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Home›Deferred Payment Credit›MERCANTILE BANK CORP Management’s Report on Financial Condition and Results of Operations (Form 10-Q)

MERCANTILE BANK CORP Management’s Report on Financial Condition and Results of Operations (Form 10-Q)

By Travis Humphrey
May 6, 2022
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Forward-looking statements

This report contains forward-looking statements that are based on management's
beliefs, assumptions, current expectations, estimates and projections about the
financial services industry, the economy, and our company. Words such as
"anticipates," "believes," "estimates," "expects," "intends," "is likely,"
"plans," "projects," "indicates," "strategy," "future," "likely," "may,"
"should," "will," and variations of such words and similar expressions are
intended to identify such forward-looking statements. These statements are not
guarantees of future performance and involve certain risks, uncertainties and
assumptions ("Future Factors") that are difficult to predict with regard to
timing, extent, likelihood and degree of occurrence. Therefore, actual results
and outcomes may materially differ from what may be expressed or forecasted in
such forward-looking statements. We undertake no obligation to update, amend, or
clarify forward-looking statements, whether as a result of new information,
future events (whether anticipated or unanticipated), or otherwise.



Future Factors include, among others, adverse changes in interest rates and
interest rate relationships; increasing rates of inflation and slower growth
rates; significant declines in the value of commercial real estate; market
volatility; demand for products and services; the degree of competition by
traditional and non-traditional financial service companies; changes in banking
regulation or actions by bank regulators; changes in tax laws; changes in
prices, levies, and assessments; the impact of technological advances; potential
cyber-attacks, information security breaches, and other criminal activities on
our computer systems; litigation liabilities; governmental and regulatory policy
changes; the outcomes of existing or future contingencies; trends in customer
behavior as well as their ability to repay loans; changes in local real estate
values; damage to our reputation resulting from adverse publicity, regulatory
actions, litigation, operational failures, and the failure to meet client
expectations and other facts; adoption of SOFR and changes in the method of
determining SOFR; direct and indirect climate change matters; changes in the
national and local economies, including the ongoing disruption to financial
market and other economic activity caused by the Coronavirus Pandemic; unstable
political and economic environment; and risk factors described in our annual
report on Form 10-K for the year ended December 31, 2021. These are
representative of the Future Factors that could cause a difference between an
ultimate actual outcome and a forward-looking statement.



Introduction

The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, including Mercantile Bank of
Michigan ("our bank") and our bank's subsidiary Mercantile Insurance Center,
Inc., at March 31, 2022 and December 31, 2021 and the results of operations for
the three months ended March 31, 2022 and March 31, 2021. This discussion should
be read in conjunction with the interim consolidated financial statements and
footnotes included in this report. Unless the text clearly suggests otherwise,
references in this report to "us," "we," "our" or "the company" include
Mercantile Bank Corporation and its consolidated subsidiaries referred to above.



Critical Accounting Policies

Accounting principles generally accepted in the United States of America
("GAAP") are complex and require us to apply significant judgment to various
accounting, reporting and disclosure matters. We must use assumptions and
estimates to apply these principles where actual measurements are not possible
or practical. This Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with our unaudited
financial statements included in this report. For a discussion of our
significant accounting policies, see Note 1 of the Notes to our Consolidated
Financial Statements included in our Form 10-K for the fiscal year ended
December 31, 2021 (Commission file number 000-26719). Our critical accounting
policies are highly dependent upon subjective or complex judgments, assumptions
and estimates. Changes in such estimates may have a significant impact on the
financial statements, and actual results may differ from those estimates. We
have reviewed the application of these policies with the Audit Committee of our
Board of Directors.


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Allowance for Credit Losses ("Allowance"): The allowance is maintained at a
level we believe is adequate to absorb estimated credit losses identified and
inherent in the loan portfolio. Our evaluation of the adequacy of the allowance
is an estimate based on past loan loss experience, the nature and volume of the
loan portfolio, information about specific borrower situations and estimated
collateral values, guidance from bank regulatory agencies, and assessments of
the impact of current and anticipated economic conditions on the loan portfolio.
Allocations of the allowance may be made for specific loans, but the entire
allowance is available for any loan that, in our judgment, should be
charged-off. Credit losses are charged against the allowance when we believe the
uncollectibility of a loan is likely. The balance of the allowance represents
our best estimate, but significant downturns in circumstances relating to loan
quality or economic conditions could result in a requirement for an increased
allowance in the future. Likewise, an upturn in loan quality or improved
economic conditions may result in a decline in the required allowance in the
future. In either instance, unanticipated changes could have a significant
impact on the allowance and operating results. The allowance is increased
through a provision charged to operating expense. Uncollectible loans are
charged-off through the allowance, while recoveries of loans previously
charged-off are added to the allowance.



In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on
Financial Instruments. This ASU (as subsequently amended by ASU 2018-19)
significantly changes how entities will measure credit losses for most financial
assets and certain other instruments that are not measured at fair value through
net income. The standard will replace the current "incurred loss" approach with
an "expected loss" model. The new model, referred to as the current expected
credit loss ("CECL") model, applies to financial assets subject to credit losses
and measured at amortized cost, and certain off-balance sheet credit exposures.
The standard also expands the disclosure requirements regarding an entity's
assumptions, models, and methods for estimating the allowance. In addition,
entities will need to disclose the amortized cost balance for each class of
financial asset by credit quality indicator, disaggregated by the year of
origination. This ASU was effective for interim and annual reporting periods
beginning after December 15, 2019.



Financial institutions were not required to comply with the CECL methodology
requirements from the enactment date of the Coronavirus Aid, Relief and Economic
Security Act ("CARES Act") until the earlier of the end of the President's
declaration of a National Emergency or December 31, 2020. The Consolidated
Appropriations Act, 2021, that was enacted in December 2020, provided for a
further extension of the required CECL adoption date to January 1, 2022. An
economic forecast is a key component of the CECL methodology. As we continued to
experience an unprecedented economic environment whereby a sizable portion of
the economy had been significantly impacted by government-imposed activity
limitations and similar reactions by businesses and individuals, substantial
government stimulus was provided to businesses, individuals and state and local
governments and financial institutions offered businesses and individuals
payment relief options, economic forecasts were regularly revised with no
economic forecast consensus. Given the high degree of uncertainty surrounding
economic forecasting, we elected to postpone the adoption of CECL until January
1, 2022, and continued to use our incurred loan loss reserve model as permitted
through December 31, 2021.



We adopted CECL effective January 1, 2022 using the modified retrospective
method for all financial assets measured at amortized cost and off-balance sheet
credit exposures. Results for reporting periods beginning after January 1, 2022
are presented under CECL while prior period amounts continue to be reported in
accordance with the incurred loss accounting standards. The transition
adjustment of the CECL adoption included a decrease in the allowance of $0.4
million, and a $0.3 million increase to the retained earnings account to reflect
the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with
the $0.1 million tax impact portion being recorded as part of the deferred tax
asset in other assets on our Consolidated Balance Sheet.



See Note 1- Significant Accounting Policies in this Quarterly Report on Form
10-Q for further detailed descriptions of our estimation process and methodology
related to the allowance. See also Note 3 - Loans and Allowance for Credit
Losses in this Quarterly Report on Form 10-Q for further information regarding
our loan portfolio and allowance.



