Fair Value | Yield | Fair Value | Yield | Fair Value | Yield | Fair Value | Yield | |||||||||||||||||||||||||||||||||||||||
| U.S. Treasury securities | $ | 900 | 0.03 | % | $ | 0 | 0.00 | % | $ | 0 | 0.00 | % | $ | 0 | 0.00 | % | |||||||||||||||||||||||||||||||
| U.S. government sponsor agency | 0 | 0.00 | % | 0 | 0.00 | % | 4,859 | 1.00 | % | 138,593 | 1.47 | % | |||||||||||||||||||||||||||||||||||
| Mortgage-backed securities: residential | 6,491 | 6.53 | % | 21,729 | 3.19 | % | 34,393 | 2.68 | % | 424,063 | 2.03 | % | |||||||||||||||||||||||||||||||||||
| Mortgage-backed securities: commercial | 523 | 2.48 | % | 0 | 0.00 | % | 0 | 0.00 | % | 0 | 0.00 | % | |||||||||||||||||||||||||||||||||||
| State and municipal securities | 2,804 | 3.38 | % | 9,823 | 4.40 | % | 50,033 | 3.65 | % | 704,347 | 3.16 | % | |||||||||||||||||||||||||||||||||||
| Total Securities | $ | 10,718 | 4.96 | % | $ | 31,552 | 3.56 | % | $ | 89,285 | 3.13 | % | $ | 1,267,003 | 2.60 | % | |||||||||||||||||||||||||||||||
The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds in the Volcker Rule.
Real Estate Mortgage Loans Held For Sale
Real estate mortgages held for sale decreased by $3.7 million to $7.5 million at December 31, 2021 from $11.2 million at December 31, 2020 as a result of reduced mortgage refinancing demand compared to refinancing activity during 2020. This asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market. The Company generally sells almost all of the mortgage loans it originates in the secondary market. Proceeds from sales totaled $126.4 million in 2021, $114.2 million in 2020 and $64.8 million in 2019.
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Loan Portfolio
The loan portfolio by class as of December 31, 2021, 2020 and 2019 was as follows:
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||
| Working capital lines of credit loans | $ | 652,861 | $ | 626,023 | $ | 709,849 | |||||||||||
| Non-working capital loans | 736,608 | 1,165,355 | 717,019 | ||||||||||||||
| Total commercial and industrial loans | 1,389,469 | 1,791,378 | 1,426,868 | ||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||
| Construction and land development loans | 379,813 | 362,653 | 287,641 | ||||||||||||||
| Owner occupied loans | 739,371 | 648,019 | 573,665 | ||||||||||||||
| Nonowner occupied loans | 588,458 | 579,625 | 571,364 | ||||||||||||||
| Multi-family loans | 247,204 | 304,717 | 240,652 | ||||||||||||||
| Total commercial real estate and multi-family residential loans | 1,954,846 | 1,895,014 | 1,673,322 | ||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||
| Loans secured by farmland | 206,331 | 195,410 | 174,380 | ||||||||||||||
| Loans for agricultural production | 239,494 | 234,234 | 205,151 | ||||||||||||||
| Total agri-business and agricultural loans | 445,825 | 429,644 | 379,531 | ||||||||||||||
| Other commercial loans | 73,490 | 94,013 | 112,302 | ||||||||||||||
| Total commercial loans | 3,863,630 | 4,210,049 | 3,592,023 | ||||||||||||||
| Consumer 1-4 family mortgage loans: | |||||||||||||||||
| Closed end first mortgage loans | 176,561 | 167,847 | 177,227 | ||||||||||||||
| Open end and junior lien loans | 156,238 | 163,664 | 186,552 | ||||||||||||||
| Residential construction and land development loans | 11,921 | 12,007 | 12,966 | ||||||||||||||
| Total consumer 1-4 family mortgage loans | 344,720 | 343,518 | 376,745 | ||||||||||||||
| Other consumer loans | 82,755 | 103,616 | 98,617 | ||||||||||||||
| Total consumer loans | 427,475 | 447,134 | 475,362 | ||||||||||||||
| Gross loans | 4,291,105 | 4,657,183 | 4,067,385 | ||||||||||||||
| Less: Allowance for credit losses | (67,773) | (61,408) | (50,652) | ||||||||||||||
| Net deferred loan fees | (3,264) | (8,027) | (1,557) | ||||||||||||||
| Loans, net | $ | 4,220,068 | $ | 4,587,748 | $ | 4,015,176 | |||||||||||
The ratio of loans to total loans by portfolio segment as of December 31, 2021, 2020 and 2019 was as follows:
| 2021 | 2020 | 2019 | |||||||||||||||
| Commercial and industrial loans | 32.38 | % | 38.46 | % | 35.08 | % | |||||||||||
| Commercial real estate and multi-family residential loans | 45.56 | % | 40.69 | % | 41.14 | % | |||||||||||
| Agri-business and agricultural loans | 10.39 | % | 9.23 | % | 9.33 | % | |||||||||||
| Other commercial loans | 1.71 | % | 2.02 | % | 2.76 | % | |||||||||||
| Consumer 1-4 family mortgage loans | 8.03 | % | 7.38 | % | 9.26 | % | |||||||||||
| Other consumer loans | 1.93 | % | 2.22 | % | 2.43 | % | |||||||||||
| Total Loans | 100.00 | % | 100.00 | % | 100.00 | % | |||||||||||
40
In 2021, net loan balances decreased by $367.7 million to $4.220 billion, which excludes approximately $119.4 million in loans originated for sale. PPP loans of $26.2 million are included in non-working capital loans of commercial and industrial loans at December 31, 2021. In 2020, net loan balances increased by $572.6 million to $4.588 billion, which excludes approximately $117.6 million in loans originated for sale. PPP loans of $412.0 million were included in non-working capital loans of commercial and industrial loans at December 31, 2020. In 2019, net loan balances increased by $148.9 million to $4.015 billion, which excludes approximately $66.0 million in loans originated for sale.
The mix of loan types within the Company’s portfolio continued a trend toward a higher percentage of the total loan portfolio being in commercial loans. This higher percentage of commercial loans to the total portfolio was a result of the Company’s long standing strategic plan that is focused on organic expansion and growth in commercial loans. Commercial and industrial loans together with owner occupied commercial real estate loans represent 49.6% and 52.4% of total loans as of December 31, 2021 and 2020, respectively. The owner-occupied commercial real estate loans tend to represent the real estate holding of our commercial and industrial loan customers. Another significant loan segment are loans to the agri-business sector. During 2021, the Bank ranked as the third largest agricultural lender in the State of Indiana.
The residential construction and land development loans class included construction loans totaling $3.3 million and $7.2 million as of December 31, 2021 and 2020. Declines in consumer loans during 2021 resulted from paydowns due to borrower excess liquidity generated from mortgage refinancing activity and government stimulus programs. The Bank generally sells conforming mortgage loans which it originates on the secondary market. These loans generally represent mortgage loans that are made to clients with long-term or substantial relationships with the Bank on terms consistent with secondary market requirements. The loan classifications are based on the nature of the loans as of the loan origination date. There were no foreign loans included in the loan portfolio for the periods presented.
Repricing opportunities of the loan portfolio occur either according to predetermined float rate indices, adjustable rate schedules included in the related loan agreements or upon maturity of each principal payment. The following table indicates the scheduled maturities of the loan portfolio as of December 31, 2021:
| (dollars in thousands) | Commercial and Industrial | Commercial Real Estate and Multi-family Residential | Agri-business and Agricultural | Other Commercial | Consumer 1-4 Family Mortgage | Other Consumer | Total | Percent | |||||||||||||||||||||||||||||||||||||||
| Within one year | $ | 684,523 | $ | 321,456 | $ | 161,999 | $ | 16,916 | $ | 10,383 | $ | 16,176 | $ | 1,211,453 | 28.23 | % | |||||||||||||||||||||||||||||||
| After one year, within five years | 562,309 | 991,600 | 163,406 | 25,429 | 60,723 | 35,949 | 1,839,416 | 42.87 | % | ||||||||||||||||||||||||||||||||||||||
| Over five years | 132,075 | 638,156 | 120,085 | 31,145 | 273,461 | 30,341 | 1,225,263 | 28.55 | % | ||||||||||||||||||||||||||||||||||||||
| Nonaccrual loans | 10,562 | 3,634 | 335 | 0 | 153 | 289 | 14,973 | 0.35 | % | ||||||||||||||||||||||||||||||||||||||
| Total loans | $ | 1,389,469 | $ | 1,954,846 | $ | 445,825 | $ | 73,490 | $ | 344,720 | $ | 82,755 | $ | 4,291,105 | 100.00 | % | |||||||||||||||||||||||||||||||
At maturity, credits are reviewed and, if renewed, are renewed at rates and conditions that prevail at the time of maturity.
Based upon the table above, all loans due after one year which have a predetermined interest rate and loans due after one year which have floating or adjustable interest rates as of December 31, 2021 amounted to $1.241 billion and $1.824 billion, respectively.
Paycheck Protection Program
During 2020 and the first half of 2021, the Bank funded PPP loans totaling $735.6 million for its customers through the PPP programs. In addition, the Bank processed forgiveness applications for PPP loans representing 97% of loans originated. As of December 31, 2021, PPP loans outstanding, net of deferred fees, totaled $26.2 million; $3.8 million from PPP round one and $22.3 million from PPP round two. As of December 31, 2021, the SBA has approved forgiveness of, or borrowers repaid, $709.5 million in PPP loans; $566.7 million for PPP loans originated during round one and $142.8 million for PPP loans originated during round two. As of December 31, 2021, the Bank had submitted additional PPP forgiveness applications on behalf of customers in the amount of $8.3 million that were awaiting SBA approval.
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| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Originated | Forgiven / Repaid | Outstanding (1) | |||||||||||||||||||||||||||||||||
| Number | Amount | Number | Amount | Number | Amount | ||||||||||||||||||||||||||||||
| PPP Round 1 | 2,409 | $ | 570,500 | 2,390 | $ | 566,682 | 19 | $ | 3,818 | ||||||||||||||||||||||||||
| PPP Round 2 | 1,192 | 165,142 | 1,117 | 142,809 | 75 | 22,333 | |||||||||||||||||||||||||||||
| Total | 3,601 | $ | 735,642 | 3,507 | $ | 709,491 | 94 | $ | 26,151 | ||||||||||||||||||||||||||
Bank Owned Life Insurance
Bank owned life insurance increased by $2.4 million to $97.7 million at December 31, 2021 and by $11.4 million to $95.2 million at December 31, 2020 from $83.8 million at December 31, 2019. The increase during 2021 was primarily due to investment returns on the life insurance policies of pre-existing life insurance policies. The increase during 2020 was primarily due to the purchase of additional life insurance policies on officers of the Bank. Bank owned life insurance provides investment income from the securities the life insurance is invested in and offsets benefit plan expenses for participants covered by insurance.
Sources of Funds
The average daily deposits and borrowings together with the average rates paid on those deposits and borrowings for the years ended December 31, 2021, 2020 and 2019 are summarized in the following table:
| 2021 | 2020 | 2019 | % Balance Change From Prior Year | ||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Balance | Rate | Balance | Rate | Balance | Rate | 2021 | 2020 | |||||||||||||||||||||||||||||||||||||||
| Noninterest bearing demand deposits | $ | 1,671,172 | 0.00 | % | $ | 1,309,901 | 0.00 | % | $ | 944,118 | 0.00 | % | 27.58 | % | 38.74 | % | |||||||||||||||||||||||||||||||
| Savings and transaction accounts: | |||||||||||||||||||||||||||||||||||||||||||||||
| Savings deposits | 360,915 | 0.08 | 270,010 | 0.08 | 240,293 | 0.11 | 33.67 | 12.37 | |||||||||||||||||||||||||||||||||||||||
| Interest bearing demand deposits | 2,392,220 | 0.28 | 1,862,077 | 0.50 | 1,669,045 | 1.56 | 28.47 | 11.57 | |||||||||||||||||||||||||||||||||||||||
| Time deposits: | |||||||||||||||||||||||||||||||||||||||||||||||
| Deposits of $100,000 or more | 218,624 | 0.93 | 946,569 | 1.64 | 1,111,172 | 2.30 | (76.90) | (14.81) | |||||||||||||||||||||||||||||||||||||||
| Other time deposits | 714,353 | 0.81 | 262,040 | 1.66 | 277,896 | 1.92 | 172.61 | (5.71) | |||||||||||||||||||||||||||||||||||||||
| Total deposits | $ | 5,357,284 | 0.28 | % | $ | 4,650,597 | 0.63 | % | $ | 4,242,524 | 1.35 | % | 15.20 | % | 9.62 | % | |||||||||||||||||||||||||||||||
| FHLB advances and other borrowings | 75,408 | 0.40 | 96,642 | 0.78 | 92,106 | 3.27 | (21.97) | 4.92 | |||||||||||||||||||||||||||||||||||||||
| Total funding sources | $ | 5,432,692 | 0.28 | % | $ | 4,747,239 | 0.63 | % | $ | 4,334,630 | 1.39 | % | 14.44 | % | 9.52 | % | |||||||||||||||||||||||||||||||
Time deposits as of December 31, 2021 will mature as follows:
| (dollars in thousands) | $100,000 or more | $100,000 or less | Total | % of Total | |||||||||||||||||||
| Within three months | $ | 118,876 | $ | 38,804 | $ | 157,680 | 19.01 | % | |||||||||||||||
| Over three months, within six months | 118,658 | 37,383 | 156,041 | 18.81 | |||||||||||||||||||
| Over six months, within twelve months | 218,642 | 59,377 | 278,019 | 33.52 | |||||||||||||||||||
| Over twelve months | 170,947 | 66,831 | 237,778 | 28.66 | |||||||||||||||||||
| Total time certificates of deposit | $ | 627,123 | $ | 202,395 | $ | 829,518 | 100.00 | % | |||||||||||||||
Deposits
Total deposits increased by $698.6 million to $5.735 billion, comparing December 31, 2021 to December 31, 2020. The increase in deposits consisted of growth of $703.6 million in core deposit combined with a decrease of $5.0 million in brokered deposits. Total deposit growth was led by an increase of $321.9 million, or 16.6%, in commercial deposits. In addition, retail deposits increased by $259.5 million, or 13.5%, while public funds deposits increased by $122.2 million, or 10.5%. PPP loan proceeds to borrowers and government stimulus to consumers impacted the increase in deposit during 2021 as loan proceeds and stimulus payments were deposited into customer checking and savings accounts at the Bank. Proceeds from the sale of customer businesses also contributed to the increase of deposits during 2021.
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Total deposits increased by $903.0 million to $5.037 billion, comparing December 31, 2020 to December 31, 2019. The growth in deposits consisted of $1.002 billion in core deposit growth offset by a decrease of $98.5 million in brokered deposits. Total deposit growth was led by an increase of $664.3 million, or 52.1%, in commercial deposits. In addition, retail deposits increased by $301.9 million, or 18.7%, while public funds deposits increased by $35.3 million, or 3.1%. The growth in deposits in 2020 resulted from increased deposit balances from new and existing customers, as well as a decreased utilization of brokered deposits. Deposit growth was impacted by excess liquidity on customer balance sheets resulting from PPP loans, due to both economic stimulus payments made to retail customers and an increase in savings rates. Core deposit growth enabled the Company to reduce reliance on wholesale funding during 2020 and 2021.
As previously noted, 22% of the Company’s deposit base is attributable to public fund entities which primarily represent customers in the Company’s geographic footprint. A majority of public fund balances represent customers with operating accounts at the Bank. A shift in funding away from public fund deposits could require the Company to execute alternative funding plans under the Contingency Funding Plan discussed in further detail under “Liquidity Risk” below. The following table presents total deposits by portfolio segment as of December 31, 2021, 2020 and 2019:
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||||||||||||||||||||
| Commercial | $ | 2,262,229 | 39.4 | % | $ | 1,940,306 | 38.5 | % | $ | 1,276,047 | 30.9 | % | |||||||||||||||||||||||
| Retail | 2,178,534 | 38.0 | 1,919,040 | 38.1 | 1,617,133 | 39.1 | |||||||||||||||||||||||||||||
| Public funds | 1,284,641 | 22.3 | 1,162,457 | 23.0 | 1,127,111 | 27.2 | |||||||||||||||||||||||||||||
| Core deposits | $ | 5,725,404 | 99.7 | % | $ | 5,021,803 | 99.6 | % | $ | 4,020,291 | 97.2 | % | |||||||||||||||||||||||
| Brokered deposits | 10,003 | 0.3 | 15,002 | 0.4 | 113,528 | 2.8 | |||||||||||||||||||||||||||||
| Total deposits | $ | 5,735,407 | 100.0 | % | $ | 5,036,805 | 100.0 | % | $ | 4,133,819 | 100.0 | % | |||||||||||||||||||||||
FHLB Advances and Other Borrowings
During 2021, average total short-term borrowings decreased by $33.9 million to $408,000, primarily due to lower short-term FHLB borrowings and lower usage of the Company's holding company line of credit. Ending balances of short-term and miscellaneous borrowings decreased $10.5 million during 2021 to $0. The decrease was due to the payoff of the Company's holding company line of credit which was used in connection with its share repurchase activity during 2020. The holding company's line repayment was funded by a dividend from the Bank. There was no share repurchase activity during 2021.
Short-term FHLB borrowings are used to fund short-term balance sheet growth due to the flexible nature of the financial instrument and allow the Company to prudently fund commercial or retail loans when opportunities are presented. Average total long-term borrowings increased by $12.7 million to $75.0 million, due to a $75.0 million long-term FHLB borrowing taken in 2020 that was outstanding for all of 2021.
During 2020, average total short-term borrowings decreased by $27.0 million to $34.3 million, primarily due to the payoff of outstanding short-term FHLB borrowings. During 2020, the Company utilized $10.5 million of the holding company's $30.0 million revolving line of credit in connection with its share repurchase activity. Average total long-term borrowings increased by $31.5 million to $62.3 million, primarily due to a $75.0 million long-term FHLB borrowing offset by the repayment of the Company's subordinated debentures in December 2019.
Capital
The Company believes that a strong, appropriately managed capital position is critical to support continued growth of loans and earnings. Capital is used primarily to fund continued organic loan growth and to support dividends to shareholders. The Company had a total risk-based capital ratio of 15.4%, a Tier I risk-based capital ratio of 14.1% and a common Tier 1 risk-based capital ratio of 14.1% as of December 31, 2021. These ratios met or exceeded the Federal Reserve Bank’s “well-capitalized” minimums of 10.0%, 8.0% and 6.5%, respectively. The Company also had a Tier 1 leverage ratio of 10.7% and a tangible equity ratio of 10.7%. See Note 16 – Capital Requirements for more information.
The ability to maintain these ratios is a function of the balance between net income and a prudent dividend policy. Total stockholders’ equity increased by 7.3% to $704.9 million as of December 31, 2021 from $657.2 million as of December 31, 2020. The Company earned $95.7 million in 2021 and $84.3 million in 2020. The Company declared cash dividends of $1.36 per share in 2021, which decreased equity by $34.7 million. The Company declared cash dividends of $1.20 per share in 2020, which decreased equity by $30.6 million. The change in accumulated other comprehensive income in 2021
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was due to changes in the fair values of available-for-sale securities and the defined benefit pension which decreased equity by $11.7 million in 2021 compared to an increase of $15.7 million in 2020. The impact to equity due to other comprehensive income (loss) is not included in regulatory capital. In addition, during March of 2020 the Company repurchased 289,101 shares of its common stock for $10.0 million.
RISK MANAGEMENT
Overview
The Company, with the oversight of the Corporate Risk Committee of the Board, has developed a company-wide risk management program intended to help identify, manage and mitigate the various business risks the Company is exposed to. Following is a discussion addressing the risks identified as most significant to the Company – Credit, Liquidity, Interest Rate and Market Risk. Item 7A. includes additional discussion about market risk.
Credit Risk
Credit risk represents the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms. Our primary credit risks result from lending and to a lesser extent, investment activities.
Investment Portfolio
The Company’s investment portfolio consists of U.S. treasuries, government agencies and municipal bonds subject to an investment security policy that is approved annually by the Board. During 2021, purchases in the securities portfolio consisted of primarily municipal bonds, agency securities and mortgage-backed securities. As of December 31, 2021, the Company’s investment in U.S government sponsored mortgage-backed securities represented approximately 35% of total securities consisting of Collateralized Mortgage Obligations, Commercial Mortgage-Backed Securities and mortgage pools issued by Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae, Fannie Mae and Freddie Mac securities are each guaranteed by their respective agencies as to principal and interest. All mortgage securities purchased by the Company in 2021 were within risk tolerances for price, prepayment, extension and original life risk characteristics contained in the Company’s investment policy. As of December 31, 2021, all mortgage-backed securities were performing in a manner consistent with management’s expectations at time of purchase. Municipal securities represent 55% of total securities as of December 31, 2021 and were rated investment grade at the time of purchase and continue to be rated investment grade. The Company uses analytics provided by its third party portfolio advisor to evaluate and monitor credit risk for all investments on a quarterly basis. Based upon these analytics as of December 31, 2021, the securities in the available-for-sale portfolio had approximately a 4.6 year effective duration. The analysis indicated a negative 16.06% change in market value in the event of a 300 basis point upward, instantaneous rate shock and an approximate positive 3.90% change in market value in the event of a 100 basis point downward, instantaneous rate shock.
Loan Portfolio
The Company has a relatively high percentage of commercial and commercial real estate loans extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing conservative credit structures, by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and market area and by obtaining personal loan guarantees.
There were no loan concentrations within industries, which exceeded ten percent of total loans, except commercial real estate and manufacturing. Commercial real estate was $1.955 billion, or 45.6%, of total loans and manufacturing was $438.8 million, or 10.2%, of total loans at December 31, 2021. The owner occupied commercial real estate portfolio generally represents the financing of factories and operational facilities for the Bank's commercial and industrial borrowers. The Company’s in-house lending limit was raised from $30.0 million to $40.0 million during 2020. Manufacturing loans are included in the commercial and industrial loans total and are well diversified by industry. Agri-business and agricultural loans represent 10.4% of total loans as of December 31, 2021 and are not concentrated to any agricultural sector. Nearly all of the Bank’s commercial, industrial, agricultural real estate mortgage, real estate construction mortgage and consumer loans are made within its geographic market areas and to diverse industries.
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The following is a summary of nonperforming loans as of December 31, 2021 and 2020.
| (dollars in thousands) | 2021 | 2020 | |||||||||
| Amount of loans outstanding, net of deferred fees, December 31, | $ | 4,287,841 | $ | 4,649,156 | |||||||
| Commercial and industrial loans | |||||||||||
| Past due accruing loans (90 days or more) | 0 | 0 | |||||||||
| Nonaccrual loans(1) | 10,562 | 5,893 | |||||||||
| Subtotal nonperforming loans | 10,562 | 5,893 | |||||||||
| Commercial real estate and multi-family residential loans | |||||||||||
| Past due accruing loans (90 days or more) | 0 | 0 | |||||||||
| Nonaccrual loans(1) | 3,634 | 5,047 | |||||||||
| Subtotal nonperforming loans | 3,634 | 5,047 | |||||||||
| Agri-business and agricultural loans | |||||||||||
| Past due accruing loans (90 days or more) | 0 | 0 | |||||||||
| Nonaccrual loans(1) | 335 | 428 | |||||||||
| Subtotal nonperforming loans | 335 | 428 | |||||||||
| Other commercial loans | |||||||||||
| Past due accruing loans (90 days or more) | 0 | 0 | |||||||||
| Nonaccrual loans(1) | 0 | 0 | |||||||||
| Subtotal nonperforming loans | 0 | 0 | |||||||||
| Consumer 1-4 family mortgage loans | |||||||||||
| Past due accruing loans (90 days or more) | 117 | 116 | |||||||||
| Nonaccrual loans(1) | 153 | 618 | |||||||||
| Subtotal nonperforming loans | 270 | 734 | |||||||||
| Other consumer loans | |||||||||||
| Past due accruing loans (90 days or more) | 0 | 0 | |||||||||
| Nonaccrual loans(1) | 289 | 0 | |||||||||
| Subtotal nonperforming loans | 289 | 0 | |||||||||
| Total nonperforming loans | $ | 15,090 | $ | 12,102 | |||||||
| Ratio: | |||||||||||
| Nonperforming loans to total loans | 0.35 | % | 0.26 | % | |||||||
(1)Includes nonaccrual troubled debt restructured loans.