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Income Tax Accounting: Current income tax assets and liabilities are established
for the amount of taxes payable or refundable for the current year. In the
preparation of income tax returns, tax positions are taken based on
interpretation of federal and state income tax laws for which the outcome may be
uncertain. We periodically review and evaluate the status of our tax positions
and make adjustments as necessary. Deferred income tax assets and liabilities
are also established for the future tax consequences of events that have been
recognized in our financial statements or tax returns. A deferred income tax
asset or liability is recognized for the estimated future tax effects
attributable to temporary differences that can be carried forward (used) in
future years. The valuation of our net deferred income tax asset is considered
critical as it requires us to make estimates based on provisions of the enacted
tax laws. The assessment of the realizability of the net deferred income tax
asset involves the use of estimates, assumptions, interpretations and judgments
concerning accounting pronouncements, federal and state tax codes and the extent
of future taxable income. There can be no assurance that future events, such as
court decisions, positions of federal and state tax authorities, and the extent
of future taxable income will not differ from our current assessment, the impact
of which could be significant to the consolidated results of operations and
reported earnings.



Accounting guidance requires that we assess whether a valuation allowance should
be established against our deferred tax assets based on the consideration of all
available evidence using a "more likely than not" standard. In making such
judgments, we consider both positive and negative evidence and analyze changes
in near-term market conditions as well as other factors which may impact future
operating results. Significant weight is given to evidence that can be
objectively verified.



Debt Securities Available for Sale: Debt securities available for sale consist
of bonds which might be sold prior to maturity due to a number of factors,
including changes in interest rates, prepayment risks, yield and availability of
alternative investments or liquidity needs. Debt securities classified as
available for sale are reported at their fair value. For available for sale debt
securities in an unrealized loss position, we first assess whether we intend to
sell, or if it is more likely than not that we will be required to sell the
security before recovery of the 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 income with the establishment of an
allowance. For debt securities available for sale that do not meet the
aforementioned criteria, we evaluate whether any decline in fair value is due to
credit loss factors. In making this assessment, we consider any changes to the
rating of the security by a rating agency and adverse conditions specifically
related to the security, among other factors. If this assessment indicates that
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 the cash flows expected to be collected is less than the
amortized cost basis, a credit loss exists and an allowance for credit 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 credit losses is recognized in other comprehensive income.



Changes in the allowance for credit losses under CECL are recorded as provision
for (or reversal of) credit loss expense. Losses are charged against the
allowance when we believe the uncollectibility of an available for sale security
is confirmed or when either of the criteria regarding intent or requirement to
sell is met. At March 31, 2022, there was no allowance for credit losses related
to the available for sale debt securities portfolio



Mortgage Servicing Rights: Mortgage servicing rights are recognized as assets
based on the allocated fair value of retained servicing rights on loans sold.
Servicing rights are carried at the lower of amortized cost or fair value and
are expensed in proportion to, and over the period of, estimated net servicing
income. We utilize a discounted cash flow model to determine the value of our
servicing rights. The valuation model utilizes mortgage prepayment speeds, the
remaining life of the mortgage pool, delinquency rates, our cost to service
loans, and other factors to determine the cash flow that we will receive from
servicing each grouping of loans. These cash flows are then discounted based on
current interest rate assumptions to arrive at the fair value of the right to
service those loans. Impairment is evaluated quarterly based on the fair value
of the servicing rights, using groupings of the underlying loans classified by
interest rates. Any impairment of a grouping is reported as a valuation
allowance.



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Goodwill: GAAP requires us to determine the fair value of all of the assets and
liabilities of an acquired entity, and record their fair value on the date of
acquisition. We employ a variety of means in determination of the fair value,
including the use of discounted cash flow analysis, market comparisons, and
projected future revenue streams. For certain items that we believe we have the
appropriate expertise to determine the fair value, we may choose to use our own
calculation of the value. In other cases, where the value is not easily
determined, we consult with outside parties to determine the fair value of the
asset or liability. Once valuations have been adjusted, the net difference
between the price paid for the acquired company and the value of its balance
sheet is recorded as goodwill.



Goodwill results from business acquisitions and represents the excess of the
purchase price over the fair value of acquired tangible assets and liabilities
and identifiable intangible assets. Goodwill is assessed at least annually for
impairment and any such impairment is recognized in the period identified. A
more frequent assessment is performed if conditions in the market place or
changes in the company's organizational structure occur.



coronavirus pandemic

There remains a significant amount of stress and uncertainty across national and
global economies due to the pandemic of coronavirus disease 2019 ("Covid-19")
caused by severe acute respiratory syndrome coronavirus 2 (the "Coronavirus
Pandemic"). This uncertainty is heightened as certain geographic areas continue
to experience surges in Covid-19 cases and governments at all levels continue to
react to changes in circumstances, including supply chain disruptions and
inflationary pressures.



The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public
health and economic crisis and may have a material negative impact on our
financial condition and results of operations. We continue to occupy an
asset-sensitive position, whereby interest rate environments characterized by
numerous and/or high magnitude interest rate reductions have a negative impact
on our net interest income and net income. Additionally, the consequences of the
unprecedented economic impact of the Coronavirus Pandemic may produce declining
asset quality, reflected by a higher level of loan delinquencies and loan
charge-offs, as well as downgrades of commercial lending relationships, which
may necessitate additional provisions for our allowance and reduce net income.



The following section summarizes the main measures that have a direct impact on us and our customers.


  ? Paycheck Protection Program


The Paycheck Protection Program ("PPP") reflects a substantial expansion of the
Small Business Administration's 100% guaranteed 7(a) loan program. The CARES Act
authorized up to $350 billion in loans to businesses with fewer than 500
employees, including non-profit organizations, tribal business concerns,
self-employed and individual contractors. The PPP provides 100% guaranteed loans
to cover specific operating costs. PPP loans are eligible to be forgiven based
upon certain criteria. In general, the amount of the loan that is forgivable is
the sum of the payroll costs, interest payments on mortgages, rent and utilities
incurred or paid by the business during a prescribed period beginning on the
loan origination date. Any remaining balance after forgiveness is maintained at
the 100% guarantee for the duration of the loan. The interest rate on the loan
is fixed at 1.00%, with the financial institution receiving a loan origination
fee paid by the Small Business Administration. The loan origination fees, net of
the direct origination costs, are accreted into interest income on loans using
the level yield methodology. The program ended on August 8, 2020. We originated
approximately 2,200 loans aggregating $553 million. As of March 31, 2022, we
recorded forgiveness transactions on all but six loans aggregating $0.9 million.
Net loan origination fees of less than $0.1 million were recorded during the
first quarter of 2022.



The Consolidated Appropriations Act, 2021 authorized an additional $284 billion
in Second Draw PPP loans ("Second Draw"). The program ended on May 31, 2021.
Under the Second Draw, we originated approximately 1,200 loans aggregating $208
million. As of March 31, 2022, we recorded forgiveness transactions on all but
38 loans aggregating $11.3 million. Net loan origination fees of $0.8 million
were recorded during the first quarter of 2022.



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? Individual Economic Impact Payments


The Internal Revenue Service has made three rounds of Individual Economic Impact
Payments via direct deposit or mailed checks. In general, and subject to
adjusted gross income limitations, qualifying individuals have received payments
of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.



  ? Troubled Debt Restructuring Relief


From March 1, 2020 through 60 days after the end of the National Emergency (or
December 31, 2020 if earlier), a financial institution may elect to suspend GAAP
principles and regulatory determinations with respect to loan modifications
related to Covid-19 that would otherwise be categorized as troubled debt
restructurings. Banking agencies must defer to the financial institution's
election. The Consolidated Appropriations Act, 2021 extended the suspension date
to January 1, 2022. We elected to suspend GAAP principles and regulatory
determinations as permitted up to December 31, 2021.



  ? Current Expected Credit Loss Methodology Delay


Financial institutions were not required to comply with the CECL methodology
requirements from the enactment date of the CARES Act until the earlier of the
end of the National Emergency or December 31, 2020. We elected to postpone CECL
adoption as permitted. The Consolidated Appropriations Act, 2021 extended the
adoption deferral date to January 1, 2022. We adopted the CECL methodology
effective January 1, 2022.




First quarter 2022 financial overview

We reported net income of $11.5 million, or $0.73 per diluted share, for the
first quarter of 2022, compared with net income of $14.2 million, or $0.87 per
diluted share, during the first quarter of 2021. Ongoing strong core commercial
loan growth, continued strength in asset quality metrics and increases in
several key fee income revenue streams in large part mitigated a significant
decline in mortgage banking revenue as originations come off of 2020 and 2021
record levels driven by low mortgage loan rates and resulting brisk refinancing
activity.



Commercial loans increased $54.1 million during the first three months of 2022,
reflecting net growth of core commercial loans and payment activities under the
PPP. Core commercial loans increased $82.0 million, or over 11% on an annualized
basis, while PPP payment activities aggregated $27.9 million, during the first
three months of 2022. Core commercial and industrial loans increased $44.3
million, multi-family and residential rental property loans grew $31.4 million,
owner occupied commercial real estate ("CRE") loans were up $17.0 million, and
vacant land, land development and residential construction loans increased $9.5
million, while non-owner occupied CRE loans were down $20.1 million. As a
percent of total commercial loans, commercial and industrial loans (excluding
PPP loans) and owner occupied CRE loans combined equaled 57.6% as of March 31,
2022, compared to 57.1% at December 31, 2021. The new commercial loan pipeline
remains strong, and as of March 31, 2022, we had $184 million in unfunded loan
commitments on commercial construction and development loans that are in the
construction phase.



The overall quality of our loan portfolio remains strong, with nonperforming
loans equaling only 0.05% of total loans as of March 31, 2022. Accruing loans
past due 30 to 89 days remain very low, and we had no foreclosed properties as
of March 31, 2022. Gross loan charge-offs totaled $0.2 million during the first
quarter of 2022, while recoveries of prior period loan charge-offs totaled $0.3
million, providing for net loan recoveries of $0.1 million, or 0.01% of average
total loans on an annualized basis.



We recorded a provision expense of $0.1 million during the first quarter of
2022, compared to $0.3 million during the prior-year first quarter. The
provision expense recorded during both periods mainly reflected allocations
necessitated by net loan growth; the recording of net loan recoveries and
continued strong loan quality metrics during the periods in large part mitigated
additional reserves associated with loan growth. Our adoption of Accounting
Standards Update No. 2016-13, Measurement of Credit Losses on Financial
Instruments, on January 1, 2022, resulted in a $0.4 million one-time reduction
to the allowance for credit losses.



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Interest-earning balances, primarily consisting of excess funds deposited at the
Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and
interest rate risk sensitivity. During the first three months of 2022, the
average balance of these funds equaled $784 million, or 16.1% of average earning
assets, compared to $592 million, or 13.7% of average earning assets, during the
first quarter of 2021, and $671 million, or 14.9% of average earning assets,
during 2021; these levels are substantially higher than our typical average
balance of $75 million, or approximately 2% of average earning assets. The
elevated levels during 2021 and through the first quarter of 2022 primarily
reflect increased local deposits from federal government stimulus programs and
reduced business and consumer investing and spending, and have resulted in a
significant negative impact on our net interest margin.



Total deposits decreased $107 million during the first three months of 2022,
totaling $3.98 billion at March 31, 2022. Local deposits decreased $99.2
million, while out-of-area deposits declined $7.7 million. The reduced level of
local deposits primarily reflected a single customer's withdrawal of a majority
of funds that were deposited in late 2021; excluding this withdrawal, local
deposits were up approximately $50 million during the first three months of
2022.



Net interest income totaled $30.9 million during the first quarter of 2022,
compared to $29.5 million during the same time period in 2021. Interest income
increased $1.1 million, as growth in average loans and securities more than
offset a lower level of PPP loan net fee income accretion. Interest expense
declined $0.3 million, primarily comprised of a $0.9 million reduction in
deposit interest expense reflecting lower deposit rates that more than offset
increased interest-bearing deposit balances, and a $0.8 million increase in the
cost of other borrowed money stemming from the issuance of $75.0 million in
subordinated notes in December 2021 and a $15.0 million follow-on issuance in
mid-January 2022.



Noninterest income totaled $9.3 million during the first quarter of 2022,
compared to $13.5 million during the first quarter of 2021. The lower level of
noninterest income almost exclusively reflected decreased mortgage banking
income, which more than offset growth in several key fee income sources,
including interest rate swap income, service charges on accounts, credit and
debit card income, and payroll processing fees. Sustained strength in purchase
mortgage loan originations partially mitigated the negative impacts of reduced
refinance activity, rising mortgage loan interest rates, a lower mortgage loan
sold percentage and a decreased gain on sale rate during the first quarter of
2022.



Noninterest expense totaled $25.7 million during the first quarter of 2022,
compared to $25.1 million during the same time period in 2021. Overhead costs
during the first three months of 2021 included write-downs of former branch
facilities totaling $0.5 million. The higher level of expense primarily resulted
from increased compensation costs, mainly depicting annual merit pay increases,
market adjustments and promotions over the past twelve months.



Financial condition

Our total assets decreased $81.9 million during the first three months of 2022,
and totaled $5.18 billion as of March 31, 2022. Total loans increased $102
million and securities available for sale grew $12.9 million, while
interest-earning deposits declined $217 million. Total deposits decreased $107
million during the first three months of 2022.



Commercial loans increased $54.1 million during the first three months of 2022,
reflecting net growth of core commercial loans and payment activities under the
PPP. Core commercial loans increased $82.0 million, or over 11% on an annualized
basis, while PPP payment activities aggregated $27.9 million, during the first
three months of 2022. Core commercial and industrial loans increased $44.3
million, multi-family and residential rental property loans grew $31.4 million,
owner occupied CRE loans were up $17.0 million, and vacant land, land
development and residential construction loans increased $9.5 million, while
non-owner occupied CRE loans were down $20.1 million. As a percent of total
commercial loans, commercial and industrial loans (excluding PPP loans) and
owner occupied CRE loans combined equaled 57.6% as of March 31, 2022, compared
to 57.1% at December 31, 2021.



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As of March 31, 2022, availability on existing construction and development
loans totaled $184 million, with most of those funds expected to be drawn over
the next 12 to 18 months. Our current pipeline reports indicate continued strong
commercial loan funding opportunities in future periods, including approximately
$158 million in new lending commitments, a majority of which we expect to be
accepted and funded over the next 12 to 18 months. Our commercial lenders also
report ongoing additional opportunities they are currently discussing with
existing and potentially new borrowers. We remain committed to prudent
underwriting standards that provide for an appropriate yield and risk
relationship, as well as concentration limits we have established within our
commercial loan portfolio. Usage of existing commercial lines of credit has been
on an increasing trend over the past several quarters, equaling 38% as of March
31, 2022. Historically, the level of commercial lines of credit usage has
equaled 40% to 45%; however, the level averaged approximately 32% since the
onset of the Coronavirus Pandemic through the end of the third quarter of 2021.