Nonperforming assets of the Company include nonperforming loans (as indicated above), nonaccrual investments and other real estate owned and repossessions, the total of which amounted to $15.3 million and $12.4 million at December 31, 2021 and 2020, respectively. Nonperforming loans increased by $3.0 million during 2021, due primarily to the downgrade of one commercial loan relationship. The relationship is a shared national credit participation of $5.2 million to a commercial borrower that operates grain elevators and handles feed processing and merchandising of agriculture products. Loans to this borrower are secured by a blanket lien on all assets, including buildings, inventory, accounts receivable and equipment. This loan is current on interest and principal payments through December 2021. As of December 31, 2021, management believed that there were no significant foreseeable losses relating to nonperforming assets, except as discussed below.
Loans for which the borrower appears to be unable or unwilling to repay its debt in full or on time and the collateral is insufficient to cover all principal and accrued interest, will be reclassified as nonperforming loans to the extent they are unsecured, on or before the date when the loan becomes 90 days delinquent, with the exception of small dollar other consumer loans which are not placed on nonaccrual status since these loans are charged-off when they have been delinquent from 90 to
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180 days, and when the related collateral, if any, is not sufficient to offset the indebtedness. When a loan is classified as a nonaccrual loan, interest on the loan is no longer accrued, all unpaid accrued interest is reversed and interest income is subsequently recorded only to the extent cash payments are received. Accrual status is resumed when all contractually due payments are brought current and future payments are reasonably assured.
A loan is individually analyzed when full payment under the original loan terms is not expected. Reserves are evaluated in total for smaller-balance loans of similar nature not in nonaccrual or troubled debt restructured status such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is individually analyzed, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flow or at the fair value of collateral if repayment is expected solely from the collateral.
Total nonperforming loans were $15.1 million, or 0.35% of total loans, at year end 2021 versus $12.1 million, or 0.26% of total loans, at year end 2020. There were 34 loans totaling $25.6 million classified as individually analyzed as of December 31, 2021 versus 39 loans totaling $20.2 million at the end of 2020. The increase in individually analyzed loans during 2021 resulted primarily from the downgrade of one commercial loan relationship. The relationship is a shared national credit participation of $5.2 million to a commercial borrower that operates grain elevators and handles feed processing and merchandising of agriculture products. Loans to this borrower are secured by a blanket lien on all assets, including buildings, inventory, accounts receivable and equipment. This loan is current on interest and principal payments through December 2021.
Loans renegotiated as troubled debt restructurings are those loans for which either the contractual interest rate has been reduced below market rates and/or other concessions to market terms are granted to the borrower because of a deterioration in the financial condition of the borrower which results in the inability of the borrower to meet the terms of the loan.
As of December 31, 2021, there were 27 loans totaling $11.3 million renegotiated as troubled debt restructurings of which $217,000 were modified in 2021. Of these loans, $6.2 million were included in nonaccrual loans in the previous table and the remaining $5.1 million were performing under their modified terms. As of December 31, 2020, there were 31 loans totaling $11.7 million renegotiated as troubled debt restructurings of which $5.5 million were modified in 2020. Of these loans, $6.5 million were included in nonaccrual loans in the previous table and the remaining $5.2 million were performing under their modified terms. The Company has no commitments to lend additional funds to any of the borrowers.
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The following is a summary of the credit loss experience for the years ended December 31, 2021, 2020 and 2019.
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Amount of loans outstanding, net of deferred fees, December 31, | $ | 4,287,841 | $ | 4,649,156 | $ | 4,065,828 | |||||||||||
| Average daily loans outstanding during the year ended December 31, | $ | 4,421,094 | $ | 4,424,472 | $ | 3,974,532 | |||||||||||
| Allowance for credit losses, January 1, | $ | 61,408 | $ | 50,652 | $ | 48,453 | |||||||||||
| Impact of adopting ASC 326 | 9,050 | 0 | 0 | ||||||||||||||
| Loans charged-off: | |||||||||||||||||
| Commercial and industrial loans | 5,575 | 4,524 | 1,447 | ||||||||||||||
| Commercial real estate and multi-family residential loans | 70 | 72 | 17 | ||||||||||||||
| Agri-business and agricultural loans | 0 | 0 | 0 | ||||||||||||||
| Other commercial loans | 0 | 0 | 0 | ||||||||||||||
| Consumer 1-4 family mortgage loans | 51 | 141 | 110 | ||||||||||||||
| Other consumer loans | 287 | 516 | 336 | ||||||||||||||
| Total loans charged-off | 5,983 | 5,253 | 1,910 | ||||||||||||||
| Recoveries of loans previously charged-off: | |||||||||||||||||
| Commercial and industrial loans | 1,559 | 428 | 459 | ||||||||||||||
| Commercial real estate and multi-family residential loans | 14 | 315 | 161 | ||||||||||||||
| Agri-business and agricultural loans | 320 | 0 | 8 | ||||||||||||||
| Other commercial loans | 0 | 0 | 0 | ||||||||||||||
| Consumer 1-4 family mortgage loans | 122 | 333 | 123 | ||||||||||||||
| Other consumer loans | 206 | 163 | 123 | ||||||||||||||
| Total recoveries | 2,221 | 1,239 | 874 | ||||||||||||||
| Net loans charged-off (recovered) | 3,762 | 4,014 | 1,036 | ||||||||||||||
| Provision for credit loss charged to expense | 1,077 | 14,770 | 3,235 | ||||||||||||||
| Balance, December 31, | $ | 67,773 | $ | 61,408 | $ | 50,652 | |||||||||||
| Ratios: | |||||||||||||||||
| Net charge-offs to average daily loans outstanding: | |||||||||||||||||
| Commercial and industrial loans | 0.09 | % | 0.09 | % | 0.02 | % | |||||||||||
| Commercial real estate and multi-family residential loans | 0.00 | 0.00 | 0.00 | ||||||||||||||
| Agri-business and agricultural loans | 0.00 | 0.00 | 0.00 | ||||||||||||||
| Other commercial loans | 0.00 | 0.00 | 0.00 | ||||||||||||||
| Consumer 1-4 family mortgage loans | 0.00 | 0.00 | 0.00 | ||||||||||||||
| Other consumer loans | 0.00 | 0.00 | 0.01 | ||||||||||||||
| Total ratio of net charge-offs (recoveries) | 0.09 | % | 0.09 | % | 0.03 | % | |||||||||||
| Allowance for credit losses on loans to: | |||||||||||||||||
| Total loans | 1.58 | % | 1.32 | % | 1.25 | % | |||||||||||
| Total loans (excluding PPP loans) | 1.59 | % | 1.45 | % | 1.25 | % | |||||||||||
| Nonperforming loans | 449.13 | % | 507.42 | % | 270.58 | % | |||||||||||
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The following is a summary of the allocation for credit losses as of December 31, 2021 and 2020.
| (dollars in thousands) | 2021 | 2020 | |||||||||
| Allocated allowance for credit losses: | |||||||||||
| Commercial and industrial loans | $ | 30,595 | $ | 28,333 | |||||||
| Commercial real estate and multi-family residential loans | 26,535 | 22,907 | |||||||||
| Agri-business and agricultural loans | 5,034 | 3,043 | |||||||||
| Other commercial loans | 1,146 | 416 | |||||||||
| Consumer 1-4 family mortgage loans | 2,866 | 2,619 | |||||||||
| Other consumer loans | 1,147 | 951 | |||||||||
| Total allocated allowance for credit losses | 67,323 | 58,269 | |||||||||
| Unallocated allowance for credit losses | 450 | 3,139 | |||||||||
| Total allowance for credit losses | $ | 67,773 | $ | 61,408 | |||||||
At December 31, 2021, the allowance for credit losses was 1.58% of total loans outstanding, versus 1.32% of total loans outstanding at December 31, 2020 under the incurred loss model. The allowance for credit losses was 1.59% of total loans outstanding, excluding PPP loans of $26.2 million, as of December 31, 2021 versus 1.45% of total loans outstanding, excluding PPP loans of $412.0 million, as of December 31, 2020. This reflects a more comparable ratio to prior periods, as PPP loans are fully guaranteed by the SBA and have not been allocated for within the allowance for credit losses calculation. Management believes the allowance for credit losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions fail to recover or continue to deteriorate due to the COVID-19 pandemic or the current economic environment, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for credit losses. The process of identifying expected credit losses is a subjective process. Therefore, the Company maintains a general allowance to cover expected credit losses within the entire portfolio. The methodology management uses to determine the adequacy of the credit loss reserve includes the considerations below.
Loans are charged against the allowance for credit losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate for expected credit losses relating to specifically identified loans based on an evaluation of the loans by management, as well as other expected credit losses inherent in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current and forecasted economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. An appropriate level of qualitative and environmental allowance is determined after considering the following factors: changes in the nature and volume of the loan portfolio, overall portfolio quality, changes in collateral strength and current economic conditions that may affect the borrowers’ ability to repay. Consideration is not limited to these factors although they represent the most commonly cited factors. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans: Substandard, Doubtful and Loss. The regulations also contain a Special Mention category. Special Mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as Substandard, Doubtful or Loss but do possess credit deficiencies or potential weaknesses deserving management’s close attention. The Company’s policy is to establish a specific allowance for credit losses for any assets where management has identified conditions or circumstances that indicate an asset is nonperforming. If an asset or portion thereof is classified as loss, the Company’s policy is to either establish specific allocations for credit losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount.
At December 31, 2021, on the basis of management’s review of the loan portfolio, the Company had 81 credits totaling $234.5 million on the classified loan list versus 96 credits totaling $286.1 million on December 31, 2020. These amounts represent outstanding balances, excluding deferred fees and costs. The decrease in classified loans during 2021 reflects the improved economic outlook some of the Company’s borrowers are experiencing, particularly in the hotel and entertainment industries as the economy continues to reopen. As of December 31, 2021, the Company had $176.6 million of assets classified as Special Mention, $57.9 million classified as Substandard, $0 classified as Doubtful and $0 classified as Loss as compared to $251.9 million, $34.3 million, $0 and $0, respectively, at December 31, 2020. The balances reported in Note 4 – Allowance for Credit Losses and Credit Quality include deferred fees and costs.
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Included in the classified loan amounts for December 31, 2021 above were the following troubled debt restructured loans: 13 mortgage loans totaling $1.2 million with total allocations of $209,000 and 7 commercial loans totaling $3.9 million with total allocations of $1.6 million. Included in the classified loan amounts for December 31, 2020 above were the following troubled debt restructured loans: 12 mortgage loans totaling $1.1 million with total allocations of $220,000, and 12 commercial loans totaling $8.9 million with total allocations of $4.1 million.
In accordance with Section 4013 of the CARES Act, loan deferrals granted to customers that resulted from the impact of COVID-19 and who were not past due at the time of deferral were not considered trouble debt restructurings as of December 31, 2021. This provision expired January 1, 2022 under the Consolidated Appropriations Act, 2021. At the time of the expiration of the provision, one retail borrower in the amount of $11,000 had a COVID-19 related deferral and was not considered to be a troubled debt restructuring.
Allowance estimates are developed by management taking into account actual loss experience, subject to a floor, adjusted for current economic conditions and a reasonably supportable forecast period. The Company has regular discussions regarding this methodology with regulatory authorities. Allowance estimates are considered a prudent measurement of the risk in the Company's loan portfolio based upon loan segment. In accordance with CECL accounting guidance, the allowance is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amounts. For a more thorough discussion of the allowance for credit losses methodology see the Critical Accounting Policies section of this Item 2.
The allowance for credit losses increased 10.4%, or $6.4 million, from $61.4 million at December 31, 2020 to $67.8 million at December 31, 2021 due to the day one impact of the adoption of CECL which increased the allowance for credit losses by $9.1 million. Pooled loan allocations increased $8.9 million from $50.2 million at December 31, 2020 to $58.7 million at December 31, 2021. The unallocated component of the allowance for credit losses was $450,000 at December 31, 2021, which decreased from $3.1 million reported at December 31, 2020, and decreased primarily due to changes in methodology as a result of the adoption of the CECL standard. The unallocated component of the allowance for credit losses incorporates the Company’s judgmental determination of expected losses that may not be fully reflected in other allocations, including factors such as the level of classified credits, economic uncertainties, industry trends impacting specific portfolio segments, broad portfolio quality trends and trends in the composition of the Company’s large commercial loan portfolio and related large dollar exposures to individual borrowers.
The Company has experienced growth in total loans, excluding PPP loans, over the last several years with organic growth exclusive of PPP loans of $24.5 million, or 0.6%, from December 31, 2020 to December 31, 2021. The concentration of this loan growth was in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits. Management has historically considered growth and portfolio composition when determining credit loss allocations. Management believes that it is prudent to continue to provide for credit losses in a manner consistent with its historical approach due to the loan growth described above and current economic conditions.
Watch list loans were $51.7 million lower at $234.5 million as of December 31, 2021, compared to $286.1 million at December 31, 2020. Watch list loans represent 5.47% of total loans at December 31, 2021 compared to 6.15% at December 31, 2020. Watch list loans excluding PPP loans, were 5.50% of total loans at December 31, 2021 compared to 6.75% at December 31, 2020. This reflects a more comparable ratio to prior periods, as PPP loans are fully guaranteed by the SBA and have not been allocated for within the allowance for credit losses calculation. The reduction in watchlist loans resulted primarily from upgrades of $62.3 million and payoffs of $2.4 million. The Company's continued growth strategy promotes diversification among industries as well as continued focus on the enforcement of a disciplined credit culture and a conservative portion in loan work-out situations.
Liquidity Risk
Liquidity risk arises from the possibility that the Company may not be able to satisfy current or future financial commitments or may become unduly reliant on alternative funding sources. Liquidity is monitored and closely managed by the ALCO Committee.
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run- off that may occur in the normal course of business. The liquidity structure is expressly detailed in the Company’s Contingency Funding Plan, which is discussed below. The Company relies on a number of different sources in order to meet these potential liquidity demands. The primary sources are increases in deposit accounts and cash flows from loan payments and the securities portfolio. The cash flow from the securities portfolio is expected to provide approximately $143.2 million of potential contingent funding in 2022.
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During 2021, the Company experienced excess levels of liquidity as a result of strong core deposit growth. Management expects the excess liquidity to dissipate over time as depositors utilize the excess funds.
The Company has approval of $3.218 billion in secondary funding sources available as of December 31, 2021, of which $85.0 million was utilized. The Company had $350.0 million of availability in federal funds lines with eleven correspondent banks, none of which was drawn on as of December 31, 2021. The Company has Board approval to borrow up to $800.0 million at the FHLB, but, given the Company’s current collateral structure and outstanding borrowings as of December 31, 2021, the Company could have only borrowed up to $227.8 million under this authority based on utilization of $75.0 million of advances at December 31, 2021. The Company also has additional collateral that could be pledged to the FHLB of $544.9 million as of December 31, 2021 to generate additional liquidity. Further, the Company had available capacity at the Federal Reserve Bank of Chicago of up to $616.5 million given its current collateral structure at the Federal Reserve Bank discount window program and the terms of these facilities at December 31, 2021, with no balances outstanding at December 31, 2021. The Company also has established relationships in the brokered time deposit and brokered money market sectors, as well as the IntraFi Network CD Option One-Way Buy program, to access these funds when desired with settlement of funds in one to two weeks’ time. Additionally, the Bank has entered agreements with IntraFi Network relative to their Insured Cash Sweep One-Way Buy program. As of December 31, 2021, the total amount available to the Bank via this program was $100.0 million, of which $10.0 million was drawn on. The Bank is also a member of the American Financial Exchange (AFX) where overnight fed funds purchased can be obtained from other banks on the exchange that have approved the Bank for an unsecured, overnight line. These funds are only available if the approving banks have an ‘offer’ out to sell that day. As of December 31, 2021, the total amount approved for the Bank via AFX banks was $319.0 million and none was outstanding at year end.
The Company had all of its securities in the available-for-sale portfolio at December 31, 2021, allowing the Company maximum flexibility to sell securities to meet funding demands. Management believes the majority of the securities in the available- for-sale portfolio are of high quality and marketable. Approximately 45% of this portfolio is comprised of U.S. government agency securities or mortgage-backed securities directly or indirectly backed by the U.S. government. In addition, the Company has historically sold the majority of its originated mortgage loans on the secondary market to reduce interest rate risk and to create an additional source of funding.
The Company has a formalized Contingency Funding Plan (“CFP”). The Board and management recognize the importance of liquidity during times of normal operations and in times of stress. The CFP was developed to ensure that the multiple liquidity sources available to the Company are readily available. The CFP specifically considers liquidity at the Bank and the Company level. The CFP identifies the potential funding sources at the Bank level, which includes the FHLB, the Federal Reserve Bank, brokered deposits, one-way buy products via the IntraFi Network (CD Option and ICS) and Fed Funds. The CFP also addresses the Bank’s ability to liquidate its securities portfolio. The CFP funding sources at the holding company level include a holding company committed line of credit, as well as the ability to transfer securities from the investment subsidiary of the Bank to the Company. The Company’s committed line of credit has availability up to $30.0 million, of which $0 was drawn upon as of December 31, 2021.
Further, the CFP identifies CFP team members and expressly details their respective roles. Potential risk scenarios are identified and the plan includes multiple scenarios, including short-term and long-term funding crisis situations. Under the long-term funding crisis, two additional scenarios are identified: a moderate risk scenario and a highly stressed scenario. The CFP details the responsibilities and the actions to be taken by the CFP team under each scenario. Quarterly reports to management and the Board under the CFP include an early warning indicator matrix and pro forma cash flows for the various scenarios.
The following table discloses information on the maturity of the Company’s contractual long-term obligations as of December 31, 2021.
| Payments Due by Period | |||||||||||||||||||||||||||||
| (dollars in thousands) | Total | One year or less | 1-3 years | 3-5 years | After 5 years | ||||||||||||||||||||||||
| Operating leases | $ | 4,696 | $ | 595 | $ | 1,228 | $ | 1,257 | $ | 1,616 | |||||||||||||||||||
| Pension and SERP plans | 2,529 | 323 | 629 | 580 | 997 | ||||||||||||||||||||||||
| Total contractual long-term cash obligations | $ | 7,225 | $ | 918 | $ | 1,857 | $ | 1,837 | $ | 2,613 | |||||||||||||||||||
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During the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk in order to meet the financing needs of its customers. These financial instruments include commitments to make loans and open-ended revolving lines of credit. The Company follows the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as it follows for those loans that are recorded in its financial statements.
The Company’s exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments. Off-balance sheet transactions are more fully discussed in Note 18 – Commitments, Off-Balance Sheet Risks and Contingencies.
The following table discloses information on the maturity of the Company’s commitments.
| Amount of Commitment Expiration Per Period | |||||||||||||||||
| (dollars in thousands) | Total Amount Committed | One year or less | Over one year | ||||||||||||||
| Unused loan commitments | $ | 2,287,659 | $ | 1,290,509 | $ | 997,150 | |||||||||||
| Standby letters of credit | 55,336 | 53,009 | 2,327 | ||||||||||||||
| Total commitments and letters of credit | $ | 2,342,995 | $ | 1,343,518 | $ | 999,477 | |||||||||||
Interest Rate Risk
Interest rate risk is the risk that the estimated fair value of the Company’s assets, liabilities and derivative financial instruments will decline as a result of changes in interest rates or financial market volatility, or that net income will be significantly reduced by interest rate changes.
Interest rate risk represents the Company’s primary market risk exposure. The Company does not have material exposure to foreign currency exchange risk and does not maintain a trading portfolio. The Corporate Risk Committee of the Board annually reviews and approves the ALCO policy and the Derivatives and Hedging policy used to manage interest rate risk. These policies set guidelines for balance sheet structure, which are designed to protect the Company from the impact that interest rate changes could have on net income, but it does not necessarily indicate the effect on future net interest income. Given the Company’s mix of interest bearing liabilities and interest bearing assets on December 31, 2021 and using changes in the interest rate environment over a one-year period, the net interest margin could be expected to decline in a falling interest rate environment and increase in a rising interest rate environment. Earnings can also be affected by the monetary and fiscal policies of the U.S. Government and its agencies, particularly the Federal Reserve Board.
During the entirety of 2021 the Federal Reserve Board’s Federal Open Market Committee (“FOMC”) kept the target federal funds rate at a range of 0% to .25%. There has been no movement in the target federal funds rate since March 2020. The Committee announced and implemented in late 2021 the beginning of their bond taper process relative to their purchases of treasury and mortgage-backed securities; this tapering is now expected to conclude in early 2022. The FOMC statement released for the meeting in December 2021 was relatively positive with the Fed suggesting the economy continues to strengthen and characterized the labor markets as solid, while they did also note that risks to the economic outlook remain including from new variants of the COVID-19 virus. The updated economic projections released at the December meeting project three quarter point rates increases in 2022, another three in 2023 and two more in 2024. Additionally, the longer run Fed median forecast for the federal funds rate was left unchanged at 2.50%. The combined result of the decrease in the yield on earning assets offset by a decrease in the cost of funding earning assets led to decrease in the net interest margin from 3.19% for 2020 to 3.07% for 2021 given the Company’s asset sensitive balance sheet. The Company’s yield on earning assets decreased 44 basis points during 2021 as assets repriced at lower rates due to the low rate environment and competitive markets for commercial loan pricing and excess liquidity was deployed into the investment portfolio. The commercial loan portfolio represents 90% of the total loan portfolio. Approximately 69% of the commercial loan portfolio are variable rate loans which are primarily indexed to 30 day LIBOR, Prime and FHLB indices. The rate paid on deposit accounts and purchased funds decreased 35 basis points for 2021 mainly due to time deposit repricing and decreased rates paid on public fund accounts, including transactional accounts and time deposit accounts, as these accounts are typically more sensitive to interest rates. The realized decrease in the rate paid on deposit accounts and purchased funds was benefited by an increase in the average balance of non-interest bearing demand deposit accounts for 2021 verses 2020, which was largely influenced by PPP Round 2 loan proceeds deposited into borrower checking and savings accounts at the Bank, as well as an overall increase in the savings rate and continued economic stimulus payments.
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Future changes in the net interest margin will be dependent upon multiple factors including further actions by the FOMC during 2022 in response to the continued COVID-19 pandemic, inflation, economic conditions and geopolitical concerns, the results of any of the administration’s changes to economic policy and laws, competitive pressures in the various markets served, and changes in the structure of the balance sheet as a result of changes in customer demands for products and services. In general, we expect loans to reprice quicker than deposits in a rising and falling rate environment as quantified in the sensitivity to market rates table in Item 7A.
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the consumer price index (“CPI”) coincides with changes in interest rates. The price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by the Company. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the reverse situation may occur.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
The Company’s primary market risk exposure is interest rate risk. The Company does not have a material exposure to foreign currency exchange rate risk and does not maintain a trading portfolio.
The following table provides information regarding the Company’s financial instruments that are sensitive to changes in interest rates. For loans, securities and liabilities with contractual maturities, the table presents principal cash flows and related weighted-average interest rates by contractual maturities, as well as the Company’s assumptions relative to the impact of interest-rate fluctuations on the prepayment of certain commercial, residential and home equity loans and mortgage-backed securities. Core deposits such as noninterest bearing deposits, interest bearing checking, savings and money market deposits that have no contractual maturity, are shown based on management’s judgment and historical experience that indicates some portion of the balances are retained over time. Weighted-average variable rates are based upon rates existing at the reporting date.
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| 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| Principal/Notional Amount Maturing in: | |||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Thereafter | Total | Fair Value 12/31/2021 | |||||||||||||||||||||||||||||||||||||||
| Rate sensitive assets: | |||||||||||||||||||||||||||||||||||||||||||||||
| Fixed interest rate loans | $ | 592,512 | $ | 330,646 | $ | 211,989 | $ | 111,048 | $ | 80,375 | $ | 55,605 | $ | 1,382,175 | $ | 1,345,499 | |||||||||||||||||||||||||||||||
| Average interest rate | 4.03 | % | 4.16 | % | 4.03 | % | 4.04 | % | 3.46 | % | 4.20 | % | |||||||||||||||||||||||||||||||||||
| Variable interest rate loans | $ | 1,416,485 | $ | 522,053 | $ | 248,960 | $ | 164,309 | $ | 179,165 | $ | 374,694 | $ | 2,905,666 | $ | 2,896,218 | |||||||||||||||||||||||||||||||
| Average interest rate | 3.33 | % | 3.36 | % | 3.31 | % | 3.22 | % | 2.90 | % | 3.19 | % | |||||||||||||||||||||||||||||||||||
| Total loans | $ | 2,008,997 | $ | 852,699 | $ | 460,949 | $ | 275,357 | $ | 259,540 | $ | 430,299 | $ | 4,287,841 | $ | 4,241,717 | |||||||||||||||||||||||||||||||
| Average interest rate | 3.54 | % | 3.67 | % | 3.64 | % | 3.55 | % | 3.08 | % | 3.32 | % | |||||||||||||||||||||||||||||||||||
| Fixed interest rate securities | $ | 170,849 | $ | 107,061 | $ | 88,326 | $ | 87,234 | $ | 98,408 | $ | 824,969 | $ | 1,376,847 | $ | 1,398,458 | |||||||||||||||||||||||||||||||
| Average interest rate | 2.16 | % | 1.86 | % | 1.75 | % | 2.02 | % | 2.26 | % | 2.10 | % | |||||||||||||||||||||||||||||||||||
| Variable interest rate securities | $ | 28 | $ | 20 | $ | 15 | $ | 11 | $ | 8 | $ | 18 | $ | 100 | $ | 100 | |||||||||||||||||||||||||||||||
| Average interest rate | 4.27 | % | 4.27 | % | 4.27 | % | 4.27 | % | 4.27 | % | 4.27 | % | |||||||||||||||||||||||||||||||||||
| Other interest-bearing assets | $ | 631,410 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 631,410 | $ | 631,410 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.16 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | |||||||||||||||||||||||||||||||||||
| Total earning assets | $ | 2,811,284 | $ | 959,780 | $ | 549,290 | $ | 362,602 | $ | 357,956 | $ | 1,255,286 | $ | 6,296,198 | $ | 6,271,685 | |||||||||||||||||||||||||||||||
| Average interest rate | 2.69 | % | 3.47 | % | 3.33 | % | 3.18 | % | 2.85 | % | 2.52 | % | |||||||||||||||||||||||||||||||||||
| Rate sensitive liabilities: | |||||||||||||||||||||||||||||||||||||||||||||||
| Noninterest bearing checking | $ | 370,382 | $ | 171,055 | $ | 151,923 | $ | 134,874 | $ | 119,720 | $ | 947,527 | $ | 1,895,481 | $ | 1,895,481 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | |||||||||||||||||||||||||||||||||||
| Savings & interest bearing checking | $ | 609,882 | $ | 228,064 | $ | 201,375 | $ | 178,402 | $ | 158,659 | $ | 1,634,026 | $ | 3,010,408 | $ | 3,010,408 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.26 | % | 0.24 | % | 0.24 | % | 0.24 | % | 0.24 | % | 0.26 | % | |||||||||||||||||||||||||||||||||||
| Time deposits | $ | 591,740 | $ | 174,035 | $ | 37,600 | $ | 13,704 | $ | 12,091 | $ | 348 | $ | 829,518 | $ | 833,617 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.46 | % | 68.00 | % | 2.21 | % | 0.96 | % | 0.63 | % | 0.49 | % | |||||||||||||||||||||||||||||||||||
| Total deposits | $ | 1,572,004 | $ | 573,154 | $ | 390,898 | $ | 326,980 | $ | 290,470 | $ | 2,581,901 | $ | 5,735,407 | $ | 5,739,506 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.27 | % | 0.30 | % | 0.34 | % | 0.17 | % | 0.16 | % | 0.16 | % | |||||||||||||||||||||||||||||||||||
| Fixed interest rate borrowings | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 75,000 | $ | 75,000 | $ | 66,118 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.39 | % | |||||||||||||||||||||||||||||||||||
| Variable interest rate borrowings | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | 0.00 | % | |||||||||||||||||||||||||||||||||||
| Total funds | $ | 1,572,004 | $ | 573,154 | $ | 390,898 | $ | 326,980 | $ | 290,470 | $ | 2,656,901 | $ | 5,810,407 | $ | 5,805,624 | |||||||||||||||||||||||||||||||
| Average interest rate | 0.27 | % | 0.30 | % | 0.34 | % | 0.17 | % | 0.16 | % | 0.16 | % | |||||||||||||||||||||||||||||||||||
| Interest rate sensitivity gap by period | $ | 1,239,280 | $ | 386,626 | $ | 158,392 | $ | 35,622 | $ | 67,486 | $ | (1,401,615) | |||||||||||||||||||||||||||||||||||
| Cumulative rate sensitivity gap | $ | 1,239,280 | $ | 1,625,906 | $ | 1,784,298 | $ | 1,819,920 | $ | 1,887,406 | $ | 485,791 | |||||||||||||||||||||||||||||||||||
| Cumulative rate sensitivity ratio | |||||||||||||||||||||||||||||||||||||||||||||||
| at December 31, 2021 | 178.8 | % | 167.5 | % | 140.5 | % | 110.9 | % | 123.2 | % | 47.2 | % | |||||||||||||||||||||||||||||||||||
| at December 31, 2020 | 155.5 | % | 220.8 | % | 163.6 | % | 95.4 | % | 84.5 | % | 33.9 | % | |||||||||||||||||||||||||||||||||||
The Company utilizes computer modeling software to stress test the balance sheet under a wide variety of interest rate scenarios. The model quantifies the income impact of changes in customer preference for products, basis risk between the assets and the liabilities that support them and the risk inherent in different yield curves as well as other factors. The ALCO committee reviews these possible outcomes and makes loan, investment and deposit decisions that maintain reasonable balance sheet structure in light of potential interest rate movements. It is the objective of the Company to monitor and manage risk exposure to net interest income caused by changes in interest rates. It is the goal of the Company’s asset/liability function to provide optimum and stable net interest income. To accomplish this, management uses two asset liability tools: GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation Modeling, which are constructed, presented and monitored quarterly. Management believes that the Company’s liquidity and interest sensitivity position at December 31, 2021, remained adequate to meet the Company’s primary goal of achieving optimum interest margins while avoiding undue interest rate risk. The Company
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places a greater level of credence in net interest income simulation modeling. The GAP/Interest Rate Sensitivity Report is believed by the Company’s management to have two major shortfalls. The GAP/Interest Rate Sensitivity Report fails to precisely gauge how often an interest rate sensitive product reprices, nor is it able to measure the magnitude of potential future rate movements. Although management does not consider GAP ratios in planning, the information can be used in a general fashion to look at asset and liability mismatches. The Company’s cumulative repricing GAP ratio as of December 31, 2021 for the next 12 months using a scenario in which interest rates remained unchanged was a negative 1.36% of earning assets.
Net interest income simulation modeling, or earnings-at-risk, measures the sensitivity of net interest income to various interest rate movements. The Company’s asset liability process monitors simulated net interest income under three separate interest rate scenarios; base, rising and falling. Estimated net interest income for each scenario is calculated over a twelve-month horizon. The immediate and parallel changes to the base case scenario used in the model are presented below. The interest rate scenarios are used for analytical purposes and do not necessarily represent management’s view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may introduce into the earnings of the Company.
The base scenario is highly dependent on numerous assumptions embedded in the model. While the base sensitivity analysis incorporates management’s best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact will likely differ from that projected. For certain assets, the base simulation model captures the expected prepayment behavior under changing interest rate environments. Assumptions and methodologies regarding the interest rate or balance behavior of indeterminate maturity core deposit products, such as savings, money market, NOW and demand deposits reflect management’s best estimate of expected future behavior.
Results for the base, falling 25 basis points, rising 25 basis points, rising 50 basis points, rising 100 basis points, rising 200 basis points, and rising 300 basis points interest rate scenarios are listed below based upon the Company’s rate sensitive assets and liabilities at December 31, 2021. The net interest income shown represents cumulative net interest income over a twelve-month time horizon.
| (dollars in thousands) | Base | Falling (25 Basis Points) | Rising (25 Basis Points) | Rising (50 Basis Points) | Rising (100 Basis Points) | Rising (200 Basis Points) | Rising (300 Basis Points) | ||||||||||||||||||||||||||||||||||
| Net interest income | $ | 176,889 | $ | 174,020 | $ | 179,790 | $ | 182,865 | $ | 189,032 | $ | 202,781 | $ | 216,499 | |||||||||||||||||||||||||||
| Variance from Base | $ | (2,869) | $ | 2,901 | $ | 5,976 | $ | 12,143 | $ | 25,892 | $ | 39,610 | |||||||||||||||||||||||||||||
| Percent of change from Base | (1.62) | % | 1.64 | % | 3.38 | % | 6.86 | % | 14.64 | % | 22.39 | % | |||||||||||||||||||||||||||||
For more information on the Company’s interest rate sensitivity see the Interest Rate Risk discussion in Item 7A. above.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and the Board of Directors of Lakeland Financial Corporation
Warsaw, Indiana
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Lakeland Financial Corporation (the "Company") as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit losses effective January 1, 2021 due to the adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification No. 326, Financial Instruments - Credit Losses (“ASC 326”). The Company adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
55
generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses (ACL) – Qualitative Adjustments
As described in Notes 1 and 4 to the consolidated financial statements and referred to in the change in accounting principle explanatory paragraph above, the Company adopted ASC 326 as of January 1, 2021, which among other things, required the Company to recognize expected credit losses over the contractual lives of financial asset carried at amortized costs, including loans receivables, utilizing the Current Expected Credit Losses (“CECL”) methodology. As of December 31, 2021, the ACL balance was $67,773,000. Estimates of expected credit losses are based on relevant information about current conditions, past events, and reasonable and supportable forward-looking forecasts regarding collectability of the reported amounts. The Company utilized a Probability of Default/ Loss Given Default model derived from historical charge-off data to construct a loss rate for each identified loan segment. The loss rates, subject to a floor, are then adjusted, for reasonable and supportable forecasts of relevant economic indicators as well as other environmental factors based on the risks present for each portfolio segment. The environmental factors (“qualitative adjustments”) include consideration of economic conditions and portfolio trends.
We have identified auditing the qualitative adjustments as a critical audit matter as management’s determination of the qualitative adjustments used in the ACL is subjective and involves significant management judgments; and our audit procedures related to the qualitative adjustments involved a high degree of auditor judgment and required significant audit effort, including the need to involve more experienced audit personnel.
The primary procedures we performed to address this critical audit matter included:
•Testing the effectiveness of controls over the qualitative adjustments used in the ACL calculation including controls addressing the:
◦Significant assumptions and judgments applied in the development of the qualitative adjustments.
◦Mathematical accuracy of the qualitative adjustments applied to the loan segments in the ACL calculation.
•Substantively testing management's determination of the qualitative adjustments used in the ACL estimate, including:
◦Testing management’s process for developing the qualitative adjustments, which included assessing the relevance and reliability of data used to develop the qualitative adjustments, including evaluating their judgments and assumptions for reasonableness. Among other procedures, our evaluation considered evidence from internal and external sources.
◦Analytically evaluating the qualitative adjustments for directional consistency, testing for reasonableness, and obtaining evidence for significant changes.
56
◦Testing the mathematical accuracy of the qualitative adjustments applied to the loan segments in the ACL calculation.
/s/ Crowe LLP
We have served as the Company’s auditor since 1983.
February 23, 2022
57
CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
| December 31 | 2021 | 2020 | |||||||||
| ASSETS | |||||||||||
| Cash and due from banks | $ | $ | |||||||||
| Short-term investments | |||||||||||
| Total cash and cash equivalents | |||||||||||
| Securities available-for-sale (carried at fair value) | |||||||||||
| Real estate mortgage loans held-for-sale | |||||||||||
Loans, net of allowance for credit losses of $ | |||||||||||
| Land, premises and equipment, net | |||||||||||
| Bank owned life insurance | |||||||||||
| Federal Reserve and Federal Home Loan Bank Stock | |||||||||||
| Accrued interest receivable | |||||||||||
| Goodwill | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| LIABILITIES | |||||||||||
| Noninterest bearing deposits | $ | $ | |||||||||
| Interest bearing deposits | |||||||||||
| Total deposits | |||||||||||
| Borrowings | |||||||||||
| Federal Home Loan Bank advances | |||||||||||
| Miscellaneous borrowings | |||||||||||
| Total borrowings | |||||||||||
| Accrued interest payable | |||||||||||
| Other liabilities | |||||||||||
| Total liabilities | |||||||||||
| Commitments, off-balance sheet risks and contingencies (Notes 1 and 18) | |||||||||||
| STOCKHOLDERS’ EQUITY | |||||||||||
Common stock: | |||||||||||
| Retained earnings | |||||||||||
| Accumulated other comprehensive income | |||||||||||
Treasury stock, at cost ( | ( | ( | |||||||||
| Total stockholders’ equity | |||||||||||
| Noncontrolling interest | |||||||||||
| Total equity | |||||||||||
| Total liabilities and equity | $ | $ | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
58
CONSOLIDATED STATEMENTS OF INCOME (in thousands, except share and per share data)
| Years Ended December 31 | 2021 | 2020 | 2019 | ||||||||||||||
| NET INTEREST INCOME | |||||||||||||||||
| Interest and fees on loans | |||||||||||||||||
| Taxable | $ | $ | $ | ||||||||||||||
| Tax exempt | |||||||||||||||||
| Interest and dividends on securities | |||||||||||||||||
| Taxable | |||||||||||||||||
| Tax exempt | |||||||||||||||||
| Interest on short-term investments | |||||||||||||||||
| Total interest income | |||||||||||||||||
| Interest on deposits | |||||||||||||||||
| Interest on borrowings | |||||||||||||||||
| Short-term | |||||||||||||||||
| Long-term | |||||||||||||||||
| Total interest expense | |||||||||||||||||
| NET INTEREST INCOME | |||||||||||||||||
| Provision for credit losses | |||||||||||||||||
| NET INTEREST INCOME AFTER PROVISION FOR | |||||||||||||||||
| CREDIT LOSSES | |||||||||||||||||
| NONINTEREST INCOME | |||||||||||||||||
| Wealth advisory fees | |||||||||||||||||
| Investment brokerage fees | |||||||||||||||||
| Service charges on deposit accounts | |||||||||||||||||
| Loan and service fees | |||||||||||||||||
| Merchant and interchange fee income | |||||||||||||||||
| Bank owned life insurance income | |||||||||||||||||
| Interest rate swap fee income | |||||||||||||||||
| Mortgage banking income | |||||||||||||||||
| Net securities gains | |||||||||||||||||
| Other income | |||||||||||||||||
| Total noninterest income | |||||||||||||||||
| NONINTEREST EXPENSE | |||||||||||||||||
| Salaries and employee benefits | |||||||||||||||||
| Net occupancy expense | |||||||||||||||||
| Equipment costs | |||||||||||||||||
| Data processing fees and supplies | |||||||||||||||||
| Corporate and business development | |||||||||||||||||
| FDIC insurance and other regulatory fees | |||||||||||||||||
| Professional fees | |||||||||||||||||
| Other expense | |||||||||||||||||
| Total noninterest expense | |||||||||||||||||
| INCOME BEFORE INCOME TAX EXPENSE | |||||||||||||||||
| Income tax expense | |||||||||||||||||
| NET INCOME | $ | $ | $ | ||||||||||||||
| BASIC WEIGHTED AVERAGE COMMON SHARES | |||||||||||||||||
| BASIC EARNINGS PER COMMON SHARE | $ | $ | $ | ||||||||||||||
| DILUTED WEIGHTED AVERAGE COMMON SHARES | |||||||||||||||||
| DILUTED EARNINGS PER COMMON SHARE | $ | $ | $ | ||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
59
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands)
| Years Ended December 31 | 2021 | 2020 | 2019 | ||||||||||||||
| Net income | $ | $ | $ | ||||||||||||||
| Other comprehensive income (loss) | |||||||||||||||||
| Change in securities available -for-sale: | |||||||||||||||||
| Unrealized holding gain (loss) on securities available-for-sale arising during the period | ( | ||||||||||||||||
| Reclassification adjustment for (gains) losses included in net income | ( | ( | ( | ||||||||||||||
| Net securities gain (loss) activity during the period | ( | ||||||||||||||||
| Tax effect | ( | ( | |||||||||||||||
| Net of tax amount | ( | ||||||||||||||||
| Defined benefit pension plans: | |||||||||||||||||
| Net gain (loss) on defined benefit pension plans | ( | ( | |||||||||||||||
| Amortization of net actuarial loss | |||||||||||||||||
| Net gain (loss) on activity during the period | ( | ||||||||||||||||
| Tax effect | ( | ( | |||||||||||||||
| Net of tax amount | ( | ||||||||||||||||
| Total other comprehensive income (loss), net of tax | ( | ||||||||||||||||
| Comprehensive income | $ | $ | $ | ||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
60
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (in thousands, except share and per share data)
| Accumulated | |||||||||||||||||||||||||||||||||||||||||||||||
| Other | Total | ||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock | Retained | Comprehensive | Treasury | Stockholders’ | Noncontrolling | Total | |||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Earnings | Income (Loss) | Stock | Equity | Interest | Equity | ||||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2019 | $ | $ | $ | ( | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Net income | |||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of tax | |||||||||||||||||||||||||||||||||||||||||||||||
Cash dividends declared, $ | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Cashless exercise of warrants | 0 | 0 | 0 | ||||||||||||||||||||||||||||||||||||||||||||
| Treasury shares purchased under deferred | |||||||||||||||||||||||||||||||||||||||||||||||
| directors’ plan | ( | ( | 0 | ||||||||||||||||||||||||||||||||||||||||||||
| Treasury shares sold and distributed under deferred | |||||||||||||||||||||||||||||||||||||||||||||||
| directors’ plan | ( | 0 | |||||||||||||||||||||||||||||||||||||||||||||
| Stock activity under equity incentive plans | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Stock based compensation expense | |||||||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | $ | ( | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Net income | |||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of tax | |||||||||||||||||||||||||||||||||||||||||||||||
Cash dividends declared, $ | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Treasury shares purchased under share repurchase plan | ( | 0 | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Treasury shares purchased under deferred | |||||||||||||||||||||||||||||||||||||||||||||||
| directors’ plan | ( | ( | 0 | ||||||||||||||||||||||||||||||||||||||||||||
| Treasury shares sold and distributed under deferred | |||||||||||||||||||||||||||||||||||||||||||||||
| directors’ plan | ( | 0 | |||||||||||||||||||||||||||||||||||||||||||||
| Stock activity under equity incentive plans | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Stock based compensation expense | |||||||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2020 | $ | $ | $ | $ | ( | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Net income | |||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
Cash dividends declared, $ | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Treasury shares purchased under deferred | |||||||||||||||||||||||||||||||||||||||||||||||
| directors’ plan | ( | ( | 0 | ||||||||||||||||||||||||||||||||||||||||||||
| Treasury shares sold and distributed under deferred | |||||||||||||||||||||||||||||||||||||||||||||||
| directors’ plan | ( | 0 | |||||||||||||||||||||||||||||||||||||||||||||
| Stock activity under equity incentive plans | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Stock based compensation expense | |||||||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | $ | $ | $ | $ | ( | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
61
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
| Years Ended December 31 | 2021 | 2020 | 2019 | ||||||||||||||
| Cash flows from operating activities: | |||||||||||||||||
| Net income | $ | $ | $ | ||||||||||||||
| Adjustments to reconcile net income to net cash from operating activities: | |||||||||||||||||
| Depreciation | |||||||||||||||||
| Provision for credit losses | |||||||||||||||||
| Net loss on sale and write down of other real estate owned | |||||||||||||||||
| Amortization of loan servicing rights | |||||||||||||||||
| Net change in loan servicing rights valuation allowance | |||||||||||||||||
| Loans originated for sale | ( | ( | ( | ||||||||||||||
| Net gain on sales of loans | ( | ( | ( | ||||||||||||||
| Proceeds from sale of loans | |||||||||||||||||
| Net (gain) loss on sale of premises and equipment | ( | ||||||||||||||||
| Net (gain) loss on sales and calls of securities available-for-sale | ( | ( | ( | ||||||||||||||
| Net amortization of available -for-sale securities | |||||||||||||||||
| Stock based compensation expense | |||||||||||||||||
| Earnings on life insurance | ( | ( | ( | ||||||||||||||
| Gain on life insurance | ( | ( | ( | ||||||||||||||
| Tax benefit of stock award issuances | ( | ( | ( | ||||||||||||||
| Net change: | |||||||||||||||||
| Interest receivable and other assets | ( | ( | ( | ||||||||||||||
| Interest payable and other liabilities | ( | ( | |||||||||||||||
| Total adjustments | |||||||||||||||||
| Net cash from operating activities | |||||||||||||||||
| Cash flows from investing activities: | |||||||||||||||||
| Proceeds from sale of securities available- for-sale | |||||||||||||||||
| Proceeds from maturities, calls and principal paydowns of securities available-for-sale | |||||||||||||||||
| Purchases of securities available-for-sale | ( | ( | ( | ||||||||||||||
| Purchase of life insurance | ( | ( | ( | ||||||||||||||
| Net increase in total loans | ( | ( | |||||||||||||||
| Proceeds from sales of land, premises and equipment | |||||||||||||||||
| Purchases of land, premises and equipment | ( | ( | ( | ||||||||||||||
| Proceeds from sales of other real estate owned | |||||||||||||||||
| Proceeds from life insurance | |||||||||||||||||
| Net cash from investing activities | ( | ( | ( | ||||||||||||||
| Cash flows from financing activities: | |||||||||||||||||
| Net increase in total deposits | |||||||||||||||||
| Net increase (decrease) in short-term borrowings | ( | ( | |||||||||||||||
| Payments on short-term FHLB borrowings | ( | ||||||||||||||||
| Payments on long-term FHLB borrowings | |||||||||||||||||
| Proceeds from long-term FHLB borrowings | |||||||||||||||||
| Payments on subordinated debentures | ( | ||||||||||||||||
| Common dividends paid | ( | ( | ( | ||||||||||||||
| Preferred dividends paid | ( | ( | ( | ||||||||||||||
| Payments related to equity incentive plan | ( | ( | ( | ||||||||||||||
| Purchase of treasury stock | ( | ( | ( | ||||||||||||||
| Sales of treasury stock | |||||||||||||||||
| Net cash from financing activities | ( | ||||||||||||||||
| Net change in cash and cash equivalents | ( | ||||||||||||||||
| Cash and cash equivalents at beginning of the year | |||||||||||||||||
| Cash and cash equivalents at end of the year | $ | $ | $ | ||||||||||||||
| Cash paid during the year for: | |||||||||||||||||
| Interest | $ | $ | $ | ||||||||||||||
| Income taxes | |||||||||||||||||
| Supplemental non-cash disclosures: | |||||||||||||||||
| Loans transferred to other real estate owned | |||||||||||||||||
| Property transferred to held for sale | |||||||||||||||||
| Right-of-use assets obtained in exchange for lease liabilities | |||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
62
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation:
The consolidated financial statements include Lakeland Financial Corporation (the “Holding Company”) and its wholly owned subsidiaries, Lake City Bank (the “Bank”) and LCB Risk Management, Inc., together referred to as (the “Company”). On December 18, 2006, LCB Investments II, Inc. was formed as a wholly owned subsidiary of the Bank incorporated in Nevada to manage a portion of the Bank’s investment portfolio beginning in 2007. On December 21, 2006, LCB Funding, Inc., a real estate investment trust incorporated in Maryland, was formed as a wholly owned subsidiary of LCB Investments II, Inc. On December 28, 2012, LCB Risk Management, Inc., a captive insurance company incorporated in Nevada, was formed as a wholly owned subsidiary of the Holding Company. All intercompany transactions and balances are eliminated in consolidation.
The Company provides financial services through the Bank, a full-service commercial bank with 51 branch offices in fifteen counties in Northern and Central Indiana. The Company provides commercial, retail, trust and investment services to its customers. Commercial products include commercial loans and technology-driven solutions to meet commercial customers’ treasury management needs such as mobile business banking and online treasury management services. Retail banking clients are provided a wide array of traditional retail banking services, including lending, deposit and investment services. Retail lending programs are focused on mortgage loans, home equity lines of credit and traditional retail installment loans. The Company provides credit card services to retail and commercial customers through its retail card program and merchant processing activity. The Company provides wealth advisory and trust clients with traditional personal and corporate trust services. The Company also provides retail brokerage services, including an array of financial and investment products such as annuities and life insurance. Other financial instruments, which represent potential concentrations of credit risk, include deposit accounts in other financial institutions.
Use of Estimates:
To prepare financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided and future results could differ.
Cash Flows:
Cash and cash equivalents include cash, demand deposits in other financial institutions and short-term investments and certificates of deposit with maturities of 90 days or less. Cash flows are reported net for customer loan and deposit transactions, and certain short-term borrowings.
Securities:
Securities are classified as available-for-sale when they might be sold before maturity. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss), net of tax. Securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity.
Purchase premiums or discounts are recognized in interest income using the interest method over the terms of the securities or over estimated lives for mortgage-backed securities. Gains and losses on sales are based on the amortized cost of the security sold and recorded on the trade date. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, nature of the security, the underlying collateral, and the financial condition of the issuer, among other factors. If this assessment indicates a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for available-for-sale securities losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for available-for-sale securities losses is recognized in other comprehensive income (loss).