Residential mortgage loans increased $48.1 million during the first quarter of
2022, totaling $523 million, or 14.7% of total loans, as of March 31, 2022.
Activity within the residential mortgage loan function has declined over the
past several months, in large part reflecting increased mortgage loan rates and
the resulting decline in mortgage loan refinance activity that was only
partially mitigated by increased purchase mortgage loan activity. Residential
mortgage loan originations totaled $168 million during the first three months of
2022, an almost 32% decline from the $245 million originated during the same
time period in 2021. Refinance mortgage loans originated comprised about 40% of
the total mortgage loans originated during the first quarter of 2022, compared
to over 66% during the first quarter of 2021. Residential mortgage loans
originated for sale, generally consisting of longer-term fixed rate residential
mortgage loans, totaled $75.7 million during the first quarter of 2022, or about
45% of the total residential mortgage loans originated during the first three
months of 2022, compared to approximately 80% during the same time period in
2021. Residential mortgage loans originated not sold are generally comprised of
adjustable rate residential mortgage loans.



Other consumer-related loans remained relatively unchanged during the first
quarter of 2022, and at March 31, 2022 totaled $28.7 million, or 0.8% of total
loans. Other consumer-related loans comprised 0.9% of total loans as of December
31, 2021. We expect this loan portfolio segment to decline in future periods as
scheduled principal payments exceed origination volumes.



The following table summarizes our loan portfolio over the past twelve months:



                                           3/31/22            12/31/21             9/30/21             6/30/21             3/31/21
Commercial:
Commercial & Industrial (1)            $ 1,153,814,000     $ 1,137,419,000  

$1,074,394,000 $1,103,807,000 $1,284,507,000
Land development and construction

             52,693,000          43,239,000  

38,380,000 43,111,000 58,738,000 Owner Occupied Commercial RE

               582,732,000         565,758,000  

551,762,000 550,504,000 544,342,000 Non-owner occupied commercial RE 1,007,361,000 1,027,415,000

998,697,000 950,993,000 932,334,000 Multifamily and residential rental 207,962,000 176,593,000

       179,126,000         161,894,000         147,294,000
Total Commercial                         3,004,562,000       2,950,424,000       2,842,359,000       2,810,309,000       2,967,215,000

Retail (2):
1-4 Family Mortgages                       522,556,000         442,547,000         411,618,000         380,292,000         337,844,000
Other Consumer Loans                        28,672,000          60,488,000          59,732,000          58,240,000          59,311,000
Total Retail                               551,228,000         503,035,000         471,350,000         438,532,000         397,155,000

Total                                  $ 3,555,790,000     $ 3,453,459,000     $ 3,313,709,000     $ 3,248,841,000     $ 3,364,370,000



(1) Includes $12.2 million, $40.1 million, $116 million, $246 millionand $455

million in loans taken out under the Paycheck Protection Program for march

31, 2022, December 31, 2021, September 30, 2021, June 30, 2021and March

31 2021, respectively.

(2) For March 31, 2022home equity line of credit balances are included in 1-4

      family mortgage loans. For prior periods, home equity lines of credit
      balances are included in other consumer loans.



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Our credit policies establish guidelines to manage credit risk and asset
quality. These guidelines include loan review and early identification of
problem loans to provide effective loan portfolio administration. The credit
policies and procedures are meant to minimize the risk and uncertainties
inherent in lending. In following these policies and procedures, we must rely on
estimates, appraisals and evaluations of loans and the possibility that changes
in these could occur quickly because of changing economic conditions. Identified
problem loans, which exhibit characteristics (financial or otherwise) that could
cause the loans to become nonperforming or require restructuring in the future,
are included on an internal watch list. Senior management and the Board of
Directors review this list regularly. Market value estimates of collateral on
impaired loans, as well as on foreclosed and repossessed assets, are reviewed
periodically. We also have a process in place to monitor whether value estimates
at each quarter-end are reflective of current market conditions. Our credit
policies establish criteria for obtaining appraisals and determining internal
value estimates. We may also adjust outside and internal valuations based on
identifiable trends within our markets, such as recent sales of similar
properties or assets, listing prices and offers received. In addition, we may
discount certain appraised and internal value estimates to address distressed
market conditions.



Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or
more and accruing interest and foreclosed properties, totaled $1.6 million
(0.03% of total assets) as of March 31, 2022, compared to $2.5 million (0.05% of
total assets) as of December 31, 2021.



The following tables provide a breakdown of nonperforming assets by collateral
type:



                                             NONPERFORMING LOANS

                                    3/31/22        12/31/21         9/30/21         6/30/21         3/31/21
Residential Real Estate:
Land Development                  $    31,000     $    32,000     $    33,000     $    34,000     $    34,000
Construction                                0               0               0               0               0
Owner Occupied / Rental             1,579,000       1,768,000       2,052,000       2,096,000       2,294,000
                                    1,610,000       1,800,000       2,085,000       2,130,000       2,328,000

Commercial Real Estate:
Land Development                            0               0               0               0               0
Construction                                0               0               0               0               0
Owner Occupied                              0               0               0               0         283,000
Non-Owner Occupied                          0               0               0               0               0
                                            0               0               0               0         283,000

Non-Real Estate:
Commercial Assets                           0         662,000         673,000         606,000         169,000
Consumer Assets                         2,000           6,000           8,000          10,000          13,000
                                        2,000         668,000         681,000         616,000         182,000

Total                             $ 1,612,000     $ 2,468,000     $ 2,766,000     $ 2,746,000     $ 2,793,000




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                        OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

                            3/31/22      12/31/21       9/30/21       6/30/21       3/31/21
Residential Real Estate:
Land Development           $       0     $       0     $       0     $       0     $       0
Construction                       0             0             0             0             0
Owner Occupied / Rental            0             0        11,000        41,000        11,000
                                   0             0        11,000        41,000        11,000

Commercial Real Estate:
Land Development                   0             0             0             0             0
Construction                       0             0             0             0             0
Owner Occupied                     0             0       100,000       363,000       363,000
Non-Owner Occupied                 0             0             0             0             0
                                   0             0       100,000       363,000       363,000

Non-Real Estate:
Commercial Assets                  0             0             0             0             0
Consumer Assets                    0             0             0             0             0
                                   0             0             0             0             0

Total                      $       0     $       0     $ 111,000     $ 404,000     $ 374,000





The following tables present a reconciliation of non-performing assets:


                                       NONPERFORMING LOANS RECONCILIATION

                                       1st Qtr         4th Qtr         3rd Qtr         2nd Qtr         1st Qtr
                                        2022            2021            2021            2021            2021

Beginning balance                    $ 2,468,000     $ 2,766,000     $ 2,746,000     $ 2,793,000     $ 3,384,000
Additions, net of transfers to ORE        93,000         218,000         361,000         492,000         116,000
Returns to performing status            (213,000 )             0         (50,000 )             0        (115,000 )
Principal payments                      (641,000 )      (377,000 )      (291,000 )      (484,000 )      (559,000 )
Loan charge-offs                         (95,000 )      (139,000 )             0         (55,000 )       (33,000 )