63
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Changes in the allowance for available-for-sale securities are recorded as a component of credit loss expense. Losses are charged against the allowance for available-for-sale securities losses when management believes the uncollectibility of available-for-sale security is confirmed or when either criteria regarding intent or requirement to sell is met.
Real Estate Mortgage Loans Held-for-Sale:
Loans held for sale are reported at the lower of cost or fair value on an aggregate basis. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Loan sales occur on the delivery date agreed to in the relevant commitment agreement. The Company retains servicing on the majority of loans sold. The carrying value of loans sold is reduced by the amount allocated to the servicing right. The gain or loss on the sale of loans is the difference between the carrying value of the loans sold and the funds received from the sale.
Loans:
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for credit losses.
Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. All classes of commercial and industrial, commercial real estate and multi-family residential, agri-business and agricultural, other commercial and consumer 1-4 family mortgage loans for which collateral is insufficient to cover all principal and accrued interest are reclassified as nonaccrual loans, on or before the date when the loan becomes 90 days delinquent. When a loan is classified as a nonaccrual loan, interest on the loan is no longer accrued, all unpaid accrued interest is reversed and interest income is subsequently recorded on the cash-basis or cost-recovery method. Accrual status is resumed when all contractually due payments are brought current and future payments are reasonably assured. Other consumer loans are not placed on a nonaccrual status since these loans are charged-off when they have been delinquent from 90 to 180 days, and when the related collateral, if any, is not sufficient to offset the indebtedness. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated and individually analyzed loans.
The recorded investment in loans is the loan balance net of unamortized deferred loan fees and costs. The total amount of accrued interest on loans as of December 31, 2021 and 2020 was $10.0 million and $14.6 million.
Allowance for Credit Losses:
The allowance for credit losses is a valuation allowance to provide for expected credit losses. Losses are charged against the allowance when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management's judgment, should be charged against the allowance. A provision for credit losses is taken based on management's ongoing evaluation of the appropriate allowance balance. A formal evaluation of the adequacy of the credit loss allowance is conducted monthly. The ultimate recovery of all loans is susceptible to future market factors beyond the Company's control.
The determination of the appropriate allowance is inherently subjective, as it requires significant estimates by management. The Company has an established process to determine the adequacy of the allowance for credit losses that generally includes consideration of changes in the nature and volume of the loan portfolio and overall portfolio quality, along with current and forecasted economic conditions that may affect borrowers' ability to repay. Consideration is not limited to these factors although they represent the most commonly cited factors. To determine the specific allocation levels for individual credits, management considers the current valuation of collateral and the amounts and timing of expected future cash flows as the primary measures. Management also considers trends in adversely classified loans based upon an ongoing review of those credits. With respect to pools of similar loans, an appropriate level of general allowance is determined by portfolio segment using a probability of default-loss given default ("PD/LGD") model, subject to a floor. A default can be triggered by one of several different asset quality factors, including past due status, nonaccrual status, TDR status or if the loan has had a charge-off. This PD is then combined with a LGD derived from historical charge-off data to construct a loss rate. This loss rate is then supplemented with adjustments for reasonable and supportable forecasts of relevant economic indicators, particularly the unemployment rate forecast from the Federal Open Market Committee's Summary of Economic Projections, as well as portfolio trends based on the risks present for each portfolio segment. These environmental factors include consideration
64
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
of portfolio trends and conditions; industry conditions; and effects of changes in credit concentrations. It is also possible that these factors could include social, political, economic, and terrorist events or activities. All of these factors are susceptible to change, which may be significant. As a result of this detailed process, the allowance results in two forms of allocations, specific and general. These two components represent the total allowance for credit losses deemed adequate to cover expected losses within the loan portfolio.
Commercial loans are subject to a dual standardized grading process administered by the credit administration function. These grade assignments are performed independent of each other and a consensus is reached by credit administration and the loan review officer. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that indicate it should be evaluated on an individual basis. Considerations with respect to specific allocations for these individual credits include, but are not limited to, the following: (a) the sufficiency of the customer's cash flow or net worth to repay the loan; (b) the adequacy of the discounted value of collateral relative to the loan balance; (c) whether the loan has been criticized in a regulatory examination; (d) whether the loan is nonperforming; (e) any other reasons the ultimate collectability of the loan may be in question; or (f) any unique loan characteristics that require special monitoring.
Allocations are also applied to categories of loans considered not to be individually analyzed, but for which the rate of loss is expected to be consistent with or greater than historical averages. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values. These general pooled loan allocations are performed for portfolio segments of commercial and industrial; commercial real estate, multi-family, and construction; agri-business and agricultural; other commercial loans; and consumer 1-4 family mortgage and other consumer loans. General allocations of the allowance are determined by a historical loss rate based on the calculation of each pool's probability of default-loss given default, subject to a floor. The length of the historical period for each pool is based on the average life of the pool. The historical loss rates are all supplemented with consideration of economic conditions and portfolio trends. The risk characteristics of each of the identified portfolio segments are as follows:
Commercial and Industrial - Borrowers may be subject to industry conditions including decreases in product demand; increase in material or other production costs that cannot be immediately recaptured in the sales or distribution cycle; interest rate increases that could have an adverse impact on profitability; non-payment of credit that has been extended under normal vendor terms for goods sold or services; and interruption related to the importing or exporting of production materials or sold products.
Commercial Real Estate and Multi-Family Residential - Borrowers may be subject to potential adverse market conditions that cause a decrease in market value or lease rates; the potential for environmental impairment from events occurring on subject or neighboring properties; and obsolescence in location or function. Multi-Family Residential is also subject to adverse market conditions associated with a change in governmental or personal funding sources for tenants; over supply of units in a specific region; a shift in population; and reputational risks. Construction and Land Development risks include slower absorption than anticipated on speculative projects; deterioration in market conditions that may impact a project's value; unforeseen costs not considered in the original construction budget; or any other factors that may impact the completion or success of the project.
Agri-business and Agricultural - Borrower may be subject to adverse market or weather conditions including changes in local or foreign demand; lower yields than anticipated; political or other impact on storage, distribution or use; foreign trade policies including tariffs; and exposure to increasing commodity prices which result in higher production, distribution or exporting costs.
Other Commercial - Borrowers may be subject to the uninterrupted flow of funds to states and other political subdivisions for the purpose of debt repayments on loans held by the Bank.
Consumer 1-4 Family Mortgage - Borrowers may be subject to adverse employment conditions in the local economy leading to increased default rates; decreased market values from oversupply in a geographic area; and impact to the borrowers' ability to maintain payments in the event of incremental rate increases on adjustable rate mortgages.
Other Consumer - Borrowers may be subject to adverse employment conditions in the local economy which may lead to higher default rates; and decreases in the value of underlying collateral.
A loan is individually analyzed for specific allocation when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified and a concession has been granted for borrowers experiencing financial difficulties, are considered troubled debt restructurings and classified as individually evaluated and may be either accruing or non-accruing. Nonaccrual troubled debt restructurings follow the same policy as described above for other loans. Individual evaluation for
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
troubled debt restructurings is measured at the present value of estimated future cash flows using the loan’s effective rate at inception or at discounted collateral value for collateral dependent loans. Allocations are analyzed individually or in total for smaller-balance loans of similar nature such as all classes of consumer 1-4 family and other consumer loans, and individually for all classes of commercial and industrial, commercial real estate and multi-family, agribusiness and agricultural and other commercial loans. The Company analyzes commercial loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis for Special Mention, Substandard and Doubtful grade loans and annually on Pass grade loans over $250,000 . Factors considered by management in determining individual evaluation include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as individually evaluated. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is individually evaluated, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral less anticipated costs to sell. All classes of commercial and industrial, commercial real estate and multifamily residential, agribusiness and agricultural, other commercial and consumer 1-4 family mortgage loans that become delinquent beyond 90 days are analyzed and a charge-off is taken when it is determined that the underlying collateral, if any, is not sufficient to offset the indebtedness.
Troubled debt restructured loans are considered for removal from troubled debt restructuring status in the year following modification or at time of subsequent restructuring for loans with cumulative principal forgiveness if the interest rate is considered a market rate at the time of modification and it has been performing according to the terms of the modification for a reasonable period of time long enough to observe an ability to repay under the modified terms. If removed from troubled debt restructuring status, the loan continues to be individually evaluated for specific allocation with either the present value of estimated future cash flows using the loan’s effective rate at inception or at discounted collateral value for collateral dependent loans. In addition, troubled debt restructured loans with subsequent modifications that do not have cumulative principal forgiveness are considered for removal from troubled debt restructuring status at the time of the subsequent modification if the following circumstances exist: (1) at the time of the subsequent restructuring, the borrower is not experiencing financial difficulties; (2) under the terms of the subsequent restructuring agreement no concession has been granted to the borrower; and (3)the subsequent restructuring agreement includes market terms that are no less favorable than those that would be offered for comparable new debt. Upon meeting these criteria, the loan is no longer individually evaluated and is no longer disclosed as a troubled debt restructuring.
Due to the imprecise nature of estimating the allowance for credit losses, the Company's allowance for credit losses includes an unallocated component. The unallocated component of the allowance for credit losses incorporates the Company's judgmental determination of potential expected losses that may not be fully reflected in other allocations, including factors such as the level of classified credits, economic uncertainties, industry trends impacting specific portfolio segments, broad portfolio quality trends, and trends in the composition of the Company's large commercial loan portfolio and related large dollar exposures to individual borrowers. As a practical expedient, the Company has elected to disclose accrued interest separately from loan principal balances on the consolidated balance sheet. Additionally, when a loan is placed on non-accrual, interest payments are reversed through interest income.
For off balance sheet credit exposures outlined in the ASU at 326-20-30-11, it is the Company's position that nearly all of the unfunded amounts on lines of credit are unconditionally cancellable, and therefore not subject to having a liability set up, which matches the current accounting conclusion in the incurred loss environment.
Investments in Limited Partnerships:
The Company enters into and invests in limited partnerships in order to invest in affordable housing projects to support Community Reinvestment Act activities and secondarily to obtain available tax benefits. The Company is a limited partner in these investments and, as such, the Company is not involved in the management or operation of such investments. These investments are accounted for using the equity method of accounting. Under the equity method of accounting, the Company records its share of the partnership’s earnings or losses in its income statement and adjusts the carrying amount of the investments on the consolidated balance sheet. These investments are evaluated for impairment when events indicate the carrying amount may not be recoverable. The investments recorded at December 31, 2021 and 2020 were $9.4 million and $9.2 million, respectively and are included with other assets in the consolidated balance sheet. The Company also has a commitment to fund an additional $2.2 million at December 31, 2021 in four of the limited partnerships compared to $2.6 million at December 31, 2020, which is included with other liabilities in the consolidated balance sheet.
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Foreclosed Assets:
Assets acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. If fair value declines, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed. At December 31, 2021 and 2020, the balance of other real estate owned was $196,000 and $316,000 , respectively, and is included with other assets on the consolidated balance sheet.
Land, Premises and Equipment, Net:
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the useful lives of the assets. Premises and improvements assets have useful lives between 5 and 40 years. Equipment and furniture assets have useful lives between 3 and 7 years.
Loan Servicing Rights:
Servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in mortgage banking income. Fair value is based on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. The amortization of servicing rights is netted against mortgage banking income. Servicing fees totaled $1.2 million, $1.2 million and $1.1 million for the years ended December 31, 2021, 2020 and 2019, respectively. Late fees and ancillary fees related to loan servicing are not material.
Servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as loan type, term and interest rate. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in the valuation allowance are reported with mortgage banking income on the income statement. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
The carrying value of mortgage servicing rights, which is included with other assets in the consolidated balance sheet, was $2.4 million and $3.5 million as of December 31, 2021 and 2020, respectively.
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans were $375.4 million and $351.0 million at December 31, 2021 and 2020, respectively. Custodial escrow balances maintained in connection with serviced loans were $1.7 million at year end 2021 and 2020.
Servicing fee income (loss), which is included in loan and service fees on the income statement, is recorded for fees earned for servicing loans. Fees earned for servicing loans are based on a contractual percentage of the outstanding principal amount of the loan and are recorded as income when earned.
Transfers of Financial Assets:
Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Mortgage Banking Derivatives:
Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free-standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked.
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in fair values of these derivatives are included in mortgage banking income.
Interest Rate Swap Derivatives:
The Company offers a derivative product to certain creditworthy commercial banking customers. This product allows the commercial banking customers to enter into an agreement with the Company to swap a variable rate loan to a fixed rate. These derivative products are designed to reduce, eliminate or modify the borrower’s interest rate exposure. The extension of credit incurred in connection with these derivative products is subject to the same approval and underwriting standards as traditional credit products. The Company limits its risk exposure by simultaneously entering into a similar, offsetting swap agreement with a separate, well-capitalized and highly rated counterparty previously approved by the Company’s Asset Liability Committee. By using these interest rate swap arrangements, the Company is also better insulated from the interest rate risk associated with underwriting fixed-rate loans and is better able to meet customer demand for fixed rate loans. These derivative contracts are not designated against specific assets or liabilities and, therefore, do not qualify for hedge accounting. The derivatives are recorded as assets and liabilities on the balance sheet at fair value with changes in fair value recorded in non-interest income for both the commercial banking customer swaps and the related offsetting swaps. The fair value of the derivative instruments incorporates a consideration of credit risk (in accordance with ASC 820), resulting in some potential volatility in earnings each period.
The notional amount of the combined interest rate swaps with customers and counterparties at December 31, 2021 and 2020 was $796.0 million and $819.1 million, respectively. The fair value of the interest rate swap asset was $14.3 million and $21.8 million and the fair value of the interest rate swap liability was $14.3 million and $21.8 million at December 31, 2021 and 2020, respectively.
The Company is a party in risk participation transactions of interest rate swaps, which had a total notional amount of $4.6 million and 5.0 million at December 31, 2021 and 2020, respectively.
Bank Owned Life Insurance:
At December 31, 2021 and 2020, the Company owned $91.1 million and $90.4 million, respectively, of life insurance policies on certain officers to provide a life insurance benefit for these officers. At December 31, 2021 and 2020, the Company also owned $6.6 million and $4.8 million, respectively, of variable life insurance on certain officers related to a deferred compensation plan. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, i.e., the cash surrender value adjusted for other changes or other amounts due that are probable at settlement.
Goodwill and Other Intangible Assets:
All goodwill on the Company’s consolidated balance sheet resulted from business combinations prior to January 1, 2009 and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is not amortized, but assessed at least annually for impairment and any such impairment will be recognized in the period identified.
FHLB and Federal Reserve Bank Stock:
FHLB and Federal Reserve Bank stock are carried at cost in other assets, classified as a restricted security and are periodically evaluated for impairment based on ultimate recoverability of par value. Both cash and stock dividends are reported as income.
Repurchase Agreements:
Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. This product was discontinued during 2019.
Long-term Assets:
Premises and equipment, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Benefit Plans:
The Company has a noncontributory defined benefit pension plan, which covered substantially all employees until the plan was frozen effective April 1, 2000. Funding of the plan equals or exceeds the minimum funding requirement determined by the actuary. Pension expense is the net of interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Benefits are based on years of service and compensation levels.
The Company maintains a 401(k) profit sharing plan for all employees meeting certain age and service requirements. The Company contributions are based upon the percentage of budgeted net income earned during the year.
An employee deferred compensation plan is available to certain employees with returns based on investments in mutual funds.
The Company maintains a directors’ deferred compensation plan. Effective January 1, 2003, the directors’ deferred compensation plan was amended to restrict the deferral to be in stock only and deferred directors’ fees are included in equity. The Company acquires shares on the open market and records such shares as treasury stock.
Revenue Recognition:
All of the Company’s revenue from contracts with customers in the scope of ASC 606 is recognized within noninterest income. The following is a description of principal activities from which we generate revenue. Revenues are recognized as the Company satisfies its obligations with our customers, in an amount that reflects the consideration that we expect to receive in exchange for those services.
Wealth advisory fees
The Company provides wealth advisory services to its customers and earns fees from its contracts with trust customers to manage assets for investment and/or to transact on their accounts. These fees are primarily earned over time as the Company provides the contracted monthly, quarterly, or annual services and are generally assessed based on a tiered scale of the market value of assets under management (AUM) at month-end. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed. Other related services, such as escrow accounts that are based on a fixed schedule, are recognized when the services are rendered.
Investment brokerage services
The Company provides investment brokerage services through a full service brokerage and investment and advisory firm, Cetera Investment Services LLC (“Cetera”). The Company receives commissions from Cetera on a monthly basis based upon customer activity for the month. The fees are recognized monthly and a receivable is recorded until commissions are generally paid by the 5th business day of the following month. Because the Company (i) acts as an agent in arranging the relationship between the customer and the Cetera and (ii) does not control the services to the customers, investment brokerage service fees are presented net of Cetera’s related costs.
Service charges on deposit accounts
The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s balance.
Interchange income
The Company provides the ability to transact on certain deposit accounts through the use of debit cards by outsourcing the services through third party service providers. Performance obligations are met on a transactional basis and income is recognized monthly based on transaction type and volume. Under the accounting standards in effect in the prior period, revenue was previously recognized net of the third party’s costs. Under ASC 606, fees from interchange income related to its customers use of debit cards will be reported gross in loan and service fees under noninterest income. The cost of using third party providers for these interchange services are reported in data processing fees and supplies under noninterest expense.
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Gain on sale of other real estate (OREO) owned financed by seller
On occasion, the Company underwrites a loan to purchase property owned by the Company. Under ASC 606, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present.
Debit card incentive rebates
The Company receives incentive rebates based on debit card transaction volume. Performance obligations are met on a transactional basis and income is recognized monthly based on transaction volume. Under the accounting standards in effect in the prior period, revenue was previously recognized in other income under noninterest income. Under ASC 606, these rebates related to debit card transaction volume are reported as a contra expense in data processing fees and supplies under noninterest expense.
Stock Based Compensation:
Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant adjusted for the present value of expected dividends is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. Certain of the restricted stock awards are performance based, as more fully discussed in Note 15 – Stock Based Compensation.
Income Taxes:
Annual consolidated federal and state income tax returns are filed by the Company. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Income tax expense is recorded based on the amount of taxes due on its tax return plus net deferred taxes computed based upon the expected future tax consequences of temporary differences between carrying amounts and tax basis of assets and liabilities, using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is more likely of being realized on examination than not. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Off-Balance Sheet Financial Instruments:
Financial instruments include credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. The fair value of standby letters of credit is recorded as a liability during the commitment period.
Earnings Per Common Share:
Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options, restricted stock awards and warrants. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements. The common shares included in treasury stock for 2021 and 2020 were 476,816 and 473,660 shares, respectively. Common stock that has been purchased under the directors’ deferred compensation plan, described above, is included in the treasury stock total and represented 187,715 and 184,559 shares of treasury stock as of December 31, 2021 and 2020, respectively. Because these shares are held in trust for the participants,
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
they are treated as outstanding when computing the weighted-average common shares outstanding for the calculation of both basic and diluted earnings per share. During the year ended December 31, 2020, the Company repurchased 289,101 of its common shares at a weighted average price of $34.63 per share. Treasury stock is carried at cost.
Comprehensive Income:
Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale and changes in the funded status of the pension plan, which are also recognized as separate components of equity.
Loss Contingencies:
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
The Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks. The former client subsequently filed several related bankruptcy cases, captioned In re Interlogic Outsourcing, Inc., et al., which are pending in the United States Bankruptcy Court for the Western District of Michigan. On April 27, 2021, the bankruptcy court entered an order approving an amended plan of liquidation, which was filed by the former client, other debtors and bankruptcy plan proponents, and approving the consolidation of the assets in the aforementioned cases under the Khan IOI Consolidated Estate Trust. On August 9, 2021, the liquidating trustee for the bankruptcy estates filed a complaint against the Bank and the Company, and has agreed to stay prosecution of the action through March 31, 2022. The action is focused on a series of business transactions among the client, related entities, and the Bank, which the liquidating trustee alleges are voidable under applicable federal bankruptcy and state law. The complaint also addresses treatment of the Bank’s claims filed in the bankruptcy cases. Based on current information, we have determined that a material loss is neither probable nor estimable at this time, and the Bank and the Company intend to vigorously defend themselves against all allegations asserted in the complaint.
Management does not believe there currently are matters that will have a material effect on the financial statements.
Restrictions on Cash:
The Federal Reserve Bank eliminated the reserve requirement for all depository institutions in March of 2020. Therefore, the Company was not required to have cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve and clearing requirements at December 31, 2021 and 2020.
Dividend Restriction:
Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to its stockholders. These restrictions currently pose no practical limit on the ability of the Bank or Company to pay dividends at historical levels.
Fair Value of Financial Instruments:
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 5 - Fair Value. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Operating Segments:
The Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. All of the Company’s financial service operations are similar and considered by management to be aggregated into one reportable operating segment. While the Company has assigned certain management responsibilities by region and business-line, the Company’s chief decision-makers monitor and evaluate financial performance on a Company-wide basis. The majority of the Company’s revenue is from the business of banking and the Company’s assigned regions have similar economic characteristics,
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
products, services and customers. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable operating segment.
Adoption of New Accounting Standards:
In June 2016, the FASB issued ASU 2016-13 "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." This update, commonly referred to as the current expected credit losses methodology (“CECL”), changes the accounting for credit losses on loans and debt securities. Under the new guidance, the Company’s measurement of expected credit losses is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. For loans, this measurement takes place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model previously required, but still permitted, under GAAP, which delays recognition until it is probable a loss has been incurred. In addition, the guidance modifies the other-than-temporary impairment model for available-for-sale debt securities to require an allowance for credit impairment instead of a direct write-down, which allows for reversal of credit impairments in future periods. This guidance was effective, subject to optional delay discussed below, for the Company for fiscal years beginning after December 15, 2019, including interim periods in those fiscal years.
As previously disclosed, the Company implemented the CECL methodology and ran it concurrently with the historical incurred method. Under a provision provided by the CARES Act, the Company elected to delay the adoption of FASB’s new rule covering the CECL standard. On December 27, 2020, then-President Trump signed into law the Consolidated Appropriations Act, 2021. This law extended relief for troubled debt restructurings and provided for further delay of the current expected credit losses adoption under the CARES Act to January 1, 2022, with early adoption permitted. The Company elected to remain on the incurred loan loss methodology for 2020.
The Company adopted ASU 2016-13 during the first quarter of 2021, effective January 1, 2021. Upon adoption, the Company recognized a $9.1 million increase in the allowance for credit losses. This resulted in a one-time cumulative effect adjustment decreasing retained earnings as of January 1, 2021 by $7.0 million, net of deferred taxes of $2.1 million. The Company did not recognize an allowance for credit impairment for available-for-sale securities.
| January 1, 2021 | ||||||||||||||||||||
| (dollars in thousands) | As Reported Under ASC 326 | Pre-ASC 326 Adoption | Impact of ASC 326 Adoption | |||||||||||||||||
| Loans | ||||||||||||||||||||
| Commercial and industrial loans | $ | $ | $ | |||||||||||||||||
| Commercial real estate and multi-family residential loans | ||||||||||||||||||||
| Agri-business and agricultural loans | ||||||||||||||||||||
| Other commercial loans | ||||||||||||||||||||
| Consumer 1-4 family loans | ||||||||||||||||||||
| Other consumer loans | ||||||||||||||||||||
| Unallocated | ( | |||||||||||||||||||
| Allowance for credit losses | $ | $ | $ | |||||||||||||||||
The Company’s loan segmentation, as disclosed in “Note 3 – Loans”, did not change as a result of adopting this ASU.
In December 2018, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. In March 2020, the OCC, the Board of Governors of the Federal Reserve System, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company did not adopt the capital transition relief over the permissible three-year or five-year periods.
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In August 2018, the FASB issued ASU 2018-14 “Compensation — Retirement Benefits — Defined Benefit Plans— General (Topic 715-20): Disclosure Framework — Changes to the Disclosure Requirements for Defined Benefit Plans.” The ASU updated the annual disclosure requirements for employers that sponsor defined benefit pension or other postretirement benefit plans by adding, clarifying and removing certain disclosures. These amendments are effective for fiscal years ending after December 15, 2020, for public business entities, and are to be applied on a retrospective basis to all periods presented. The Company adopted this new accounting standard on January 1, 2021, and the adoption did not have a material impact on its financial statements.
In December 2019, the FASB issued ASU 2019-12 “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” These amendments remove specific exceptions to the general principles in Topic 740 in GAAP. It eliminates the need for an organization to analyze whether the following apply in a given period: exception to the incremental approach for intraperiod tax allocation; exceptions to accounting for basis differences where there are ownership changes in foreign investments; and exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. It also improves financial statement preparers’ application of income tax-related guidance and simplifies GAAP for: franchise taxes that are partially based on income; transactions with a government that result in a step up in the tax basis of goodwill; separate financial statements of legal entities that are not subject to tax. It also enacts changes in tax laws in interim periods. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company adopted this new accounting standard on January 1, 2021, and the adoption did not have a material impact on its financial statements.
In January 2020, the FASB issued ASU No. 2020-1 “Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” These amendments, among other things, clarify that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under Topic 323, Investments-Equity Method and Joint Ventures, for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that, when determining the accounting for certain forward contracts and purchased options a company should not consider, whether upon settlement or exercise, if the underlying securities would be accounted for under the equity method or fair value option. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application is permitted, including early adoption in an interim period. An entity should apply ASU 2020-1 prospectively at the beginning of the interim period that includes the adoption date. The Company adopted ASU 2020-1 on January 1, 2021 and it did not have a material impact on its financial statements.
In October 2020, the FASB issued ASU No. 2020-8, "Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs," to clarify that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, and early application is not permitted. The Company adopted this new accounting standard on January 1, 2021, and the adoption did not have a material impact on its financial statements.
Newly Issued But Not Yet Effective Accounting Standards:
On March 12, 2020, the FASB issued Accounting Standards Update (ASU) 2020-4, "Reference Rate Reform (“ASC 848”): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." ASC 848 contains optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The Company has formed a cross-functional project team to lead the transition from LIBOR to adoption of alternative reference rates which include Secured Overnight Financing Rate (“SOFR”), American Interbank Offered Rate ("Ameribor"), and Bloomberg Short-Term Bank Yield Index ("BSBY"). The Company identified loans that renewed prior to 2021 and obtained updated reference rate language at the time of renewal. Additionally, management is utilizing the timeline guidance published by the Alternative Reference Rates Committee to develop and achieve internal milestones during this transitional period. Additionally, the Company has adhered to the International Swaps and Derivatives Association 2020 IBOR Fallbacks Protocol that was released on October 23, 2020.
The Company discontinued the use of new LIBOR-based loans by December 31, 2021, according to regulatory guidelines. Legacy LIBOR-based loans will be transitioned to an alternative reference rate on or before June 30, 2023. The
73
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
guidance under ASC-848 will be available for a limited time, generally through December 31, 2022. The Company expects to adopt the LIBOR transition relief allowed under this standard.
In August 2021, the FASB issued ASU 2021-6, "Presentation of Financial Statements (Topic 205), Financial Services - Depository and Lending (Topic 942) and Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants." The guidance is effective upon its addition to the FASB codification and will not have a material impact on the consolidated financial statements.
Reclassifications:
Certain amounts appearing in the financial statements and notes thereto for prior periods have been reclassified to conform with the current presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported.
NOTE 2 – SECURITIES
| (dollars in thousands) | Amortized Cost | Gross Unrealized Gain | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
| 2021 | |||||||||||||||||||||||
| U.S. Treasury securities | $ | $ | $ | $ | |||||||||||||||||||
| U.S. government sponsored agencies | ( | ||||||||||||||||||||||
| Mortgage-backed securities: residential | ( | ||||||||||||||||||||||
| Mortgage-backed securities: commercial | |||||||||||||||||||||||
| State and municipal securities | ( | ||||||||||||||||||||||
| Total | $ | $ | $ | ( | $ | ||||||||||||||||||
| 2020 | |||||||||||||||||||||||
| U.S. government sponsored agencies | $ | $ | $ | ( | $ | ||||||||||||||||||
| Mortgage-backed securities: residential | ( | ||||||||||||||||||||||
| Mortgage-backed securities: commercial | |||||||||||||||||||||||
| State and municipal securities | ( | ||||||||||||||||||||||
| Total | $ | $ | $ | ( | $ | ||||||||||||||||||
Information regarding the fair value and amortized cost of available-for-sale debt securities by maturity as of December 31, 2021 is presented below. Maturity information is based on contractual maturity for all securities other than mortgage-backed securities. Actual maturities of securities may differ from contractual maturities because borrowers may have the right to prepay the obligation without prepayment penalty.
74
NOTE 2 – SECURITIES (continued)
| (dollars in thousands) | Amortized Cost | Fair Value | |||||||||
| Due in one year or less | $ | $ | |||||||||
| Due after one year through five years | |||||||||||
| Due after five years through ten years | |||||||||||
| Due after ten years | |||||||||||
| Mortgage-backed securities | |||||||||||
| Total debt securities | $ | $ | |||||||||
Security proceeds, gross gains and gross losses for 2021, 2020 and 2019 were as follows:
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Sales of securities available-for-sale | |||||||||||||||||
| Proceeds | $ | $ | $ | ||||||||||||||
| Gross gains | |||||||||||||||||
| Gross losses | ( | ||||||||||||||||
| Number of securities | |||||||||||||||||
In accordance with ASU No. 2017-8, purchase premiums for callable securities are amortized to the earliest call date and premiums on non-callable securities as well as discounts are recognized in interest income using the interest method over the terms of the securities or over the estimated lives of mortgage-backed securities. Gains and losses on sales are based on the amortized cost of the security sold and recorded on the trade date.
Securities with carrying values of $300.8 million and $382.7 million were pledged as of December 31, 2021 and 2020, respectively, as collateral for borrowings from the FHLB and Federal Reserve Bank and for other purposes as permitted or required by law.
| Less than 12 months | 12 months or more | Total | |||||||||||||||||||||||||||||||||
| (dollars in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||||
| 2021 | |||||||||||||||||||||||||||||||||||
| U.S. government sponsored agencies | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Mortgage-backed securities: residential | |||||||||||||||||||||||||||||||||||
| State and municipal securities | |||||||||||||||||||||||||||||||||||
| Total temporarily impaired | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| 2020 | |||||||||||||||||||||||||||||||||||
| U.S. government sponsored agencies | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Mortgage-backed securities: residential | |||||||||||||||||||||||||||||||||||
| State and municipal securities | |||||||||||||||||||||||||||||||||||
| Total temporarily impaired | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
75
NOTE 2 – SECURITIES (continued)
The number of securities with unrealized losses as of December 31, 2021 and 2020 is presented below.
| Less than 12 months | 12 months or more | Total | |||||||||||||||
| 2021 | |||||||||||||||||
| U.S. government sponsored agencies | |||||||||||||||||
| Mortgage-backed securities: residential | |||||||||||||||||
| State and municipal securities | |||||||||||||||||
| Total temporarily impaired | |||||||||||||||||
| 2020 | |||||||||||||||||
| U.S. government sponsored agencies | |||||||||||||||||
| Mortgage-backed securities: residential | |||||||||||||||||
| State and municipal securities | |||||||||||||||||
| Total temporarily impaired | |||||||||||||||||
Available-for-sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For available-for sale debt securities in an unrealized loss position, management first assesses whether it intends to sell, or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through the consolidated income statement. For available-for sale debt securities that do not meet the criteria, management evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors. If this assessment indicates that a credit loss exists, management compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of applicable taxes. No allowance for credit losses for available-for-sale debt securities was needed at December 31, 2021. Accrued interest receivable on available-for-sale debt securities totaled $7.4 million at December 31, 2021 and is excluded from the estimate of credit losses.
The Company does not have a history of actively trading securities, but keeps the securities available-for-sale should liquidity for interest rate risk management or other needs develop that would warrant the sale of securities. While these securities are held in the available-for-sale portfolio, it is management’s current intent and ability to hold them until a recovery in fair value or maturity.
76
NOTE 3 – LOANS
Total loans outstanding as of the years ended December 31, 2021 and 2020 consisted of the following:
| (dollars in thousands) | 2021 | 2020 | |||||||||
| Commercial and industrial loans: | |||||||||||
| Working capital lines of credit loans | $ | $ | |||||||||
| Non-working capital loans | |||||||||||
| Total commercial and industrial loans | |||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||
| Construction and land development loans | |||||||||||
| Owner occupied loans | |||||||||||
| Nonowner occupied loans | |||||||||||
| Multi-family loans | |||||||||||
| Total commercial real estate and multi-family residential loans | |||||||||||
| Agri-business and agricultural loans: | |||||||||||
| Loans secured by farmland | |||||||||||
| Loans for agricultural production | |||||||||||
| Total agri-business and agricultural loans | |||||||||||
| Other commercial loans | |||||||||||
| Total commercial loans | |||||||||||
| Consumer 1-4 family mortgage loans: | |||||||||||
| Closed end first mortgage loans | |||||||||||
| Open end and junior lien loans | |||||||||||
| Residential construction and land development loans | |||||||||||
| Total consumer 1-4 family mortgage loans | |||||||||||
| Other consumer loans | |||||||||||
| Total consumer loans | |||||||||||
| Gross loans | |||||||||||
| Less: Allowance for credit losses | ( | ( | |||||||||
| Net deferred loan fees | ( | ( | |||||||||
| Loans, net | $ | $ | |||||||||
The recorded investment in loans does not include accrued interest, which totaled $10.0 million at December 31, 2021.
The Company had $350,000 and $19,000 in residential real estate loans in process of foreclosure as of December 31, 2021 and 2020, respectively.
77
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY
The Company adopted ASC 326 using the modified retrospective for all financial assets measured at amortized cost. Results for reporting periods after January 1, 2021 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.
| (dollars in thousands) | Commercial and Industrial | Commercial Real Estate and Multi-family Residential | Agri-business and Agricultural | Other Commercial | Consumer 1-4 Family Mortgage | Other Consumer | Unallocated | Total | |||||||||||||||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Impact of adopting ASC 326 | ( | ||||||||||||||||||||||||||||||||||||||||||||||
| Provision for credit losses | ( | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||
| Loans charged-off | ( | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Recoveries | |||||||||||||||||||||||||||||||||||||||||||||||
| Net loans (charged-off) recovered | ( | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes commercial loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis for Special Mention, Substandard and Doubtful grade loans and annually on Pass grade loans over $250,000 .
The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as Special Mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard. Loans classified as Substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized as the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loans are considered to be "Pass" rated when they are reviewed as part of the previously described process and do not meet the criteria above with the exception of consumer troubled debt restructurings, which are evaluated and listed with Substandard commercial grade loans and consumer nonaccrual loans which are evaluated individually and listed with “Not Rated” loans. Loans listed as Not Rated are consumer loans or commercial loans with consumer characteristics included in groups of homogenous loans which are analyzed for credit quality indicators utilizing delinquency status.
78
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
The following table summarizes the risk category of loans by loan segment and origination date as of December 31, 2021:
| (dollars in thousands) | 2021 | 2020 | 2019 | 2018 | 2017 | Prior | Term Total | Revolving | Total | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Working capital lines of credit loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Substandard | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Non-working capital loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Substandard | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Not Rated | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Construction and land development loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Owner occupied loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Substandard | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Nonowner occupied loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Multi-family loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loans secured by farmland: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Substandard | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loans for agricultural production: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other commercial loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Special Mention | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Consumer 1-4 family mortgage loans: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Substandard | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Not Rated | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Open end and junior lien loans | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Substandard | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Not Rated | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Residential construction loans | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Not Rated | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Other consumer loans | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pass | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Substandard | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Not Rated | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| TOTAL | $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||
79
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
As of December 31, 2021, $26.2 million in PPP loans were included in the "Pass" category of non-working capital commercial and industrial loans. These loans were included in this risk rating category because they are fully guaranteed by the Small Business Administration ("SBA").
Nonaccrual and Past Due Loans:
The Company does not record interest on nonaccrual loans until principal is recovered. For all loan classes, a loan is generally placed on nonaccrual status when principal or interest becomes 90 days past due unless it is well secured and in process of collection, or earlier when concern exists as to the ultimate collectability of principal or interest. Interest accrued but not received is reversed against earnings. Cash interest received on these loans is applied to the principal balance until the principal is recovered or until the loan returns to accrual status. Loans may be returned to accrual status when all the principal and interest amounts contractually due are brought current, remain current for a prescribed period, and the payments are reasonably assured.
| (dollars in thousands) | Loans Not Past Due | 30-89 Days Past Due | Greater than 89 Days Past Due and Accruing | Total Accruing | Total Nonaccrual | Nonaccrual With No Allowance For Credit Loss | Total | |||||||||||||||||||||||||||||||||||||
| Commercial and industrial loans: | ||||||||||||||||||||||||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
| Non-working capital loans | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | ||||||||||||||||||||||||||||||||||||||||||||
| Construction and land development loans | ||||||||||||||||||||||||||||||||||||||||||||
| Owner occupied loans | ||||||||||||||||||||||||||||||||||||||||||||
| Nonowner occupied loans | ||||||||||||||||||||||||||||||||||||||||||||
| Multi-family loans | ||||||||||||||||||||||||||||||||||||||||||||
| Agri-business and agricultural loans: | ||||||||||||||||||||||||||||||||||||||||||||
| Loans secured by farmland | ||||||||||||||||||||||||||||||||||||||||||||
| Loans for agricultural production | ||||||||||||||||||||||||||||||||||||||||||||
| Other commercial loans | ||||||||||||||||||||||||||||||||||||||||||||
| Consumer 1‑4 family mortgage loans: | ||||||||||||||||||||||||||||||||||||||||||||
| Closed end first mortgage loans | ||||||||||||||||||||||||||||||||||||||||||||
| Open end and junior lien loans | ||||||||||||||||||||||||||||||||||||||||||||
| Residential construction loans | ||||||||||||||||||||||||||||||||||||||||||||
| Other consumer loans | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
As of December 31, 2021, there were an insignificant number of loans 30-89 days past due or greater than 89 days past due on nonaccrual. Additionally, interest income recognized on nonaccrual loans was insignificant during the year ended December 31, 2021.
80
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
When management determines that foreclosure is probable, expected credit losses for collateral dependent loans are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. A loan is considered collateral dependent when the borrower is experiencing financial difficulty and the loan is expected to be repaid substantially through the operation or sale of the collateral. The class of loan represents the primary collateral type associated with the loan. Significant year over year changes are reflective of changes in nonaccrual status and not necessarily associated with credit quality indicators like appraisal value.
| (dollars in thousands) | Real Estate | General Business Assets | Other | Total | ||||||||||||||||||||||
| Commercial and industrial loans: | ||||||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | $ | ||||||||||||||||||||||
| Non-working capital loans | ||||||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | ||||||||||||||||||||||||||
| Owner occupied loans | ||||||||||||||||||||||||||
| Nonowner occupied loans | ||||||||||||||||||||||||||
| Agri-business and agricultural loans: | ||||||||||||||||||||||||||
| Loans secured by farmland | ||||||||||||||||||||||||||
| Consumer 1-4 family mortgage loans: | ||||||||||||||||||||||||||
| Closed end first mortgage loans | ||||||||||||||||||||||||||
| Open end and junior lien loans | ||||||||||||||||||||||||||
| Other consumer loans | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
Troubled Debt Restructurings:
Troubled debt restructured loans are included in the totals for individually analyzed loans. The Company has allocated $5.8 million and $5.5 million of specific allocations to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2021 and December 31, 2020, respectively. The Company is not committed to lend additional funds to debtors whose loans have been modified in a troubled debt restructuring.
| (dollars in thousands) | December 31, 2021 | December 31, 2020 | ||||||||||||
| Accruing troubled debt restructured loans | $ | $ | ||||||||||||
| Nonaccrual troubled debt restructured loans | ||||||||||||||
| Total troubled debt restructured loans | $ | $ | ||||||||||||
During the year ending December 31, 2021, certain loans were modified as troubled debt restructurings. The modified terms of these loans include one or a combination of the following: inadequate compensation for the terms of the restructure or renewal; a modification of the repayment terms which delays principal payment for some period; terms offered to borrowers in financial distress where no additional credit enhancements were obtained at the time of renewal.
Additional concessions were granted to borrowers during 2021 with previously identified troubled debt restructured loans. There were 8 loans with recorded investments totaling $2.2 million where collateral values or cash flows were insufficient to support the loans. These troubled debt restructured loans with additional concessions decreased the allowance by $423,000 and resulted in no charge-offs for the year ending December 31, 2021. These concessions are not included in the table below.
81
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
| Modified Repayment Terms | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | Number of Loans | Extension Period or Range (in months) | |||||||||||||||||||||||||||
| Troubled Debt Restructurings | ||||||||||||||||||||||||||||||||
| Consumer 1-4 family loans: | ||||||||||||||||||||||||||||||||
| Closed end first mortgage loans | $ | $ | ||||||||||||||||||||||||||||||
| Total | $ | $ | ||||||||||||||||||||||||||||||
For the period ending December 31, 2021, the troubled debt restructurings described above had no impact to the allowance and no charge-offs were recorded.
As of December 31, 2021, one retail loan in the amount of $11,000 had a COVID-19 related deferral. In accordance with Section 4013 of the CARES Act, this deferral was not considered to be a troubled debt restructuring. This provision was effective through January 1, 2022 under the Consolidated Appropriations Act, 2021.
During the year ended December 31, 2020, certain loans were modified as troubled debt restructurings. The modified terms of these loans include one or a combination of the following: inadequate compensation for the terms of the restructure or renewal; a modification of the repayment terms which delays principal repayment for some period; or renewal terms offered to borrowers in financial distress where no additional credit enhancements were obtained at the time of renewal.
| Modified Repayment Terms | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | Number of Loans | Extension Period or Range (in months) | |||||||||||||||||||||||||||
| Troubled Debt Restructurings | ||||||||||||||||||||||||||||||||
| Commercial and industrial loans: | ||||||||||||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | ||||||||||||||||||||||||||||||
| Non-working capital lines of credit loans | ||||||||||||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | ||||||||||||||||||||||||||||||||
| Owner occupied loans | ||||||||||||||||||||||||||||||||
| Total | $ | $ | ||||||||||||||||||||||||||||||
For the period ending December 31, 2020, the troubled debt restructurings described above had no impact to the allowance and no charge-offs were recorded.
As of December 31, 2020, total deferrals attributed to COVID-19 were $100.7 million representing 49 borrowers. This represented 2.2 % of the total loan portfolio. Of that 22 were commercial loan borrowers representing $98.2 million in loans, or 2.3 % of commercial loans, and 27 were retail loan borrowers representing $2.5 million, or 0.7 % of total retail loans. The majority of all loan deferrals were for a period of 90 days. Of the total commercial deferrals attributed to COVID-19, $11.9 million represented a first deferral action, $22.8 million represented a second deferral action, $41.9 million represented a third deferral action and $24.1 million represented a fourth deferral action. Two borrowers represented 90 % of the fourth deferral population and were commercial real estate nonowner occupied loans supported by adequate collateral and personal guarantors and consist of loans to the hotel and accommodation industry. All COVID-19 related loan deferrals remain on accrual status, as each deferral is individually analyzed, and management has determined that all contractual cashflows are collectable at this
82
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
time. In accordance with Section 4013 of the CARES Act, these were not considered to be troubled debt restructurings and were excluded from the table above.
During the year ending December 31, 2019, certain loans were modified as troubled debt restructurings. The modified terms of these loans include one or a combination of the following: inadequate compensation for the terms of the restructure or renewal; a modification of the repayment terms which delays principal repayment for some period; or renewal terms offered to borrowers in financial distress where no additional credit enhancements were obtained at the time of renewal.
Additional concessions were granted to borrowers during 2019 with previously identified troubled debt restructured loans. There were three commercial real estate loans with recorded investments totaling $1.9 million and five commercial and industrial loans with recorded investments totaling $2.4 million where the collateral values or cash flows were insufficient to support the loans. These troubled debt restructured loans with additional concessions decreased the allowance by $484,000 and resulted in no charge-offs for year ending December 31, 2019. These concessions are not included in the table below.
| Modified Repayment Terms | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | Number of Loans | Extension Period or Range (in months) | |||||||||||||||||||||||||||
| Troubled Debt Restructurings | ||||||||||||||||||||||||||||||||
| Commercial and industrial loans: | ||||||||||||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | ||||||||||||||||||||||||||||||
| Total | $ | $ | ||||||||||||||||||||||||||||||
For the period ending December 31, 2019, the working capital line of credit troubled debt restructuring described above had no impact to the allowance and no charge-offs were recorded.
A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. The following table presents loans modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the period ending December 31, 2021, 2020 and 2019.
| 2021 | 2020 | 2019 | |||||||||||||||||||||||||||||||||
| (dollars in thousands) | Number of Loans | Recorded Investment | Number of Loans | Recorded Investment | Number of Loans | Recorded Investment | |||||||||||||||||||||||||||||
| Troubled Debt Restructurings that Subsequently Defaulted Commercial and industrial loans: | |||||||||||||||||||||||||||||||||||
| Non-working capital loans | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||||||||||||||||||||
83
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
Allowance for Loan Losses (Prior to January 1, 2021)
Prior to the adoption of ASC 326 on January 1, 2021 the Company calculated the allowance for loan losses using the incurred losses methodology. The following tables are disclosures related to the allowance for loan losses in prior periods.