Total                                $ 1,612,000     $ 2,468,000     $ 2,766,000     $ 2,746,000     $ 2,793,000



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                OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

                         1st Qtr       4th Qtr        3rd Qtr        2nd Qtr       1st Qtr
                          2022           2021           2021          2021           2021

Beginning balance       $       0     $  111,000     $  404,000     $ 374,000     $  701,000
Additions                       0              0              0        30,000              0
Sale proceeds                   0       (111,000 )     (209,000 )           0        (77,000 )
Valuation write-downs           0              0        (84,000 )           0       (250,000 )

Total                   $       0     $        0     $  111,000     $ 404,000     $  374,000




During the first quarter of 2022, loan charge-offs totaled $0.2 million, while
recoveries of prior period loan charge-offs equaled $0.3 million, providing for
net loan recoveries of $0.1 million, or an annualized 0.01% of average total
loans. We continue our collection efforts on charged-off loans and expect to
record recoveries in future periods; however, given the nature of these efforts,
it is not practical to forecast the dollar amount and timing of the recoveries.
The allowance equaled $35.2 million, or 0.99% of total loans, and 2,181% of
nonperforming loans, as of March 31, 2022.



We adopted CECL effective January 1, 2022 using the modified retrospective
method for all financial assets measured at amortized cost and off-balance sheet
credit exposures. Results for reporting periods beginning after January 1, 2022
are presented under CECL while prior period amounts continue to be reported in
accordance with the incurred loss accounting standards. The transition
adjustment of the CECL adoption included a decrease in the allowance of $0.4
million, which included a $0.3 million increase to the retained earnings account
to reflect the cumulative effect of adopting CECL on our Consolidated Balance
Sheet, with the $0.1 million tax impact portion being recorded as part of the
deferred tax asset in other assets on our Consolidated Balance Sheet.



The allowance for loan loss accounting in effect at December 31, 2021 and all
prior periods was based on our estimate of probable incurred loan losses as of
the reporting date ("incurred loss" methodology). Under the CECL methodology,
our allowance is based on the total amount of credit losses that are expected
over the remaining life of the loan portfolio. Our estimate of credit losses
under CECL is determined using a complex model that relies on historical loss
information, reasonable and supportable economic forecasts, and various
qualitative factors.



The primary risk elements with respect to commercial loans are the financial
condition of the borrower, the sufficiency of collateral, and timeliness of
scheduled payments. We have a policy of requesting and reviewing periodic
financial statements from commercial loan customers, and we have a disciplined
and formalized review of the existence of collateral and its value. The primary
risk element with respect to each residential mortgage loan and consumer loan is
the timeliness of scheduled payments. We have a reporting system that monitors
past due loans and have adopted policies to pursue creditors' rights in order to
preserve our collateral position.



See Note 1- Significant Accounting Policies in this Quarterly Report on Form
10-Q for further detailed descriptions of our estimation process and methodology
related to the allowance. See also Note 3 - Loans and Allowance for Credit
Losses in this Quarterly Report on Form 10-Q for further information regarding
our loan portfolio and allowance.



As of March 31, 2022, the allowance was comprised of $34.9 million in general
reserves relating to performing loans and $0.3 million in specific reserves on
other loans, primarily accruing loans designated as troubled debt
restructurings. Specific reserve allocations relating to nonaccrual loans were
nominal in amount. Troubled debt restructurings totaled $5.5 million at March
31, 2022, consisting of $0.4 million that are on nonaccrual status and $5.1
million that are on accrual status. The latter are not included in our
nonperforming loan totals. Loans with an aggregate carrying value of $0.4
million as of March 31, 2022 had been subject to previous partial charge-offs
aggregating $0.4 million over the past several years. As of March 31, 2022,
there were no specific reserves allocated to loans that had been subject to a
previous partial charge-off.


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The following table provides a breakdown of our loans categorized as troubled
debt restructurings:



                  3/31/22         12/31/21         9/30/21          6/30/21          3/31/21
Performing      $ 5,131,000     $ 16,728,000     $ 20,518,000     $ 20,840,000     $ 19,606,000
Nonperforming       379,000          746,000          782,000          859,000          431,000

Total           $ 5,510,000     $ 17,474,000     $ 21,300,000     $ 21,699,000     $ 20,037,000



Although we believe the allowance is sufficient to absorb loan losses from our originated loan portfolio as they arise, there can be no assurance that we will not incur loan losses in any particular period. which could be substantial in relation to, or greater than, the size of the award.



Securities available for sale increased $12.9 million during the first three
months of 2022, totaling $606 million as of March 31, 2022. Purchases of U.S.
Government agency bonds totaled $43.7 million during the first quarter of 2022.
There were no purchases of U.S. Government agency guaranteed mortgage-backed
securities during the first three months of 2022; however, we did receive $1.6
million in principal paydowns on U.S. Government agency guaranteed
mortgage-backed securities. Purchases of municipal bonds totaled $8.0 million
during the first quarter of 2022; proceeds from matured and called municipal
bonds totaled $1.1 million. At March 31, 2022, the portfolio was primarily
comprised of U.S. Government agency bonds (68%), municipal bonds (26%) and U.S.
Government agency guaranteed mortgage-backed securities (6%). All of our
securities are currently designated as available for sale, and are therefore
stated at fair value. The fair value of securities designated as available for
sale at March 31, 2022 totaled $606 million, including a net unrealized loss of
$40.4 million. The net unrealized loss equaled $4.7 million as of December 31,
2021; the increase in the net unrealized loss during the first quarter of 2022
reflects significant increases in market interest rates during that time. We
maintain the securities portfolio at levels to provide adequate pledging and
secondary liquidity for our daily operations. In addition, the securities
portfolio serves a primary interest rate risk management function. We expect
purchases during the remainder of 2022 to generally consist of U.S. Government
agency bonds and municipal bonds, with the securities portfolio maintained at
about 12% of total assets.



Federal Home Loan Bank of Indianapolis ("FHLBI") stock totaled $17.7 million as
of March 31, 2022, compared to $18.0 million as of December 31, 2021. The
reduction reflects the FHLBI's repurchase of excess stock. Our investment in
FHLBI stock is necessary to engage in their advance and other financing
programs. We have regularly received quarterly cash dividends, and we expect a
cash dividend will continue to be paid in future quarterly periods.



Market values on our U.S. Government agency bonds, mortgage-backed securities
issued or guaranteed by U.S. Government agencies and municipal bonds are
generally determined on a monthly basis with the assistance of a third party
vendor. Evaluated pricing models that vary by type of security and incorporate
available market data are utilized. Standard inputs include issuer and type of
security, benchmark yields, reported trades, broker/dealer quotes and issuer
spreads. The market value of certain non-rated securities issued by relatively
small municipalities generally located within our markets is estimated at
carrying value. We believe our valuation methodology provides for a reasonable
estimation of market value, and that it is consistent with the requirements of
accounting guidelines.



Interest-earning balances, primarily consisting of excess funds deposited at the
Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and
interest rate sensitivity. During the first three months of 2022, the average
balance of these funds equaled $784 million, or 16.1% of average earning assets,
compared to $592 million, or 13.7% of average earning assets, during the first
quarter of 2021, and $671 million, or 14.9% of average earning assets, during
2021; these levels are substantially higher than our typical average balance of
$75 million, or approximately 2% of average earning assets. The elevated levels
during 2021 and through the first quarter of 2022 primarily reflect increased
local deposits from federal government stimulus programs and reduced business
and consumer investing and spending, and have resulted in a significant negative
impact on our net interest margin.



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Net premises and equipment equaled $56.1 million at March 31, 2022, representing
a decrease of $1.2 million during the first three months of 2022. The decline
was primarily attributable to depreciation expense of $1.6 million. We had no
foreclosed or repossessed assets as of March 31, 2022 or December 31, 2021.



Total deposits decreased $107 million during the first three months of 2022,
totaling $3.98 billion at March 31, 2022. Local deposits decreased $99.2
million, while out-of-area deposits declined $7.7 million. The reduced level of
local deposits primarily reflected a single customer's withdrawal of a majority
of funds that were deposited in late 2021; excluding this withdrawal, local
deposits were up approximately $50 million during the first three months of
2022. As a percent of total deposits, out-of-area deposits equaled 0.4% as of
March 31, 2022, compared to 0.6% as of December 31, 2021.



Noninterest-bearing deposits increased $8.3 million during the first three
months of 2022, while interest-bearing checking accounts and savings deposits
were up $5.4 million and $12.2 million, respectively. Money market deposit
balances were down $96.9 million on an actual basis and up approximately $53
million excluding the previously mentioned large withdrawal from a single
customer. Local time deposits declined $28.1 million during the first three
months of 2022. The reduction in out-of-area deposits during the first three
months of 2022 reflects maturities not replaced as the funds were no longer
needed.



Sweep accounts increased $6.8 million during the first three months of 2022,
totaling $204 million as of March 31, 2022. The aggregate balance of this
funding type is subject to relatively large daily fluctuations given the nature
of the customers utilizing this product and the sizable balances maintained by
many of the customers. The average balance of sweep accounts equaled $199
million during the first quarter of 2022, with a high balance of $224 million
and a low balance of $176 million. Our sweep account program entails
transferring collected funds from certain business noninterest-bearing checking
accounts and savings deposits into over-night interest-bearing repurchase
agreements. Such sweep accounts are not deposit accounts and are not afforded
federal deposit insurance, and are accounted for as secured borrowings.



FHLBI advances increased $8.3 million during the first quarter of 2022, totaling
$382 million as of March 31, 2022. Amortizing FHLBI advance aggregating $28.3
million were obtained, while bullet advances aggregating $20.0 million matured.
Amortizing FHLBI advances are generally acquired to match-fund specific
longer-term fixed rate commercial loans, with the dollar amount and amortization
structure of the underlying advances reflective of the associated commercial
loans. Bullet FHLBI advances are generally obtained to provide funds for loan
growth and are used to assist in managing interest rate risk. FHLBI advances are
collateralized by residential mortgage loans, first mortgage liens on
multi-family residential property loans, first mortgage liens on commercial real
estate property loans, and substantially all other assets of our bank, under a
blanket lien arrangement. Our borrowing line of credit as of March 31, 2022
totaled $932 million, with remaining availability based on collateral equaling
$544 million.



On January 14, 2022, we entered into Subordinated Note Purchase Agreements with
certain institutional accredited investors pursuant to which we issued and sold
$15.0 million in aggregate principal amount of its 3.25% fixed-to-floating rate
subordinated notes ("Notes"). The Notes have a stated maturity date of January
30, 2032, are redeemable by us at our option, in whole or in part, on or after
January 30, 2027 on any interest payment date at a redemption price of 100% of
the principal amount of the Notes being redeemed. The Notes are not subject to
redemption at the option of the holder. The Notes will bear interest at a fixed
rate of 3.25% per year until January 29, 2027. Commencing on January 30, 2027
and through the stated maturity date of January 30, 2032, the interest rate will
reset quarterly at a variable rate equal to the then-current Three-Month Term
SOFR plus 212 basis points. On January 14, 2022, we injected $15.0 million of
the issuance proceeds into our bank as an increase to equity capital. This $15.0
million issuance was a follow-on to the $75.0 million issuance that was
completed on December 15, 2021, in which $70.0 million of the issuance proceeds
were injected into our bank as an increase to equity capital.



Shareholders' equity was $436 million at March 31, 2022, compared to $457
million at December 31, 2021. Shareholders' equity was positively impacted by
first quarter net income of $11.5 million, which was partially offset by the
$4.8 million payment of a cash dividend. A $28.2 million after-tax decline in
the market value of our available for sale securities portfolio, reflecting
significant increases in market interest rates, negatively impacted
shareholders' equity during the first three months of 2022.



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Liquidity

Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, and capital, or cash flow from the repayment of loans and securities.
These funds are used to fund loans, meet deposit withdrawals, maintain reserve
requirements and operate our company. Liquidity is primarily achieved through
local and out-of-area deposits and liquid assets such as securities available
for sale, matured and called securities, federal funds sold and interest-earning
deposits. Asset and liability management is the process of managing our balance
sheet to achieve a mix of earning assets and liabilities that maximizes
profitability, while providing adequate liquidity.



To assist in providing needed funds and managing interest rate risk, we
periodically obtain monies from wholesale funding sources. Wholesale funds,
primarily comprised of deposits from customers outside of our market areas and
advances from the FHLBI, totaled $398 million, or 8.7% of combined deposits and
borrowed funds, as of March 31, 2022, compared to $398 million, or 8.5% of
combined deposits and borrowed funds, as of December 31, 2021.



Sweep accounts increased $6.8 million during the first three months of 2022,
totaling $204 million as of March 31, 2022. The aggregate balance of this
funding type is subject to relatively large daily fluctuations given the nature
of the customers utilizing this product and the sizable balances maintained by
many of the customers. The average balance of sweep accounts equaled $199
million during the first quarter of 2022, with a high balance of $224 million
and a low balance of $176 million. Our sweep account program entails
transferring collected funds from certain business noninterest-bearing checking
accounts and savings deposits into over-night interest-bearing repurchase
agreements. Such sweep accounts are not deposit accounts and are not afforded
federal deposit insurance, and are accounted for as secured borrowings.
Information regarding our repurchase agreements as of March 31, 2022 and during
the first three months of 2022 is as follows:



Outstanding balance at March 31, 2022                                  $ 

204,271,000

Weighted average interest rate at March 31, 2022                                0.10 %
Maximum daily balance three months ended March 31, 2022                $ 

224,345,000

Average daily balance for three months ended March 31, 2022            $ 

198,949,000

Weighted average interest rate for the three months ended March 31, 2022

    0.10 %




FHLBI advances increased $8.3 million during the first quarter of 2022, totaling
$382 million as of March 31, 2022. Amortizing FHLBI advance aggregating $28.3
million were obtained, while bullet advances aggregating $20.0 million matured.
Amortizing FHLBI advances are generally acquired to match-fund specific
longer-term fixed rate commercial loans, with the dollar amount and amortization
structure of the underlying advances reflective of the associated commercial
loans. Bullet FHLBI advances are generally obtained to provide funds for loan
growth and are used to assist in managing interest rate risk. FHLBI advances are
collateralized by residential mortgage loans, first mortgage liens on
multi-family residential property loans, first mortgage liens on commercial real
estate property loans, and substantially all other assets of our bank, under a
blanket lien arrangement. Our borrowing line of credit as of March 31, 2022
totaled $932 million, with remaining availability based on collateral equaling
$544 million.