The following tables present the activity and balance in the allowance for loan losses by portfolio segment for the year ended December 31, 2020 and 2019. PPP loans are fully guaranteed by the SBA and have not been allocated for within the allowance for loan losses.
| (dollars in thousands) | Commercial and Industrial | Commercial Real Estate and Multi-family Residential | Agri-business and Agricultural | Other Commercial | Consumer 1-4 Family Mortgage | Other Consumer | Unallocated | Total | |||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Provision for loan losses | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Loans charged-off | ( | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Recoveries | |||||||||||||||||||||||||||||||||||||||||||||||
| Net loans (charged-off) recovered | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Commercial and Industrial | Commercial Real Estate and Multi-family Residential | Agri-business and Agricultural | Other Commercial | Consumer 1-4 Family Mortgage | Other Consumer | Unallocated | Total | |||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | |||||||||||||||||||||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Provision for loan losses | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Loans charged-off | ( | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Recoveries | |||||||||||||||||||||||||||||||||||||||||||||||
| Net loans (charged-off) recovered | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
84
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
The following tables present balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2020:
| (dollars in thousands) | Commercial and Industrial | Commercial Real Estate and Multi-family Residential | Agri-business and Agricultural | Other Commercial | Consumer 1-4 Family Mortgage | Other Consumer | Unallocated | Total | |||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for loan losses: | |||||||||||||||||||||||||||||||||||||||||||||||
| Ending allowance balance attributable to loans: | |||||||||||||||||||||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Collectively evaluated for impairment | |||||||||||||||||||||||||||||||||||||||||||||||
| Total ending allowance balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Loans: | |||||||||||||||||||||||||||||||||||||||||||||||
| Loans individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Loans collectively evaluated for impairment | |||||||||||||||||||||||||||||||||||||||||||||||
| Total ending loans balance | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
85
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2020:
| (dollars in thousands) | Unpaid Principal Balance | Recorded Investment | Allowance for Loan Losses Allocated | ||||||||||||||
| With no related allowance recorded: | |||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | ||||||||||||||
| Non-working capital loans | |||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||
| Owner occupied loans | |||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||
| Loans secured by farmland | |||||||||||||||||
| Consumer 1‑4 family loans: | |||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||
| Open end and junior lien loans | |||||||||||||||||
| With an allowance recorded: | |||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||
| Working capital lines of credit loans | |||||||||||||||||
| Non-working capital loans | |||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||
| Owner occupied loans | |||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||
| Loans secured by farmland | |||||||||||||||||
| Consumer 1‑4 family mortgage loans: | |||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
86
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
The following table presents loans individually evaluated for impairment by class of loans for the year ended December 31, 2020:
| (dollars in thousands) | Average Recorded Investment | Interest Income Recognized | Cash Basis Interest Income Recognized | ||||||||||||||
| With no related allowance recorded: | |||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | ||||||||||||||
| Non-working capital loans | |||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||
| Owner occupied loans | |||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||
| Loans secured by farmland | |||||||||||||||||
| Loans for agricultural production | |||||||||||||||||
| Consumer 1-4 family loans: | |||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||
| Open end and junior lien loans | |||||||||||||||||
| With an allowance recorded: | |||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||
| Working capital lines of credit loans | |||||||||||||||||
| Non-working capital loans | |||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||
| Construction and land development loans | |||||||||||||||||
| Owner occupied loans | |||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||
| Loans secured by farmland | |||||||||||||||||
| Consumer 1-4 family mortgage loans: | |||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||
| Open end and junior lien loans | |||||||||||||||||
| Residential construction loans | |||||||||||||||||
| Other consumer loans | |||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
87
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
The following table presents loans individually evaluated for impairment by class of loans for the year ended December 31, 2019:
| (dollars in thousands) | Average Recorded Investment | Interest Income Recognized | Cash Basis Interest Income Recognized | ||||||||||||||
| With no related allowance recorded: | |||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | ||||||||||||||
| Non-working capital loans | |||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||
| Owner occupied loans | |||||||||||||||||
| Loans for ag production | |||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||
| Loans secured by farmland | |||||||||||||||||
| Consumer 1‑4 family loans: | |||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||
| Open end and junior lien loans | |||||||||||||||||
| With an allowance recorded: | |||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||
| Working capital lines of credit loans | |||||||||||||||||
| Non-working capital loans | |||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||
| Construction and land development loans | |||||||||||||||||
| Owner occupied loans | |||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||
| Loans secured by farmland | |||||||||||||||||
| Consumer 1‑4 family mortgage loans: | |||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||
| Open end and junior lien loans | |||||||||||||||||
| Residential constructions loans | |||||||||||||||||
| Other consumer loans | |||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
88
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
The following table presents the aging of the recorded investment in past due loans as of December 31, 2020 by class of loans:
| (dollars in thousands) | Loans Not Past Due | 30-89 Days Past Due | Greater than 90 Days Past Due and Still Accruing | Nonaccrual | Total Past Due and Nonaccrual | Total | |||||||||||||||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Non-working capital loans | |||||||||||||||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||||||||||||||||||||
| Construction and land development loans | |||||||||||||||||||||||||||||||||||
| Owner occupied loans | |||||||||||||||||||||||||||||||||||
| Nonowner occupied loans | |||||||||||||||||||||||||||||||||||
| Multi-family loans | |||||||||||||||||||||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||||||||||||||||||||
| Loans secured by farmland | |||||||||||||||||||||||||||||||||||
| Loans for agricultural production | |||||||||||||||||||||||||||||||||||
| Other commercial loans | |||||||||||||||||||||||||||||||||||
| Consumer 1‑4 family mortgage loans: | |||||||||||||||||||||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||||||||||||||||||||
| Open end and junior lien loans | |||||||||||||||||||||||||||||||||||
| Residential construction loans | |||||||||||||||||||||||||||||||||||
| Other consumer loans | |||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
89
NOTE 4 – ALLOWANCE FOR CREDIT LOSSES AND CREDIT QUALITY (continued)
As of December 31, 2020, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
| (dollars in thousands) | Pass | Special Mention | Substandard | Doubtful | Not Rated | Total | ||||||||||||||||||||||||||||||||
| Commercial and industrial loans: | ||||||||||||||||||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Non-working capital loans | ||||||||||||||||||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | ||||||||||||||||||||||||||||||||||||||
| Construction and land development loans | ||||||||||||||||||||||||||||||||||||||
| Owner occupied loans | ||||||||||||||||||||||||||||||||||||||
| Nonowner occupied loans | ||||||||||||||||||||||||||||||||||||||
| Multi-family loans | ||||||||||||||||||||||||||||||||||||||
| Agri-business and agricultural loans: | ||||||||||||||||||||||||||||||||||||||
| Loans secured by farmland | ||||||||||||||||||||||||||||||||||||||
| Loans for agricultural production | ||||||||||||||||||||||||||||||||||||||
| Other commercial loans | ||||||||||||||||||||||||||||||||||||||
| Consumer 1‑4 family mortgage loans: | ||||||||||||||||||||||||||||||||||||||
| Closed end first mortgage loans | ||||||||||||||||||||||||||||||||||||||
| Open end and junior lien loans | ||||||||||||||||||||||||||||||||||||||
| Residential construction loans | ||||||||||||||||||||||||||||||||||||||
| Other consumer loans | ||||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
90
NOTE 5 – FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1 Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2 Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Securities: Securities available-for-sale are valued primarily by a third party pricing service. The fair values of securities available-for-sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or pricing models which utilize significant observable inputs such as matrix pricing. This is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). These models utilize the market approach with standard inputs that include, but are not limited to benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. For certain municipal securities that are not rated and observable inputs about the specific issuer are not available, fair values are estimated using observable data from other municipal securities presumed to be similar or other market data on other non-rated municipal securities (Level 3 inputs).
The Company’s Finance Department, which is responsible for all accounting and SEC compliance, and the Company’s Treasury Department, which is responsible for investment portfolio management and asset/liability modeling, are the two areas that determine the Company’s valuation policies and procedures. Both of these areas report directly to the Executive Vice President and Chief Financial Officer of the Company. For assets or liabilities that may be considered for Level 3 fair value measurement on a recurring basis, these two departments and the Executive Vice President and Chief Financial Officer determine the appropriate level of the assets or liabilities under consideration. If there are assets or liabilities that are determined to be Level 3 by this group, the Risk Management Committee of the Company and the Audit Committee of the board of directors (the “Board”) are made aware of such assets at their next scheduled meeting.
Securities pricing is obtained on securities from a third party pricing service and all security prices are tested annually against prices from another third party provider and reviewed with a market value price tolerance variance that varies by sector: municipal securities +/- 5 3 % and U.S. treasuries +/-1 100,000 or more, a determination of materiality is made for the amount over the threshold. Any security that would have a material threshold difference would be further investigated to determine why the variance exists and if any action is needed concerning the security pricing for that individual security. Changes in market value are reviewed monthly in aggregate by security type and any material differences are reviewed to determine why they exist. At least annually, the pricing methodology of the pricing service is received and reviewed to support the fair value levels used by the Company. A detailed pricing evaluation is requested and reviewed on any security determined to be fair valued using unobservable inputs by the pricing service.
Mortgage banking derivative: The fair values of mortgage banking derivatives are based on observable market data as of the measurement date (Level 2).
Interest rate swap derivatives: Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing
91
NOTE 5 – FAIR VALUE (continued)
services. The fair value of interest rate swap derivatives is determined by pricing or valuation models using observable market data as of the measurement date (Level 2).
Collateral dependent loans: Collateral dependent loans with specific allocations of the allowance for credit losses generally based on the fair value of the underlying collateral when repayment is expected solely from the collateral. Fair value is determined using several methods. Generally, the fair value of real estate is based on appraisals by qualified third party appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and result in a Level 3 classification of the inputs for determining fair value. In addition, the Company’s management routinely applies internal discount factors to the value of appraisals used in the fair value evaluation of collateral dependent loans. The deductions to the appraisals take into account changing business factors and market conditions, as well as value impairment in cases where the appraisal date predates a likely change in market conditions. Commercial real estate is generally discounted from its appraised value by 0 -50 % with the higher discounts applied to real estate that is determined to have a thin trading market or to be specialized collateral. In addition to real estate, the Company’s management evaluates other types of collateral as follows: (a) raw and finished inventory is discounted from its cost or book value by 35 -65 %, depending on the marketability of the goods (b) finished goods are generally discounted by 30 -60 %, depending on the ease of marketability, cost of transportation or scope of use of the finished good (c) work in process inventory is typically discounted by 50 %-100 %, depending on the length of manufacturing time, types of components used in the completion process, and the breadth of the user base (d) equipment is valued at a percentage of depreciated book value or recent appraised value, if available, and is typically discounted at 30 -70 % after various considerations including age and condition of the equipment, marketability, breadth of use, and whether the equipment includes unique components or add-ons; and (e) marketable securities are discounted by 10 %-30 %, depending on the type of investment, age of valuation report and general market conditions. This methodology is based on a market approach and typically results in a Level 3 classification of the inputs for determining fair value.
Mortgage servicing rights: As of December 31, 2021, the fair value of the Company’s Level 3 servicing assets for residential mortgage loans (“MSRs”) was $3.1 million, carried at amortized cost less $715,000 in a valuation reserve, or $2.4 million. These residential mortgage loans have a weighted average interest rate of 3.4 %, a weighted average maturity of 20 years and are secured by homes generally within the Company’s market area of Northern Indiana and Indianapolis. A valuation model is used to estimate fair value by stratifying the portfolios on the basis of certain risk characteristics, including loan type and interest rate. Impairment is estimated based on an income approach. The inputs used include estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, late fees, and float income. The most significant assumption used to value MSRs is prepayment rate. Prepayment rates are estimated based on published industry consensus prepayment rates. The most significant unobservable assumption is the discount rate. At December 31, 2021, the constant prepayment speed (“PSA”) used was 249 and discount rate used was 9.5 %. At December 31, 2020, the PSA used was 204 and the discount rate used was 9.4 %.
Other real estate owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are reviewed by the Company’s internal appraisal officer. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable properties used to determine value. Such adjustments are usually significant and result in a Level 3 classification. In addition, the Company’s management may apply discount factors to the appraisals to take into account changing business factors and market conditions, as well as value impairment in cases where the appraisal date predates a likely change in market conditions. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.
Real estate mortgage loans held-for-sale: Real estate mortgage loans held for sale are carried at the lower of cost or fair value, as determined by outstanding commitments, from third party investors, and result in a Level 2 classification.
92
NOTE 5 – FAIR VALUE (continued)
The table below presents the balances of assets and liabilities measured at fair value on a recurring basis:
| December 31, 2021 | |||||||||||||||||||||||
| Fair Value Measurements Using | Assets | ||||||||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | at Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| U.S. Treasury securities | $ | $ | $ | $ | |||||||||||||||||||
| U.S. government sponsored agency securities | |||||||||||||||||||||||
| Mortgage-backed securities: residential | |||||||||||||||||||||||
| Mortgage-backed securities: commercial | |||||||||||||||||||||||
| State and municipal securities | |||||||||||||||||||||||
| Total Securities | |||||||||||||||||||||||
| Mortgage banking derivative | |||||||||||||||||||||||
| Interest rate swap derivative | |||||||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Mortgage banking derivative | $ | $ | $ | $ | |||||||||||||||||||
| Interest rate swap derivative | |||||||||||||||||||||||
| Total liabilities | $ | $ | $ | $ | |||||||||||||||||||
| December 31, 2020 | |||||||||||||||||||||||
| Fair Value Measurements Using | Assets | ||||||||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | at Fair Value | |||||||||||||||||||
| Assets: | |||||||||||||||||||||||
| U.S. government sponsored agency securities | $ | $ | $ | $ | |||||||||||||||||||
| Mortgage-backed securities: residential | |||||||||||||||||||||||
| Mortgage-backed securities: commercial | |||||||||||||||||||||||
| State and municipal securities | |||||||||||||||||||||||
| Total Securities | |||||||||||||||||||||||
| Mortgage banking derivative | |||||||||||||||||||||||
| Interest rate swap derivative | |||||||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||
| Mortgage banking derivative | $ | $ | $ | $ | |||||||||||||||||||
| Interest rate swap derivative | |||||||||||||||||||||||
| Total liabilities | $ | $ | $ | $ | |||||||||||||||||||
The fair value of Level 3 available-for-sale securities was immaterial to warrant additional recurring fair value disclosures as of December 31, 2021 and 2020.
93
NOTE 5 – FAIR VALUE (continued)
The tables below present the amount of assets measured at fair value on a nonrecurring basis:
| December 31, 2021 | |||||||||||||||||||||||
| Fair Value Measurements Using | Assets | ||||||||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | at Fair Value | |||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | $ | |||||||||||||||||||
| Non-working capital loans | |||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||||||||
| Owner occupied loans | |||||||||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||||||||
| Loans secured by farmland | |||||||||||||||||||||||
| Total collateral dependent loans | $ | $ | $ | $ | |||||||||||||||||||
| Other real estate owned | |||||||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
| December 31, 2020 | |||||||||||||||||||||||
| Fair Value Measurements Using | Assets | ||||||||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | at Fair Value | |||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||
| Commercial and industrial loans: | |||||||||||||||||||||||
| Working capital lines of credit loans | $ | $ | $ | $ | |||||||||||||||||||
| Non-working capital loans | |||||||||||||||||||||||
| Commercial real estate and multi-family residential loans: | |||||||||||||||||||||||
| Owner occupied loans | |||||||||||||||||||||||
| Agri-business and agricultural loans: | |||||||||||||||||||||||
| Loans secured by farmland | |||||||||||||||||||||||
| Consumer 1‑4 family mortgage loans: | |||||||||||||||||||||||
| Closed end first mortgage loans | |||||||||||||||||||||||
| Total collateral dependent loans | $ | $ | $ | $ | |||||||||||||||||||
| Other real estate owned | |||||||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
94
NOTE 5 – FAIR VALUE (continued)
The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2021:
| (dollars in thousands) | Fair Value | Valuation Methodology | Unobservable Inputs | Average | Range of Inputs | ||||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||||||||
| Commercial and industrial | $ | ||||||||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||||||||
| Commercial real estate and multi-family residential loans | |||||||||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||||||||
| Agri-business and agricultural | |||||||||||||||||||||||||||||
| Other real estate owned | |||||||||||||||||||||||||||||
95
NOTE 5 – FAIR VALUE (continued)
The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2020:
| (dollars in thousands) | Fair Value | Valuation Methodology | Unobservable Inputs | Average | Range of Inputs | ||||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||||||||
| Commercial and industrial | $ | ||||||||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||||||||
| Commercial real estate | |||||||||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||||||||
| Agri-business and agricultural | |||||||||||||||||||||||||||||
| Collateral dependent loans: | |||||||||||||||||||||||||||||
| Consumer 1-4 family mortgage | |||||||||||||||||||||||||||||
96
NOTE 5 – FAIR VALUE (continued)
The following table contains the estimated fair values and the related carrying values of the Company’s financial instruments at December 31, 2021. Items which are not financial instruments are not included.
| December 31, 2021 | |||||||||||||||||||||||||||||
| Carrying | Estimated Fair Value | ||||||||||||||||||||||||||||
| (dollars in thousands) | Value | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||
| Financial Assets: | |||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Securities available-for-sale | |||||||||||||||||||||||||||||
| Real estate mortgages held-for-sale | |||||||||||||||||||||||||||||
| Loans, net | |||||||||||||||||||||||||||||
| Mortgage banking derivative | |||||||||||||||||||||||||||||
| Interest rate swap derivative | |||||||||||||||||||||||||||||
| Federal Reserve and Federal Home Loan Bank Stock | N/A | N/A | N/A | N/A | |||||||||||||||||||||||||
| Accrued interest receivable | |||||||||||||||||||||||||||||
| Financial Liabilities: | |||||||||||||||||||||||||||||
| Certificates of deposit | ( | ( | ( | ||||||||||||||||||||||||||
| All other deposits | ( | ( | ( | ||||||||||||||||||||||||||
| Federal Home Loan Bank advances | ( | ( | ( | ||||||||||||||||||||||||||
| Mortgage banking derivative | ( | ( | ( | ||||||||||||||||||||||||||
| Interest rate swap derivative | ( | ( | ( | ||||||||||||||||||||||||||
| Standby letters of credit | ( | ( | ( | ||||||||||||||||||||||||||
| Accrued interest payable | ( | ( | ( | ( | |||||||||||||||||||||||||
97
NOTE 5 – FAIR VALUE (continued)
The following table contains the estimated fair values and the related carrying values of the Company’s financial instruments at December 31, 2020. Items which are not financial instruments are not included.
| December 31, 2020 | |||||||||||||||||||||||||||||
| Carrying | Estimated Fair Value | ||||||||||||||||||||||||||||
| (dollars in thousands) | Value | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||
| Financial Assets: | |||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Securities available-for-sale | |||||||||||||||||||||||||||||
| Real estate mortgages held-for-sale | |||||||||||||||||||||||||||||
| Loans, net | |||||||||||||||||||||||||||||
| Mortgage banking derivative | |||||||||||||||||||||||||||||
| Interest rate swap derivative | |||||||||||||||||||||||||||||
| Federal Reserve and Federal Home Loan Bank Stock | N/A | N/A | N/A | N/A | |||||||||||||||||||||||||
| Accrued interest receivable | |||||||||||||||||||||||||||||
| Financial Liabilities: | |||||||||||||||||||||||||||||
| Certificates of deposit | ( | ( | ( | ||||||||||||||||||||||||||
| All other deposits | ( | ( | ( | ||||||||||||||||||||||||||
| Miscellaneous borrowings | ( | ( | ( | ||||||||||||||||||||||||||
| Federal Home Loan Bank advances | ( | ( | ( | ||||||||||||||||||||||||||
| Mortgage banking derivative | ( | ( | ( | ||||||||||||||||||||||||||
| Interest rate swap derivative | ( | ( | ( | ||||||||||||||||||||||||||
| Standby letters of credit | ( | ( | ( | ||||||||||||||||||||||||||
| Accrued interest payable | ( | ( | ( | ( | |||||||||||||||||||||||||
98
NOTE 6 – LAND, PREMISES AND EQUIPMENT, NET
Land, premises and equipment and related accumulated depreciation were as follows at December 31, 2021 and 2020:
| (dollars in thousands) | 2021 | 2020 | |||||||||
| Land | $ | $ | |||||||||
| Premises and improvements | |||||||||||
| Equipment and furniture | |||||||||||
| Total cost | |||||||||||
| Less accumulated depreciation | |||||||||||
| Land, premises and equipment, net | $ | $ | |||||||||
The Company had land, premises and equipment of $0 and $100,000 held for sale and included in other assets as of December 31, 2021 and 2020.
NOTE 7 – GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
There have been no changes in the $5.0 million carrying amount of goodwill since 2002.
Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. At December 31, 2021, the Company’s reporting unit had positive equity and the Company elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment. The Company’s annual impairment analysis was performed as of May 31, 2021. Circumstances did not substantially change during the second half of the year such that the Company did not believe it was necessary to do an additional impairment analysis.
NOTE 8 – DEPOSITS
The following table details total deposits as of December 31, 2021 and 2020:
| (dollars in thousands) | 2021 | 2020 | |||||||||
| Non-interest bearing demand deposits | $ | $ | |||||||||
| Savings and transaction accounts: | |||||||||||
| Savings deposits | |||||||||||
| Interest bearing demand deposits | |||||||||||
| Time deposits: | |||||||||||
| Other time deposits | |||||||||||
| Deposits of $100,000 to $250,000 | |||||||||||
| Deposits of $250,000 or more | |||||||||||
| Total deposits | $ | $ | |||||||||
99
NOTE 8 – DEPOSITS (continued)
At December 31, 2021, the scheduled maturities of time deposits were as follows:
| (dollars in thousands) | Amount | ||||
| Maturing in 2022 | $ | ||||
| Maturing in 2023 | |||||
| Maturing in 2024 | |||||
| Maturing in 2025 | |||||
| Maturing in 2026 | |||||
| Thereafter | |||||
| Total time deposits | $ | ||||
During 2021 and 2020 the Bank entered into agreements with IntraFi Network relative to their Insured Cash Sweep One-Way Buy program. As of December 31, 2021, the total amount available to the Bank via this program was $100.0 million, of which, $10.0 million was drawn compared to availability of $100.0 million and $10.0 million usage as of December 31, 2020.
NOTE 9 – BORROWINGS
For the years ending December 31, there was one outstanding advance from the FHLB as follows:
| (dollars in thousands) | 2021 | 2020 | |||||||||
Federal Home Loan Bank of Indianapolis Putable Advance, | $ | $ | |||||||||
The outstanding advance is a fixed-rate putable advance and may not be prepaid by the Company without penalty. The note requires monthly interest payments and is secured by residential real estate loans and securities with a carrying value of $478.4 million and $611.2 million at December 31, 2021 and 2020, respectively. At December 31, 2021 and 2020, the Company owned $10.4 800.0 million at the FHLB, but availability is limited to $227.8 million based on collateral and outstanding borrowings. Federal Reserve Discount Window borrowings were secured by commercial loans and investment securities with a carrying value of $804.4 million and $557.2 million as of December 31, 2021 and 2020. The Company had a borrowing capacity of $616.5 million and $490.4 million at the Federal Reserve Bank as of December 31, 2021 and 2020, respectively. There were no borrowings outstanding at the Federal Reserve Bank at December 31, 2021 and 2020.
The Company had $350.0 eleven 319.0 million and $394.0 million, respectively. There were no
On August 2, 2019 the Company entered into an unsecured revolving credit agreement with another financial institution allowing the Company to borrow up to $30.0 million; this credit agreement was subsequently amended and renewed on July 30, 2021. Funds provided under the agreement may be used to repurchase shares of the Company’s common stock under the share repurchase program, which was reauthorized by the Company’s board of directors on April 13, 2021. The credit agreement includes a negative pledge agreement whereby the Company agrees not to pledge or otherwise encumber the stock of the Bank. The credit agreement has a one year term which may be amended, extended, modified or renewed. Outstanding borrowings on the credit agreement were $0.00 million and $10.5 million at December 31, 2021 and 2020, respectively.
100
NOTE 10 – SUBORDINATED DEBENTURES
Lakeland Statutory Trust II, a trust formed by the Company (the “Trust”), issued $30.0 million of floating rate trust preferred securities on October 1, 2003 as part of a privately placed offering of such securities. The Company issued $30.9 million of subordinated debentures to the Trust in exchange for the proceeds of the Trust. The Company held a controlling interest in the Trust, but did not have a majority of voting rights; therefore the Trust was considered a variable interest entity. The Company was not considered the primary beneficiary of this Trust; therefore, the Trust was not consolidated in the Company’s financial statements, but rather the subordinated debentures was shown as a liability prior to being redeemed.
Subject to the Company having received prior approval of the Federal Reserve, the Company was able to redeem the subordinated debentures, in whole or in part, but in all cases in a principal amount with integral multiples of $1,000 , on any interest payment date on or after October 1, 2008 at 100 % of the principal amount, plus accrued and unpaid interest. The subordinated debentures were required to be redeemed no later than 2033. These securities were considered Tier I capital (with certain limitations applicable) under current regulatory guidelines and, subject to certain limitations, were also considered Tier 1 capital under Basel III.
On December 31, 2019, the Company redeemed $30.0 million of trust preferred securities of the Trust. The trust preferred securities were redeemed, along with $928,000 in common securities issued by the Trust and held by the Company, as a result of the concurrent redemption of 100 % of the Company’s junior subordinated debentures due 2033 and held by the Trust, which underlie the trust preferred securities. The redemption price for the junior subordinated debentures was equal to 100 % of the principal amount plus accrued interest up to, but not including, the redemption date. The proceeds from the redemption of the junior subordinated debentures were simultaneously applied to redeem all of the outstanding common securities and the outstanding trust preferred securities at a price of 100 % of the aggregate liquidation amount of the trust preferred securities plus accumulated but unpaid distributions up to, but not including, the redemption date. The redemption was pursuant to the optional redemption provisions of the underlying indenture.
101
NOTE 11 – PENSION AND OTHER POSTRETIREMENT PLANS
In April 2000, the Lakeland Financial Corporation Pension Plan was frozen. The Company also maintains a Supplemental Executive Retirement Plan (“SERP”) for select officers that was established as a funded, non-qualified deferred compensation plan. Currently, six retired officers are the only participants in the SERP. The measurement date for both the pension plan and SERP is December 31, 2021 and 2020.
Information as to the Company’s employee benefit plans at December 31, 2021 and 2020 is as follows:
| Pension Benefits | SERP Benefits | ||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Change in benefit obligation: | |||||||||||||||||||||||
| Beginning benefit obligation | $ | $ | $ | $ | |||||||||||||||||||
| Interest cost | |||||||||||||||||||||||
| Actuarial (gain) loss | ( | ||||||||||||||||||||||
| Benefits paid | ( | ( | ( | ( | |||||||||||||||||||
| Ending benefit obligation | |||||||||||||||||||||||
| Change in plan assets (primarily equity and fixed income investments and money market funds), at fair value: | |||||||||||||||||||||||
| Beginning plan assets | |||||||||||||||||||||||
| Actual return | |||||||||||||||||||||||
| Employer contribution | |||||||||||||||||||||||
| Benefits paid | ( | ( | ( | ( | |||||||||||||||||||
| Ending plan assets | |||||||||||||||||||||||
| Funded status at end of year | $ | $ | ( | $ | ( | $ | ( | ||||||||||||||||
Amounts recognized in the consolidated balance sheets consist of:
| Pension Benefits | SERP Benefits | ||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Funded status included in other liabilities | $ | $ | ( | $ | ( | $ | ( | ||||||||||||||||
Amounts recognized in accumulated other comprehensive income consist of:
| Pension Benefits | SERP Benefits | ||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2021 | 2020 | |||||||||||||||||||
| Net actuarial loss | $ | $ | $ | $ | |||||||||||||||||||
The accumulated benefit obligation for the pension plan was $2.3 million and $2.7 million for December 31, 2021 and 2020, respectively. The accumulated benefit obligation for the SERP was $0.9 million and $1.0 million for December 31, 2021 and 2020, respectively.
102
NOTE 11 – PENSION AND OTHER POSTRETIREMENT PLANS (continued)
Net period benefit cost and other amounts recognized in other comprehensive income (loss) include the following:
| Pension Benefits | SERP Benefits | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2019 | 2021 | 2020 | 2019 | |||||||||||||||||||||||||||||
| Net pension expense: | |||||||||||||||||||||||||||||||||||
| Service cost | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Interest cost | |||||||||||||||||||||||||||||||||||
| Expected return on plan assets | ( | ( | ( | ( | ( | ( | |||||||||||||||||||||||||||||
| Recognized net actuarial (gain) loss | |||||||||||||||||||||||||||||||||||
| Settlement cost | |||||||||||||||||||||||||||||||||||
| Net pension expense | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Net (gain) loss | $ | ( | $ | $ | $ | ( | $ | $ | |||||||||||||||||||||||||||
| Amortization of net loss | ( | ( | ( | ( | ( | ( | |||||||||||||||||||||||||||||
| Total recognized in other comprehensive income (loss) | ( | ( | ( | ( | ( | ||||||||||||||||||||||||||||||
| Total recognized in net pension expense and other comprehensive income (loss) | $ | ( | $ | $ | $ | ( | $ | $ | |||||||||||||||||||||||||||
The estimated net loss (gain) for the defined benefit pension plan and SERP that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost over the next fiscal year is $99,000 for the pension plan and $44,000 for the SERP. The settlement costs in 2021 and 2020 were related to participants taking lump sum distributions from the pension plan during those years.
For 2021, 2020 and 2019, the assumed form of payment elected by active participants upon retirement was a lump sum to reflect participant trends. The lump sum assumed interest rates, below, for December 31, 2021, 2020 and 2019 reflect the mortality table in effect for 2021, 2020 and 2019, respectively. For 2021, the mortality assumption was changed to the PRI-2012 White Collar Mortality Table, with full generational Projection Scale MP-2021 as of December 31, 2021, to reflect improved mortality expectations. For 2020, the mortality assumption was the PRI-2012 White Collar Mortality Table, with full generational Projection Scale MP-2020 as of December 31, 2020. For 2019, the mortality assumption was the PRI-2012 White Collar Mortality Table, with full generational Projection Scale MP-2019 as of December 31, 2019.
103
NOTE 11 – PENSION AND OTHER POSTRETIREMENT PLANS (continued)
| Pension Benefits | SERP Benefits | ||||||||||||||||||||||||||||||||||
| 2021 | 2020 | 2019 | 2021 | 2020 | 2019 | ||||||||||||||||||||||||||||||
| The following assumptions were used in calculating the net benefit obligation: | |||||||||||||||||||||||||||||||||||
| Weighted average discount rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
| Rate of increase in future compensation | N/A | N/A | N/A | N/A | N/A | N/A | |||||||||||||||||||||||||||||
| Lump sum assumed interest rates First 5 years | % | % | % | N/A | N/A | N/A | |||||||||||||||||||||||||||||
| Next 15 years | % | % | % | N/A | N/A | N/A | |||||||||||||||||||||||||||||
| All future years | % | % | % | N/A | N/A | N/A | |||||||||||||||||||||||||||||
| The following assumptions were used in calculating the net pension expense: | |||||||||||||||||||||||||||||||||||
| Weighted average discount rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
| Rate of increase in future compensation | N/A | N/A | N/A | N/A | N/A | N/A | |||||||||||||||||||||||||||||
| Expected long-term rate of return | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Pension Plan and SERP Assets
The Company’s investment strategies are to invest in a prudent manner for the purpose of providing benefits to participants in the pension plan and the SERP. The investment strategies are targeted to maximize the total return of the portfolio net of inflation, spending and expenses. Risk is controlled through diversification of asset types and investments in domestic and international equities and fixed income securities. The target allocations for plan assets are shown in the tables below. Equity securities primarily include investments in common stocks. Debt securities include government agency and commercial bonds. Other investments consist of money market mutual funds.
The weighted average expected long-term rate of return on pension plan and SERP assets is developed in consultation with the plans actuary. It is primarily based upon industry trends and consensus rates of return which are then adjusted to reflect the specific asset allocations and historical rates of return of the Company’s plan assets. The following assumptions were used in determining the total long-term rate of return: equity securities were assumed to have a long-term rate of return of approximately 8.85 % and debt securities were assumed to have a long-term rate of return of approximately 3.00 %. These rates of return were adjusted to reflect an approximate target allocation of 60 % equity securities and 40 % debt securities with a small downward adjustment due to investments in the “Other” category, which consist of low yielding money market mutual funds.
Certain asset types and investment strategies are prohibited including, the investment in commodities, options, futures, short sales, margin transactions and non-marketable securities.
104
NOTE 11 – PENSION AND OTHER POSTRETIREMENT PLANS (continued)
| Target Allocation | Percentage of Plan Assets at Year End | Weighted Average Expected Long-Term Rate of Return | |||||||||||||||||||||||||||
| Asset Category | 2022 | 2021 | 2020 | ||||||||||||||||||||||||||
| Equity securities | - | % | % | % | % | ||||||||||||||||||||||||
| Debt securities | - | % | % | % | % | ||||||||||||||||||||||||
| Other | - | % | % | % | % | ||||||||||||||||||||||||
| Total | % | % | % | ||||||||||||||||||||||||||
The Company’s SERP plan asset allocation at year end 2021 and 2020, target allocation for 2021, and expected long-term rate of return by asset category are as follows:
| Target Allocation | Percentage of Plan Assets at Year End | Weighted Average Expected Long-Term Rate of Return | |||||||||||||||||||||||||||
| Asset Category | 2022 | 2021 | 2020 | ||||||||||||||||||||||||||
| Equity securities | - | % | % | % | % | ||||||||||||||||||||||||
| Debt securities | - | % | % | % | % | ||||||||||||||||||||||||
| Other | - | % | % | % | % | ||||||||||||||||||||||||
| Total | % | % | % | ||||||||||||||||||||||||||
Fair Value of Pension Plan and SERP Assets
Fair value is the exchange price that would be received for an asset in the principal or most advantageous market for the asset in an orderly transaction between market participants on the measurement date. Also, a fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Equity and debt securities: The fair values of securities are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or pricing models, which utilize significant observable inputs such as matrix pricing. This is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
105
NOTE 11 – PENSION AND OTHER POSTRETIREMENT PLANS (continued)
The fair values of the Company’s pension plan assets at December 31, 2021, by asset category are as follows:
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||||||
| (dollars in thousands) | |||||||||||||||||||||||
| Equity securities - US large cap common stocks | $ | $ | $ | $ | |||||||||||||||||||
| Equity securities - US mid cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - US small cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - international stock mutual funds | |||||||||||||||||||||||
| Equity securities - emerging markets stock mutual funds | |||||||||||||||||||||||
| Debt securities - intermediate term bond mutual funds | |||||||||||||||||||||||
| Debt securities - short term bond mutual funds | |||||||||||||||||||||||
| Cash - money market account | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
The fair values of the Company’s pension plan assets at December 31, 2020, by asset category are as follows:
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2 ) | Significant Unobservable Inputs (Level 3) | |||||||||||||||||||
| (dollars in thousands) | |||||||||||||||||||||||
| Equity securities - US large cap common stocks | $ | $ | $ | $ | |||||||||||||||||||
| Equity securities - US mid cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - US small cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - international stock mutual funds | |||||||||||||||||||||||
| Equity securities - emerging markets stock mutual funds | |||||||||||||||||||||||
| Debt securities - intermediate term bond mutual funds | |||||||||||||||||||||||
| Debt securities - short term bond mutual funds | |||||||||||||||||||||||
| Cash - money market account | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
Total pension plan assets available for benefits also include $3,000 in accrued interest and dividend income.
There were no Level 2 or 3 securities during either year.
106
NOTE 11 – PENSION AND OTHER POSTRETIREMENT PLANS (continued)
The fair values of the Company’s SERP assets at December 31, 2021, by asset category are as follows:
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||||||
| (dollars in thousands) | |||||||||||||||||||||||
| Equity securities - US large cap common stocks | $ | $ | $ | $ | |||||||||||||||||||
| Equity securities - US mid cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - US small cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - emerging markets stock mutual funds | |||||||||||||||||||||||
| Equity securities - international stock mutual funds | |||||||||||||||||||||||
| Debt securities - intermediate term bond mutual funds | |||||||||||||||||||||||
| Debt securities - short term bond mutual funds | |||||||||||||||||||||||
| Cash - money market account | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
The fair values of the Company’s SERP assets at December 31, 2020, by asset category are as follows:
| Asset Category | Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||||||
| (dollars in thousands) | |||||||||||||||||||||||
| Equity securities - US large cap common stocks | $ | $ | $ | $ | |||||||||||||||||||
| Equity securities - US mid cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - US small cap stock mutual funds | |||||||||||||||||||||||
| Equity securities - emerging markets stock mutual funds | |||||||||||||||||||||||
| Equity securities - international stock mutual funds | |||||||||||||||||||||||
| Debt securities - intermediate term bond mutual funds | |||||||||||||||||||||||
| Debt securities - short term bond mutual funds | |||||||||||||||||||||||
| Cash - money market account | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
Total SERP plan assets available for benefits also include $1,000 in accrued interest and dividend income.
There were no Level 2 or 3 securities during either year.
Contributions
The Company does not expect to contribute to its pension or SERP plans in 2021.
107
NOTE 11 – PENSION AND OTHER POSTRETIREMENT PLANS (continued)
Estimated Future Benefit Payments
The following benefit payments are expected to be paid over the next ten years:
| Plan Year | Pension Benefits | SERP Benefits | |||||||||
| (dollars in thousands) | |||||||||||
| 2022 | $ | $ | |||||||||
| 2023 | |||||||||||
| 2024 | |||||||||||
| 2025 | |||||||||||
| 2026 | |||||||||||
| 2027-2031 | |||||||||||
NOTE 12 – OTHER BENEFIT PLANS
401(k) Plan
The Company maintains a 401(k) profit sharing plan for all employees meeting certain age and service requirements. The 401(k) plan allows employees to contribute up to the maximum amount allowable under the Internal Revenue Code, which are matched based upon the percentage of budgeted net income earned during the year on the first 6 % of the compensation contributed. The expense recognized from matching was $2.3 million, $1.9 million and $1.8 million in 2021, 2020 and 2019, respectively.
Deferred Compensation Plan
Effective January 1, 2004, the Company adopted the Lake City Bank Deferred Compensation Plan. The purpose of the deferred compensation plan is to extend full 401(k) type retirement benefits to certain individuals without regard to statutory limitations under tax qualified plans. A liability is accrued by the Company for its obligation under this plan. The expense recognized was $1.2 million, $1.0 million and $461,000 during the years ended December 31, 2021, 2020 and 2019, respectively. This resulted in a deferred compensation liability of $7.0 million and $5.7 million as of year end 2021 and 2020, respectively. The deferred compensation plan is funded solely by participant contributions and does not receive a Company match.
Employee Agreements
Under employment agreements with certain executives, certain events leading to separation from the Company could result in cash payments totaling $5.3 million as of December 31, 2021. On December 31, 2021, no amounts were accrued on these contingent obligations.
Directors’ Deferred Compensation and Cash Plans
The Company maintains a directors’ deferred compensation plan and a cash plan. The amount owed to directors for fees under the deferred directors’ compensation and cash plans as of December 31, 2021 and 2020 was $5.2 million and $4.8 million, respectively. The related expense for the deferred directors’ compensation and cash plans for the years ended December 31, 2021, 2020 and 2019 was $482,000 , $505,000 and $515,000 , respectively.
108
NOTE 13 – INCOME TAXES
Income tax expense for the years ended December 31, 2021, 2020 and 2019 consisted of the following:
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Current federal | $ | $ | $ | ||||||||||||||
| Deferred federal | ( | ( | ( | ||||||||||||||
| Current state | |||||||||||||||||
| Deferred state | ( | ( | ( | ||||||||||||||
| Total income tax expense | $ | $ | $ | ||||||||||||||
The differences between financial statement tax expense and amounts computed by applying the statutory federal income tax rate of 21 % to income before income taxes were as follows:
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Income taxes at statutory federal rate of 21% | $ | $ | $ | ||||||||||||||
| Increase (decrease) in taxes resulting from: | |||||||||||||||||
| Tax exempt income | ( | ( | ( | ||||||||||||||
| Nondeductible expense | |||||||||||||||||
| State income tax, net of federal tax effect | |||||||||||||||||
| Captive insurance premium income | ( | ( | ( | ||||||||||||||
| Tax credits | ( | ( | ( | ||||||||||||||
| Bank owned life insurance | ( | ( | ( | ||||||||||||||
| Long-term incentive plan | ( | ( | ( | ||||||||||||||
| Nondeductible compensation expense | |||||||||||||||||
| Other | |||||||||||||||||
| Total income tax expense | $ | $ | $ | ||||||||||||||
109
NOTE 13 – INCOME TAXES (continued)
The net deferred tax asset recorded in the consolidated balance sheets at December 31, 2021 and 2020 consisted of the following:
| (dollars in thousands) | 2021 | 2020 | |||||||||
| Deferred tax assets: | |||||||||||
| Bad debts | $ | $ | |||||||||
| Pension and deferred compensation liability | |||||||||||
| Nonaccrual loan interest | |||||||||||
| Long-term incentive plan | |||||||||||
| Lease liability | |||||||||||
| Deferred loan fees | |||||||||||
| Other | |||||||||||
| Deferred tax liabilities: | |||||||||||
| Depreciation | |||||||||||
| Loan servicing rights | |||||||||||
| State taxes | |||||||||||
| Intangible assets | |||||||||||
| REIT spillover dividend | |||||||||||
| Prepaid expenses | |||||||||||
| Lease right of use | |||||||||||
| Other | |||||||||||
| Valuation allowance | |||||||||||
| Net deferred tax asset | $ | $ | |||||||||
In addition to the net deferred tax assets included above, the deferred income tax liability allocated to the unrealized net gain on securities available-for-sale included in equity was ($4.5 million) and ($7.8 million) for 2021 and 2020, respectively. The deferred income tax asset allocated to the pension plan and SERP included in equity was $319,000 and $476,000 for 2021 and 2020, respectively.
The Company evaluated its deferred tax asset at year end 2021 and has concluded that it is more likely than not that it will be realized. The Company expects to have taxable income in the future such that the deferred tax asset will be realized. Therefore, no valuation allowance is required.
Unrecognized Tax Benefits
The Company did no
The Company and its subsidiaries file a consolidated U.S. federal tax return and a combined unitary return in the States of Indiana and Michigan. These returns are subject to examinations by authorities for all years after 2017.
110
NOTE 14 – RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates as of December 31, 2021 and 2020 were as follows:
| (dollars in thousands) | 2021 | 2020 | |||||||||
| Beginning balance | $ | $ | |||||||||
| New loans and advances | |||||||||||
| Effect of changes in related parties | ( | ||||||||||
| Repayments and renewals | ( | ( | |||||||||
| Ending balance | $ | $ | |||||||||
Deposits from principal officers, directors, and their affiliates at year end 2021 and 2020 were $30.2 million and $36.8 million, respectively.
NOTE 15 – STOCK BASED COMPENSATION
Effective April 8, 2008, the Company adopted the Lakeland Financial Corporation 2008 Equity Incentive Plan (the “2008 Plan”), which was approved by the Company’s stockholders. At its inception there were 1,125,000 shares of common stock reserved for grants of stock options, stock appreciation rights, stock awards and cash incentive awards to employees of the Company, its subsidiaries and Board. Effective April 9, 2013, the Company adopted the Lakeland Financial Corporation 2013 Equity Incentive Plan (the “2013 Plan”), which was also approved by the Company’s stockholders. At its inception the remaining shares of common stock available to grant under the 2008 Plan of 435,867 were transferred to the 2013 Plan and reserved for grants of stock options, stock appreciation rights, stock awards and cash incentive awards to employees of the Company, its subsidiaries and Board. Non-vested shares from the 2008 Plan that were unused at vesting were added to the shares available to grant of the 2013 Plan. Effective April 12, 2017, the Company adopted the Lakeland Financial Corporation 2017 Equity Incentive Plan (the “2017 Plan”), which was also approved by the Company’s stockholders and does not permit share recycling. At its inception there were 1,000,000 shares of common stock reserved for grants of stock options, stock appreciation rights, stock awards and cash incentive awards to employees of the Company, its subsidiaries and Board. As of December 31, 2021, 454,308 shares were available for future grants in the 2017 Plan, which is the only active plan. Certain stock awards provide for accelerated vesting if there is a change in control. The Company has a policy of issuing new shares to satisfy exercises of stock awards.
Included in net income for the years ended December 31, 2021, 2020 and 2019 was employee stock compensation expense of $7.2 million, $1.8 million and $4.2 million, and a related tax benefit of $1.8 million, $0.5 million and $1.1 million, respectively.
Stock Options
The equity incentive plan requires that the exercise price for options be the market price on the date the options are granted. The maximum option term is ten years and the awards usually vest over three years . The fair value of each stock option is estimated with the Black-Scholes pricing model, using the following weighted-average assumptions as of the grant date for stock options granted during the years presented. Expected volatilities are based on historical volatility of the Company’s stock over the immediately preceding expected life period, as well as other factors known on the grant date that would have a significant effect on the stock price during the expected life period. The expected stock option life used is the historical option life of the similar employee base or Board. The turnover rate is based on historical data of the similar employee base as a group and the Board as a group. The risk-free interest rate is the Treasury rate on the date of grant corresponding to the expected life period of the stock option.
There were no no unrecognized compensation cost related to non-vested stock options granted under the plan.
There were no options exercised during the years ended December 31, 2021, 2020 or 2019.
111
NOTE 15 – STOCK BASED COMPENSATION (continued)
Restricted Stock Awards and Units
The fair value of restricted stock awards and units is the closing price of the Company’s common stock on the date of grant adjusted for the present value of expected dividends. The restricted stock awards fully vest after one year or more of service, determined at the grant date, with the exception of 14,950 shares granted to non-employee directors of the Board included as vested, below, which vested on the grant date.
A summary of the changes in the Company’s non-vested shares for the year follows:
| Nonvested Shares | Shares | Weighted-Average Grant-Date Fair Value | |||||||||
| Nonvested at January 1, 2021 | $ | ||||||||||
| Granted | |||||||||||
| Vested | ( | ||||||||||
| Nonvested at December 31, 2021 | $ | ||||||||||
As of December 31, 2021, there was no unrecognized compensation cost related to non-vested shares granted under the plan. The total fair value of shares vested during the years ended December 31, 2021, 2020 and 2019 was $1.1 million, $0.7 million and $0.7 million, respectively.
Performance Stock Units
The fair value of stock awards is the closing price of the Company’s common stock on the date of grant adjusted for the present value of expected dividends. The expected dividend rate is assumed to be the most recent dividend rate declared by the Board on the grant date. The grant date fair value of stock awards is assumed at the target payout rate. The stock awards fully vest on the third anniversary of the grant date. The 2021-2023, 2020-2022 and 2019-2021 Long-Term Incentive Plans must be paid in stock and have performance conditions which include revenue growth, diluted earnings per share growth and average return on beginning equity. Shares granted below include the number of shares assumed granted based on actual performance criteria of the 2021-2023, 2020-2022 and 2019-2021 Long-Term Incentive Plans at December 31, 2021.
| Nonvested Shares | Shares | Weighted-Average Grant-Date Fair Value | |||||||||
| Nonvested at January 1, 2021 | $ | ||||||||||
| Granted, net | |||||||||||
| Vested | ( | ||||||||||
| Forfeited | ( | ||||||||||
| Nonvested at December 31, 2021 | $ | ||||||||||
As of December 31, 2021, there was $6.4 million of total unrecognized compensation cost related to non-vested shares granted under the Plan. The cost is expected to be recognized over a weighted period of 1.77 years. The total fair value of shares vested during the year ended December 31, 2021, 2020 and 2019 was $5.2 million, $5.7 million and $5.7 million, respectively. During the years ended December 31, 2021, 2020 and 2019, 83,216 , 120,204 and 126,672 shares vested, respectively.
112
NOTE 16 – CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS
The Company became a financial holding company effective May 30, 2012 and is now required to be well capitalized under the applicable regulatory guidelines. The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet certain heightened minimum capital requirements can initiate certain mandatory, and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.
The capital adequacy requirements were heightened by the Basel III Rule, previously defined, which went into effect on January 1, 2015 with a phase-in period for certain aspects of the rule through 2019. Under the Basel III rule, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in from 0.00% for 2015 to 2.50% by 2019. The capital conservation buffer for 2021 and 2020 was 2.50%. The net unrealized gain or loss on available-for-sale securities is not included in computing regulatory capital. .The quantitative measures established by regulation to ensure capital adequacy that were in effect on December 31, 2021 and 2020, require the Company and the Bank to maintain minimum capital amounts and ratios (set forth in the following table) of Total, Tier I and Common Equity Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined in the regulation), and of Tier I capital (as defined in the regulation) to average assets (as defined). Management believes, as of the years ended December 31, 2021 and 2020, that the Company and the Bank met all capital adequacy requirements to which they are subject.
113
NOTE 16 – CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS (continued)
As of December 31, 2021, the most recent notification from the federal regulators categorized the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum Total risk-based capital ratios, Tier I risk-based capital ratios and Tier I leverage capital ratios as set forth in the table. There have been no conditions or events since that notification that management believes have changed the Company and the Bank’s category.
| Actual | Minimum Required For Capital Adequacy Purposes | For Capital Adequacy Purposes Plus Capital Conservation Buffer | Minimum "Required" to Be "Well" Capitalized Under "Prompt" Corrective Action Regulations | ||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||||||||||||||||||||||
| As of December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| Total Capital (to Risk Weighted Assets) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| Tier I Capital (to Risk Weighted Assets) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| Common Equity Tier 1 (CET1) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| Tier I Capital (to Average Assets) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| As of December 31, 2020 | |||||||||||||||||||||||||||||||||||||||||||||||
| Total Capital (to Risk Weighted Assets) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| Tier I Capital (to Risk Weighted Assets) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| Common Equity Tier 1 (CET1) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
| Tier I Capital (to Average Assets) | |||||||||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | $ | $ | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||||||||
| Bank | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||||
The Bank is required to obtain the approval of the Indiana Department of Financial Institutions for the payment of any dividend if the total amount of all dividends declared by the Bank during the calendar year, including the proposed dividend, would exceed the sum of the retained net income for the year-to-date combined with the retained net income for the previous two years. Indiana law defines “retained net income” to mean the net income of a specified period, calculated under the consolidated report of income instructions, less the total amount of all dividends declared for the specified period. As of December 31, 2021, approximately $106.9 million was available to be paid as dividends to the Company by the Bank.
The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2021. Notwithstanding the availability of funds for dividends, however, the FDIC may prohibit the payment of any dividends by the Bank if the FDIC determines such payment would constitute an unsafe or unsound practice.
114
NOTE 17 – OFFSETTING ASSETS AND LIABILITIES
The following tables summarize gross and net information about financial instruments and derivative instruments that are offset in the statement of financial position or that are subject to an enforceable master netting arrangement at December 31, 2021 and 2020.
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Gross Amounts of Recognized Assets/ Liabilities | Gross Amounts Offset in the Statement of Financial Position | Net Amounts presented in the Statement of Financial Position | Gross Amounts Not Offset in the Statement of Financial Position | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | Financial Instruments | Cash Collateral Position | Net Amount | ||||||||||||||||||||||||||||||||
| Assets | |||||||||||||||||||||||||||||||||||
| Interest Rate Swap Derivatives | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||
| Total Assets | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||
| Liabilities | |||||||||||||||||||||||||||||||||||
| Interest Rate Swap Derivatives | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||
| Total Liabilities | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||
| December 31, 2020 | |||||||||||||||||||||||||||||||||||
| Gross Amounts of Recognized Assets/ Liabilities | Gross Amounts Offset in the Statement of Financial Position | Net Amounts presented in the Statement of Financial Position | Gross Amounts Not Offset in the Statement of Financial Position | ||||||||||||||||||||||||||||||||
| (dollars in thousands) | Financial Instruments | Cash Collateral Position | Net Amount | ||||||||||||||||||||||||||||||||
| Assets | |||||||||||||||||||||||||||||||||||
| Interest Rate Swap Derivatives | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Total Assets | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Liabilities | |||||||||||||||||||||||||||||||||||
| Interest Rate Swap Derivatives | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||
| Total Liabilities | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||
If an event of default occurs causing an early termination of an interest rate swap derivative, any early termination amount payable to one party by the other party may be reduced by set-off against any other amount payable by the one party to the other party. If a default in performance of any obligation of a repurchase agreement occurs, each party will set-off property held in respect of transactions against obligations owing in respect of any other transactions.