We also have the ability to borrow up to an aggregate $70.0 million on a daily
basis through correspondent banks using established unsecured federal funds
purchased lines of credit. We did not access these lines of credit during the
first three months of 2022. In contrast, our interest-earning deposit balance
with the Federal Reserve Bank of Chicago averaged $776 million during the first
three months of 2022. We also have a line of credit through the Discount Window
of the Federal Reserve Bank of Chicago. Using certain municipal bonds as
collateral, we could have borrowed up to $31.1 million as of March 31, 2022. We
did not utilize this line of credit during the first three months of 2022 or at
any time during the previous 13 fiscal years, and do not plan to access this
line of credit in future periods.



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The following table reflects, as of March 31, 2022, significant fixed and
determinable contractual obligations to third parties by payment date, excluding
accrued interest:



                                        One Year            One to           Three to           Over
                                         or Less          Three Years       Five Years       Five Years           Total

Deposits without a stated maturity   $ 3,580,215,000     $           0     $          0     $          0     $ 3,580,215,000
Time deposits                            233,776,000       106,437,000       55,823,000                0         396,036,000
Short-term borrowings                    204,271,000                 0                0                0         204,271,000
Federal Home Loan Bank advances           84,353,000       171,689,000       71,838,000       54,383,000         382,263,000
Subordinated debentures                            0                 0                0       48,415,000          48,415,000
Subordinated notes                                 0                 0                0       88,428,000          88,428,000
Other borrowed money                               0                 0                0        1,201,000           1,201,000
Property leases                              787,000         1,217,000          232,000        1,145,000           3,381,000




In addition to normal loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of March 31, 2022, we had a total of $1.51 billion in unfunded loan
commitments and $33.0 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $1.35 billion were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $158
million were for loan commitments generally expected to close and become funded
within the next 12 to 18 months. We regularly monitor fluctuations in loan
balances and commitment levels, and include such data in our overall liquidity
management.



We monitor our liquidity position and funding strategies on an ongoing basis,
but recognize that unexpected events, changes in economic or market conditions,
a reduction in earnings performance, declining capital levels or situations
beyond our control could cause liquidity challenges. While we believe it is
unlikely that a funding crisis of any significant degree is likely to
materialize, we have developed a comprehensive contingency funding plan that
provides a framework for meeting liquidity disruptions.



Capital resources

Shareholders' equity was $436 million at March 31, 2022, compared to $457
million at December 31, 2021. Shareholders' equity was positively impacted by
first quarter net income of $11.5 million, which was partially offset by the
$4.8 million payment of a cash dividend. A $28.2 million after-tax decline in
the market value of our available for sale securities portfolio, reflecting
significant increases in market interest rates, negatively impacted
shareholders' equity during the first three months of 2022.



We and our bank are subject to regulatory capital requirements administered by
state and federal banking agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. Under the final BASEL III capital rules that
became effective on January 1, 2015, there is a requirement for a common equity
Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in
addition to the other minimum risk-based capital standards in the rule.
Institutions that do not meet this required capital buffer will become subject
to progressively more stringent limitations on the percentage of earnings that
can be paid out in cash dividends or used for stock repurchases and on the
payment of discretionary bonuses to senior executive management. The capital
buffer requirement was phased in over three years beginning in 2016. The capital
buffer requirement raised the minimum required common equity Tier 1 capital
ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to
10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of
March 31, 2022, our bank met all capital adequacy requirements under the BASEL
III capital rules on a fully phased-in basis.



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As of March 31, 2022, our bank's total risk-based capital ratio was 13.8%,
compared to 13.6% at December 31, 2021. Our bank's total regulatory capital
increased $22.3 million during the first three months of 2022, in large part
reflecting net income totaling $13.6 million and a $15.0 million equity
injection associated with the Notes issuance, which was partially offset by cash
dividends paid to us aggregating $6.5 million. Our bank's total risk-based
capital ratio was also impacted by a $121 million increase in total
risk-weighted assets, primarily resulting from net growth in commercial loans
and the securities portfolio. As of March 31, 2022, our bank's total regulatory
capital equaled $574 million, or $157 million in excess of the 10.0% minimum
that is among the requirements to be categorized as "well capitalized." Our and
our bank's capital ratios as of March 31, 2022 and December 31, 2021 are
disclosed in Note 12 of the Notes to Consolidated Financial Statements.



Operating results

We recorded net income of $11.5 million, or $0.73 per basic and diluted share,
for the first quarter of 2022, compared to net income of $14.2 million, or $0.87
per basic and diluted share, for the first quarter of 2021. The decline in net
income resulted from decreased noninterest income and increased noninterest
expense, which more than offset improved net interest income and a lower
provision for credit losses. The reduction in noninterest income primarily
reflected decreased mortgage banking income, which outweighed increases in all
other key fee income categories. Noninterest expense increased in the first
three months of 2022 compared to the respective prior-year period mainly due to
higher compensation and data processing costs. The higher level of net interest
income during the first quarter of 2022 resulted from the positive impact of
earning asset growth, which more than offset the negative impact of a lower net
interest margin, in large part driven by reduced PPP net loan fee income
accretion. The credit loss provision expense recorded during both the first
quarter of 2022 and the prior-year first quarter was primarily necessitated by
net loan growth; the recording of net loan recoveries and ongoing strong loan
quality metrics during both periods in large part offset additional reserve
allocations stemming from loan growth.



Interest income during the first quarter of 2022 was $35.9 million, an increase
of $1.1 million, or 3.2%, from the $34.8 million earned during the first quarter
of 2021. The increase resulted from growth in average earning assets, which more
than offset the impact of a lower yield on average earning assets. Average
earning assets equaled $4.88 billion during the current-year first quarter, up
$553 million, or 12.8%, from the level of $4.33 billion during the respective
2021 period; average securities were up $194 million, average interest-earning
deposits increased $193 million, and average loans were up $166 million. The
yield on average earning assets was 2.99% during the first quarter of 2022,
compared to 3.26% during the first quarter of 2021. The decline primarily
resulted from a change in earning asset mix and a decreased yield on loans. On
average, lower-yielding interest-earning deposits and securities represented
16.1% and 12.5% of earning assets, respectively, during the first quarter of
2022, up from 13.7% and 9.7%, respectively, during the first quarter of 2021,
while higher-yielding loans represented 71.4% and 76.6% of earning assets during
the respective periods. A significant volume of excess on-balance sheet
liquidity, which initially surfaced in the second quarter of 2020 as a result of
the Covid-19 environment and has persisted since that time, negatively impacted
the yield on average earning assets by approximately 45 basis points during the
first quarters of 2022 and 2021. The excess funds, consisting almost entirely of
low-yielding deposits with the Federal Reserve Bank of Chicago, are mainly a
product of local deposit growth and PPP loan forgiveness activities. The yield
on loans was 3.87% during the first three months of 2022, down from 4.03% during
the respective prior-year period mainly due to a decreased yield on commercial
loans, which declined from 4.07% during the first quarter of 2021 to 3.94%
during the first quarter of 2022. The reduced yield on commercial loans
primarily reflected a lower level of PPP loan fee accretion, which totaled $0.8
million and $2.8 million in the first quarters of 2022 and 2021, respectively.