115
NOTE 18 – COMMITMENTS, OFF-BALANCE SHEET RISKS AND CONTINGENCIES
During the normal course of business, the Company becomes a party to financial instruments with off-balance sheet risk in order to meet the financing needs of its customers. These financial instruments include commitments to make loans and open-ended revolving lines of credit. Amounts as of the years ended December 31, 2021 and 2020, were as follows:
| 2021 | 2020 | ||||||||||||||||||||||
| (dollars in thousands) | Fixed Rate | Variable Rate | Fixed Rate | Variable Rate | |||||||||||||||||||
| Commercial loan lines of credit | $ | $ | $ | $ | |||||||||||||||||||
| Standby letters of credit | |||||||||||||||||||||||
| Real estate mortgage loans | |||||||||||||||||||||||
| Real estate construction mortgage loans | |||||||||||||||||||||||
| Home equity mortgage open-ended revolving lines | |||||||||||||||||||||||
| Consumer loan open-ended revolving lines | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
The index on variable rate commercial loan commitments is principally the national prime rate. Interest rate ranges on commitments and open-ended revolving lines of credit for years ended December 31, 2021 and 2020, were as follows:
| 2021 | 2020 | ||||||||||||||||||||||
| Fixed Rate | Variable Rate | Fixed Rate | Variable Rate | ||||||||||||||||||||
| Commercial loan | |||||||||||||||||||||||
| Real estate mortgage loan | |||||||||||||||||||||||
| Consumer loan open-ended revolving line | |||||||||||||||||||||||
Commitments, excluding open-ended revolving lines, generally have fixed expiration dates of one year or less. Open-ended revolving lines are monitored for proper performance and compliance on a monthly basis. Since many commitments expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Company follows the same credit policy (including requiring collateral, if deemed appropriate) to make such commitments as it follows for those loans that are recorded in its financial statements.
The Company’s exposure to credit losses in the event of nonperformance is represented by the contractual amount of the commitments. Management does not expect any significant losses as a result of these commitments.
116
NOTE 19 – PARENT COMPANY STATEMENTS
The Company operates primarily in the banking industry, which accounts for substantially all of its revenues, operating income and assets. Presented below are parent only financial statements:
CONDENSED BALANCE SHEETS
| December 31, | |||||||||||
| (dollars in thousands) | 2021 | 2020 | |||||||||
| ASSETS | |||||||||||
| Deposits with Lake City Bank | $ | $ | |||||||||
| Deposits with other depository institutions | |||||||||||
| Cash | |||||||||||
| Investments in banking subsidiary | |||||||||||
| Investments in other subsidiaries | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| LIABILITIES | |||||||||||
| Dividends payable and other liabilities | $ | $ | |||||||||
| Borrowings | |||||||||||
| STOCKHOLDERS’ EQUITY | |||||||||||
| Total liabilities and stockholders’ equity | $ | $ | |||||||||
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
| Years Ended December 31, | |||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Dividends from Lake City Bank | $ | $ | $ | ||||||||||||||
| Dividends from non-bank subsidiaries | |||||||||||||||||
| Other income | |||||||||||||||||
| Interest expense | ( | ( | |||||||||||||||
| Miscellaneous expense | ( | ( | ( | ||||||||||||||
| INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES | |||||||||||||||||
| Income tax benefit | |||||||||||||||||
| INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES | |||||||||||||||||
| Equity in undistributed income of subsidiaries | |||||||||||||||||
| NET INCOME | $ | $ | $ | ||||||||||||||
| COMPREHENSIVE INCOME | $ | $ | $ | ||||||||||||||
117
NOTE 19 – PARENT COMPANY STATEMENTS (continued)
| Years Ended December 31, | |||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||||||||
| Cash flows from operating activities: | |||||||||||||||||
| Net income | $ | $ | $ | ||||||||||||||
| Adjustments to net cash from operating activities: | |||||||||||||||||
| Equity in undistributed income of subsidiaries | ( | ( | ( | ||||||||||||||
| Other changes | |||||||||||||||||
| Net cash from operating activities | |||||||||||||||||
| Cash flows from financing activities | |||||||||||||||||
| Repayment of long-term debt | ( | ||||||||||||||||
| Proceeds from (payments on) short-term borrowings | ( | ||||||||||||||||
| Payments related to equity incentive plans | ( | ( | ( | ||||||||||||||
| Purchase of treasury stock | ( | ( | ( | ||||||||||||||
| Sales of treasury stock | |||||||||||||||||
| Dividends paid | ( | ( | ( | ||||||||||||||
| Cash flows from financing activities | ( | ( | ( | ||||||||||||||
| Net increase (decrease) in cash and cash equivalents | ( | ( | |||||||||||||||
| Cash and cash equivalents at beginning of the year | |||||||||||||||||
| Cash and cash equivalents at end of the year | $ | $ | $ | ||||||||||||||
NOTE 20 – EARNINGS PER SHARE
Following are the factors used in the earnings per share computations:
| (dollars in thousand except share and per share data) | 2021 | 2020 | 2019 | ||||||||||||||
| Basic earnings per common share: | |||||||||||||||||
| Net income | $ | $ | $ | ||||||||||||||
| Weighted-average common shares outstanding | |||||||||||||||||
| Basic earnings per common share | $ | $ | $ | ||||||||||||||
| Diluted earnings per common share: | |||||||||||||||||
| Net income | $ | $ | $ | ||||||||||||||
| Weighted-average common shares outstanding for basic earnings per common share | |||||||||||||||||
| Add: Dilutive effect of assumed exercises of stock options and awards | |||||||||||||||||
| Average shares and dilutive potential common shares | |||||||||||||||||
| Diluted earnings per common share | $ | $ | $ | ||||||||||||||
There were no
118
NOTE 21 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following tables summarize the changes within each classification of accumulated other comprehensive income (loss) for December 31, 2021 and 2020, all shown net of tax:
| (dollars in thousands) | Unrealized Gains and (Losses) on Available-for-Sales Securities | Defined Benefit Pension Items | Total | ||||||||||||||
| Balance at January 1, 2021 | $ | $ | ( | $ | |||||||||||||
| Other comprehensive income (loss) before reclassification | ( | ( | |||||||||||||||
| Amounts reclassified from accumulated other comprehensive income (loss) | ( | ( | |||||||||||||||
| Net current period other comprehensive income (loss) | ( | ( | |||||||||||||||
| Balance at December 31, 2021 | $ | $ | ( | $ | |||||||||||||
| (dollars in thousands) | Unrealized Gains and (Losses) on Available-for-Sales Securities | Defined Benefit Pension Items | Total | ||||||||||||||
| Balance at January 1, 2020 | $ | $ | ( | $ | |||||||||||||
| Other comprehensive income (loss) before reclassification | ( | ||||||||||||||||
| Amounts reclassified from accumulated other comprehensive income (loss) | ( | ( | |||||||||||||||
| Net current period other comprehensive income (loss) | |||||||||||||||||
| Balance at December 31, 2020 | $ | $ | ( | $ | |||||||||||||
119
NOTE 21 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (continued)
Reclassifications out of accumulated comprehensive income for the years ended December 31, 2021, 2020 and 2019 are as follows:
| Details about Accumulated Other Comprehensive Income Components | Amount Reclassified From Accumulated Other Comprehensive Income | Affected Line Item in the Statement Where Net Income is Presented | |||||||||
| 2021 | |||||||||||
| (dollars in thousands) | |||||||||||
| Realized gains and (losses) on available-for-sale securities | $ | Net securities gains | |||||||||
| Tax effect | ( | Income tax expense | |||||||||
| Subtotal | Net of tax | ||||||||||
Amortization of defined benefit pension items(1) | ( | Salaries and employee benefits | |||||||||
| Tax effect | Income tax expense | ||||||||||
| Subtotal | ( | Net of tax | |||||||||
| Total reclassifications for the period | $ | Net income | |||||||||
| 2020 | |||||||||||
| (dollars in thousands) | |||||||||||
| Realized gains and (losses) on available-for-sale securities | $ | Net securities gains | |||||||||
| Tax effect | ( | Income tax expense | |||||||||
| Subtotal | Net of tax | ||||||||||
Amortization of defined benefit pension items(1) | ( | Salaries and employee benefits | |||||||||
| Tax effect | Income tax expense | ||||||||||
| Subtotal | ( | Net of tax | |||||||||
| Total reclassifications for the period | $ | Net income | |||||||||
| 2019 | |||||||||||
| (dollars in thousands) | |||||||||||
| Realized gains and (losses) on available-for-sale securities | $ | Net securities gains | |||||||||
| Tax effect | ( | Income tax expense | |||||||||
| Subtotal | Net of tax | ||||||||||
Amortization of defined benefit pension items(1) | ( | Salaries and employee benefits | |||||||||
| Tax effect | Income tax expense | ||||||||||
| Subtotal | ( | Net of tax | |||||||||
| Total reclassifications for the period | $ | ( | Net income | ||||||||
(1)Included in the computation of net pension plan expense as more fully discussed in Note 11 – Pension and Other Postretirement Plans.
120
NOTE 22 – SELECTED QUARTERLY DATA (UNAUDITED) (in thousands except per share data)
| 2021 | 4th Quarter | 3rd Quarter | 2nd Quarter | 1st Quarter | |||||||||||||||||||
| Interest income | $ | $ | $ | $ | |||||||||||||||||||
| Interest expense | |||||||||||||||||||||||
| Net interest income | |||||||||||||||||||||||
| Provision for credit losses | ( | ||||||||||||||||||||||
| Net interest income after provision | |||||||||||||||||||||||
| Noninterest income | |||||||||||||||||||||||
| Noninterest expense | |||||||||||||||||||||||
| Income tax expense | |||||||||||||||||||||||
| Net income | $ | $ | $ | $ | |||||||||||||||||||
| Basic earnings per common share | $ | $ | $ | $ | |||||||||||||||||||
| Diluted earnings per common share | $ | $ | $ | $ | |||||||||||||||||||
| 2020 | 4th Quarter | 3rd Quarter | 2nd Quarter | 1st Quarter | |||||||||||||||||||
| Interest income | $ | $ | $ | $ | |||||||||||||||||||
| Interest expense | |||||||||||||||||||||||
| Net interest income | |||||||||||||||||||||||
| Provision for credit losses | |||||||||||||||||||||||
| Net interest income after provision | |||||||||||||||||||||||
| Noninterest income | |||||||||||||||||||||||
| Noninterest expense | |||||||||||||||||||||||
| Income tax expense | |||||||||||||||||||||||
| Net income | $ | $ | $ | $ | |||||||||||||||||||
| Basic earnings per common share | $ | $ | $ | $ | |||||||||||||||||||
| Diluted earnings per common share | $ | $ | $ | $ | |||||||||||||||||||
NOTE 23 – WARRANT
On February 27, 2009, the Company entered into a Letter Agreement with the Treasury, pursuant to which the Company issued (i) 56,044 shares of the Company’s Series A Preferred Stock and (ii) the Warrant to purchase 396,538 shares of the Company’s common stock, no par value, for an aggregate purchase price of $56,044,000 in cash. This transaction was conducted in accordance with the CPP. On June 9, 2010, the Company redeemed the Series A Preferred Stock and accreted the remaining unamortized discount on these shares. The Company did not repurchase the Warrant, and the Warrant was sold by Treasury to an independent, third party.
The Warrant had a 10 -year term and was immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $21.20 per share of the common stock (trailing 20-day Lakeland average closing price as of December 17, 2008, which was the last trading day prior to date of receipt of Treasury’s preliminary approval for our participation in the CPP). The Warrant was valued using the Black-Scholes model with the following assumptions: market price of $17.45 ; exercise price of $21.20 ; risk-free interest rate of 3.02 %; expected life of 10 years; expected dividend rate on common stock of 4.5759 % and volatility of common stock price of 41.8046 %. This resulted in a value of $4.4433 per share of common stock underlying the Warrant.
121
NOTE 23 – WARRANT (continued)
On December 3, 2009, the Company was notified by Treasury that, as a result of the Company’s completion of our November 18, 2009 Qualified Equity Offering, the amount of the Warrant was reduced by 50% to 198,269 shares. In accordance with the terms of the Warrant, the number of shares issuable upon exercise and the exercise price were adjusted each time the Company paid a dividend to its stockholders in excess of the dividend paid at the time the warrant was issued.
Based on the formula set forth in the warrant, at December 31, 2018, the number of shares issuable upon exercise of the Warrant were 314,846 and the exercise price was $13.3503 .
On February 4, 2019, the Company was notified that the holder of the Warrant was initiating the exercise on a cashless basis. At the time of exercise, the holder was entitled to 315,961 shares of common stock. The cost to exercise the Warrant was approximately $4.2 million, which was the equivalent of 91,894 shares of common stock with a fair value of $45.74 per share. On February 8, 2019, the Company issued 224,066 shares to the Warrant holder as a cashless exercise and the Warrant was retired. The issuance of the shares was exempt from registration pursuant to Section 3(a)(9) under the Securities Act of 1933.
NOTE 24 – LEASES
The Company leases certain office facilities under long-term operating lease agreements. The leases expire at various dates through 2029 and some include renewal options. Many of these leases require the payment of property taxes, insurance premiums, maintenance, utilities and other costs. In many cases, rentals are subject to increase in relation to a cost-of-living index. The Company accounts for lease and non-lease components together as a single lease component. The Company determines if an arrangement is a lease at inception. Operating leases are recorded as a right-of-use (“ROU”) lease assets and are included in other assets on the consolidated balance sheet. The Company’s corresponding lease obligations are included in other liabilities on the consolidated balance sheet. ROU lease assets represent the Company’s right to use an underlying asset for the lease term and lease obligations represent the Company’s obligation to make lease payments arising from the lease. Operating ROU lease assets and obligations are recognized at the commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The ROU lease asset also includes any lease payments made and excludes lease incentives. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option.
Lease expense for lease payments is recognized on a straight-line basis over the lease term. Short-term leases are leases having a term of twelve months or less. The Company recognizes short-term leases on a straight-line basis and does not record a related lease asset or liability for such leases, as allowed as practical expedient of the standard. The following is a maturity analysis of the operating lease liabilities as of December 31, 2021:
| Years ending December 31, (in thousands) | Operating Lease Obligation | ||||
| 2022 | $ | ||||
| 2023 | |||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| 2027 and thereafter | |||||
| Total undiscounted lease payments | |||||
| Less imputed interest | ( | ||||
| $ | |||||
| $ | |||||
122
NOTE 24 – LEASES (continued)
| Year Ended | Year Ended | Year Ended | |||||||||||||||
| December 31, 2021 | December 31, 2020 | December 31, 2019 | |||||||||||||||
| Lease cost | |||||||||||||||||
| Operating lease cost | $ | $ | $ | ||||||||||||||
| Short-term lease cost | |||||||||||||||||
| Total lease cost | $ | $ | $ | ||||||||||||||
| Other information | |||||||||||||||||
| Operating cash outflows from operating leases | $ | $ | $ | ||||||||||||||
| Weighted-average remaining lease term - operating leases | |||||||||||||||||
| Weighted average discount rate - operating leases | % | % | % | ||||||||||||||
NOTE 25 – COVID-19 and CURRENT ECONOMIC CONDITIONS
On March 11, 2020, the World Health Organization announced that the COVID-19 outbreak was deemed a pandemic, and on March 13, 2020, the President declared the ongoing COVID-19 pandemic of sufficient magnitude to warrant an emergency declaration. The extent of COVID-19’s effect on the Company’s operational and financial performance will depend on future developments. As a result, it is not currently possible to ascertain the overall impact of COVID-19 on the Company’s business. However, if the pandemic continues to evolve into a prolonged worldwide health crisis, the disease could have a material adverse effect on the Company’s business, results of operations, financial condition, liquidity and cash flows.
The fair value of certain assets could be impacted by the effects of COVID-19. The carrying value of loans, goodwill, right-of-use lease assets, other real estate owned and mortgage servicing rights could decrease resulting in future impairment losses. Management will continue to evaluate current economic conditions to determine if a triggering event would impact the current valuations for these assets.
123
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Within the prior two years of the date of the most recent financial statement, there have been no changes in or disagreements with the Company’s accountants.
ITEM 9A. CONTROLS AND PROCEDURES
a)An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a -15(e) and 15d-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of December 31, 2021. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.
b)MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities and Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles (“GAAP”).
The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment, management used the 2013 criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2021.
The Company’s independent registered public accounting firm (Crowe LLP - PCAOB ID: 173 ) has issued their report on the Company’s internal control over financial reporting. That report appears under the heading, Report of Independent Registered Public Accounting Firm.
c)There have been no changes in the Company’s internal controls during the previous fiscal quarter, ended December 31, 2021, that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not applicable.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required in response to this item will be contained under the captions “Election of Directors,” “Corporate Governance and the Board of Directors” and “Delinquent Section 16(a) Reports” in the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on April 12, 2022, to be filed with the SEC on March 3, 2022, on Form DEF 14A, and such sections are incorporated herein by reference in response to this Item.
ITEM 11. EXECUTIVE COMPENSATION
The information required in response to this item will be contained under the captions “Director Compensation,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report” in the definitive Proxy Statement, for the Annual Meeting of Stockholders to be held on April 12, 2022, to be filed with the SEC on March 3, 2022, on Form DEF 14A, is incorporated herein by reference in response to this Item. The information included under the heading “Compensation Committee Report” in the Proxy Statement shall not be deemed “soliciting” materials or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information appearing under the caption “Security Ownership of Certain Beneficial Owners and Management” in the definitive Proxy Statement, for the Annual Meeting of Stockholders to be held on April 12, 2022, to be filed with the SEC on Form DEF 14A, is incorporated herein by reference in response to this Item.
See Item 5 above for equity compensation plan information.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information appearing under the caption “Certain Relationships and Related Transactions” in the definitive Proxy Statement, for the Annual Meeting of Stockholders to be held on April 12, 2022, to be with the SEC on Form DEF 14A, is incorporated herein by reference in response to this Item. Certain additional information on related party transactions is also included in Note 14 - Related Party Transactions to the Company’s financial statements contained in Item 8.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information appearing under the caption “Fees Paid to Independent Registered Public Accounting Firm” in the definitive Proxy Statement, for the Annual Meeting of Stockholders to be held on April 12, 2022, to be filed with the SEC on Form DEF 14A, is incorporated herein by reference in response to this Item.
125
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The documents listed below are filed as a part of this report:
(a)Exhibits
| Exhibit No. | Document | Location | ||||||||||||
| 3.1 | Exhibit 3.1 to the Company’s Form 8-K filed on March 2, 2009 | |||||||||||||
| 3.2 | Exhibit 3.2 to the Company’s Form 10-K for the fiscal year ended December 31, 2012 | |||||||||||||
| 3.3 | Exhibit 3.2 to the Company’s Form 10-K For the fiscal year ended December 31, 2011 | |||||||||||||
| 4.1 | Exhibit 4.1 to the Company’s Form 10-K for the fiscal year ended December 31, 2003 | |||||||||||||
| 4.2 | Exhibit 4.4 to the Company's Form 10-K for the fiscal year ended December 31, 2019 | |||||||||||||
| 10.1* | Exhibit 10.1 to the Company’s Form S-8 filed on May 14, 2008 | |||||||||||||
| 10.2* | Exhibit 10.4 to the Company’s Form 10-K for the fiscal year ended December 31, 2008 | |||||||||||||
| 10.3* | Exhibit 10.1 of the Company’s Form 8-K filed on March 2, 2016 | |||||||||||||
| 10.4* | Exhibit 10.7 to the Company’s Form 10-K for the fiscal year ended December 31, 2008 | |||||||||||||
| 10.5* | Exhibit 10.6 to the Company's Form 10-K for the fiscal year ended December 31, 2020 | |||||||||||||
| 10.6* | Exhibit 10.11 to the Company’s Form 10-K for the fiscal year ended December 31, 2004 | |||||||||||||
| 10.7* | Exhibit 10.1 to the Company’s Form10-Q for the quarter ended September 30, 2009 | |||||||||||||
126
| 10.8* | Appendix A to the Definitive Proxy Statement on Form DEF-14A filed on March 4, 2013 | |||||||||||||
| 10.9* | Exhibit 4.3 to the Company’s Form S-8 filed on July 9, 2013 | |||||||||||||
| 10.10* | Exhibit 4.4 to the Company’s Form S-8 filed on July 9, 2013 | |||||||||||||
| 10.11* | Exhibit 4.5 to the Company’s Form S-8 filed on July 9, 2013 | |||||||||||||
| 10.12* | Exhibit 4.5 to the Company’s Form S-8 filed on April 13, 2017 | |||||||||||||
| 10.13* | Exhibit 4.6 to the Company’s Form S-8 filed on April 13, 2017 | |||||||||||||
| 10.14* | Exhibit 4.7 to the Company’s Form S-8 filed on April 13, 2017 | |||||||||||||
| 10.15* | Exhibit 4.8 to the Company’s Form S-8 filed on April 13, 2017 | |||||||||||||
| 10.16* | Exhibit 4.9 to the Company’s Form S-8 filed on April 13, 2017 | |||||||||||||
| 10.17* | Exhibit 10.1 to the Company's Form 10-Q for the quarter ended September 30, 2021 | |||||||||||||
| 21.0 | Attached hereto | |||||||||||||
| 23.1 | Attached hereto | |||||||||||||
| 31.1 | Attached hereto | |||||||||||||
| 31.2 | Attached hereto | |||||||||||||
| 32.1 | Attached hereto | |||||||||||||
| 32.2 | Attached hereto | |||||||||||||
* Management contract or compensatory plan or arrangement.
127
| 101.INS | XBRL Instance Document - the instance document does not appear in the Interactive Data File because XBRL tags are embedded within the Inline XBRL document | |||||||||||||
| 101.SCH | XBRL Taxonomy Extension Schema Document | |||||||||||||
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |||||||||||||
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |||||||||||||
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |||||||||||||
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |||||||||||||
| 104 | Cover Page Interactive Data File - the cover page XBRL tags are embedded within the Inline XBRL document contained in Exhibit 101 | |||||||||||||
ITEM 16. FORM 10-K SUMMARY
None.
128
SIGNATURES
Pursuant to the requirements of Section 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| LAKELAND FINANCIAL CORPORATION | ||||||||
| Date: February 23, 2022 | By | /s/ David M. Findlay | ||||||
| David M. Findlay, Chief Executive Officer | ||||||||
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| Name | Title | Date | ||||||||||||
| /s/ David M. Findlay | President, Chief Executive Officer and Director | |||||||||||||
| David M. Findlay | (principal executive officer) | February 23, 2022 | ||||||||||||
| /s/ Lisa M. O’Neill | Executive Vice President, Chief Financial Officer | |||||||||||||
| Lisa M. O’Neill | (principal financial officer) | February 23, 2022 | ||||||||||||
| /s/ Brok A. Lahrman | Senior Vice President, Finance and Chief Accounting Officer | |||||||||||||
| Brok A. Lahrman | (principal accounting officer) | February 23, 2022 | ||||||||||||
| /s/ A. Faraz Abbasi | ||||||||||||||
| A. Faraz Abbasi | Director | February 23, 2022 | ||||||||||||
| /s/ Blake W. Augsburger | ||||||||||||||
| Blake W. Augsburger | Director | February 23, 2022 | ||||||||||||
| /s/ Robert E. Bartels, Jr. | ||||||||||||||
| Robert E. Bartels, Jr. | Director | February 23, 2022 | ||||||||||||
| /s/Darrianne P. Christian | ||||||||||||||
| Darrianne P. Christian | Director | February 23, 2022 | ||||||||||||
| /s/ Daniel F. Evans, Jr. | ||||||||||||||
| Daniel F. Evans, Jr. | Director | February 23, 2022 | ||||||||||||
| /s/ Michael L. Kubacki | ||||||||||||||
| Michael L. Kubacki | Chairman and Director | February 23, 2022 | ||||||||||||
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| /s/ Emily E. Pichon | ||||||||||||||
| Emily E. Pichon | Director | February 23, 2022 | ||||||||||||
| /s/ Steven D. Ross | ||||||||||||||
| Steven D. Ross | Director | February 23, 2022 | ||||||||||||
| /s/ Brian J. Smith | ||||||||||||||
| Brian J. Smith | Director | February 23, 2022 | ||||||||||||
| /s/ Bradley J. Toothaker | ||||||||||||||
| Bradley J. Toothaker | Director | February 23, 2022 | ||||||||||||
| /s/ Ronald D. Truex | ||||||||||||||
| Ronald D. Truex | Director | February 23, 2022 | ||||||||||||
| /s/ M. Scott Welch | ||||||||||||||
| M. Scott Welch | Director | February 23, 2022 | ||||||||||||
130