Interest expense during the first quarter of 2022 was $5.0 million, a decrease
of $0.3 million, or 4.9%, from the $5.3 million expensed during the first
quarter of 2021. The decrease is attributable to a lower weighted average cost
of interest-bearing liabilities, which equaled 0.66% in the current-year first
quarter compared to 0.82% in the prior-year first quarter. The decline mainly
reflected lower rates paid on local time deposits and a change in funding mix,
consisting of an increase in average lower-cost interest-bearing non-time
deposits and a decrease in average higher-cost time deposits as a percentage of
average total interest-bearing liabilities. The cost of time deposits declined
from 1.49% during the first quarter of 2021 to 0.89% during the current-year
first quarter primarily due to lower interest rates paid on local time deposits,
reflecting a decreasing interest rate environment. On average, lower-cost
non-time deposits represented 63.9% of total interest-bearing liabilities during
the first quarter of 2022, up from 57.4% during the first quarter of 2021, while
higher-cost time deposits represented 13.1% and 20.5% of total interest-bearing
liabilities during the respective periods. Average interest-bearing liabilities
were $3.07 billion during the first three months of 2022, up $468 million, or
18.0%, from the $2.60 billion average during the respective 2021 period.



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Net interest income during the first quarter of 2022 was $30.9 million, an
increase of $1.4 million, or 4.6%, from the $29.5 million earned during the
prior-year first quarter. The increase resulted from the positive impact of an
increase in average earning assets, which more than offset a lower net interest
margin, in large part reflecting a reduced level of PPP net loan fee income
accretion. The net interest margin decreased from 2.77% in the first quarter of
2021 to 2.57% in the current-year first quarter due to a lower yield on average
earning assets, which more than offset a reduction in the cost of funds. The
decreased yield on average earning assets mainly reflected a change in earning
asset mix and a lower yield on commercial loans, while the reduced cost of funds
primarily reflected lower rates paid on local time deposits and a change in
funding mix. The previously discussed significant level of excess on-balance
sheet liquidity negatively impacted the net interest margin by approximately 40
basis points during the first quarters of 2022 and 2021.



The following table sets forth certain information relating to our consolidated
average interest-earning assets and interest-bearing liabilities and reflects
the average yield on assets and average cost of liabilities for the first
quarters of 2022 and 2021. Such yields and costs are derived by dividing income
or expense by the average daily balance of assets or liabilities, respectively,
for the period presented. Tax-exempt securities interest income and yield for
the first quarters of 2022 and 2021 have been computed on a tax equivalent basis
using a marginal tax rate of 21.0%. Securities interest income was increased by
$60,000 in the first quarter of both 2022 and 2021 for this non-GAAP, but
industry standard, adjustment. These adjustments equated to increases in our net
interest margin of less than one basis point for the first three months of 2022
and the respective 2021 period.



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                                                         Quarters ended March 31,
                                           2 0 2 2                                       2 0 2 1
                            Average                       Average         Average                       Average
                            Balance        Interest         Rate          Balance        Interest         Rate
                                                          (dollars in thousands)
ASSETS
Loans                     $ 3,484,511     $   33,251           3.87 %   $ 3,318,281     $   32,985           4.03 %
Investment securities         613,317          2,325           1.52         419,514          1,692           1.61
Other interest-earning
assets                        784,193            366           0.19         591,617            168           0.11
Total interest -
earning assets              4,882,021         35,942           2.99       4,329,412         34,845           3.26

Allowance for
credit losses                 (35,288 )                                     (38,467 )
Other assets                  321,829                                       287,942

Total assets              $ 5,168,562                                   $ 4,578,887


LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
deposits                  $ 2,364,437     $    1,825           0.31 %   $ 2,026,896     $    2,717           0.54 %
Short-term borrowings         198,949             50           0.10         132,845             36           0.11
Federal Home Loan Bank
advances                      372,662          1,864           2.00         394,000          2,027           2.06
Other borrowings              135,867          1,258           3.76          49,801            472           3.79
Total interest-bearing
liabilities                 3,071,915          4,997           0.66       2,603,542          5,252           0.82

Noninterest-bearing
deposits                    1,625,453                                     1,510,334
Other liabilities              21,331                                        21,463
Shareholders' equity          449,863                                       443,548

Total liabilities and
shareholders' equity      $ 5,168,562                                   $ 4,578,887

Net interest income                       $   30,945                                    $   29,593

Net interest rate
spread                                                         2.33 %                                        2.44 %
Net interest spread on
average assets                                                 2.43 %                                        2.62 %
Net interest margin on
earning assets                                                 2.57 %                                        2.77 %




A credit loss provision expense of $0.1 million and $0.3 million was recorded
during the first quarters of 2022 and 2021, respectively. The provision expense
recorded during both periods mainly reflected allocations stemming from net loan
growth; the recording of net loan recoveries and continued strong loan quality
metrics during the periods essentially offset additional reserve allocations
associated with loan growth. We adopted CECL effective January 1, 2022 using the
modified retrospective method for all financial assets measured at amortized
cost and off-balance sheet credit exposures. Results for reporting periods
beginning after January 1, 2022 are presented under CECL while prior period
amounts continue to be reported in accordance with the incurred loss accounting
standards. The transition adjustment of the CECL adoption included a decrease in
the allowance of $0.4 million, and a $0.3 million increase to the retained
earnings account to reflect the cumulative effect of adopting CECL on our
Consolidated Balance Sheet, with the $0.1 million tax impact portion being
recorded as part of the deferred tax asset in other assets on our Consolidated
Balance Sheet.


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During the first quarter of 2022, loan charge-offs totaled $0.2 million, while
recoveries of prior period loan charge-offs equaled $0.3 million, providing for
net loan recoveries of $0.1 million, or an annualized 0.01% of average total
loans. During the first quarter of 2021, loan charge-offs totaled $0.1 million,
while recoveries of prior period loan charge-offs equaled $0.5 million,
providing for net loan recoveries of $0.4 million, or an annualized 0.05% of
average total loans. The allowance for loans, as a percentage of total loans,
was 1.0% as of March 31, 2022, and December 31, 2021, and 1.2% as of March 31,
2021. Excluding PPP loans, the allowance for loans, as a percentage of total
loans, equaled 1.0% as of March 31, 2022, and December 31, 2021, and 1.3% as of
March 31, 2021.



Noninterest income during the first quarter of 2022 was $9.3 million, compared
to $13.5 million during the prior-year first quarter. The lower level of
noninterest income almost exclusively reflected decreased mortgage banking
income, which more than offset growth in several key fee income sources,
including interest rate swap income, service charges on accounts, credit and
debit card income, and payroll processing fees. Sustained strength in purchase
mortgage originations partially mitigated the negative impacts of reduced
refinance activity, rising mortgage loan interest rates, a lower mortgage loan
sold percentage, and a decreased gain on sale rate on mortgage banking income
during the first quarter of 2022. Purchase transactions totaled $101 million
during the first three months of 2022, compared to $81.5 million during the
respective 2021 period, representing an increase of $19.9 million, or
approximately 24%. Refinance transactions totaled $66.8 million during the first
quarter of 2022, compared to $164 million during the first quarter of 2021,
representing a decrease of $96.9 million, or approximately 59%. Residential
mortgage loans originated for sale, generally consisting of longer-term fixed
rate residential mortgage loans, totaled $75.7 million, or approximately 45% of
total mortgage loans originated, during the first three months of 2022. During
the first three months of 2021, residential mortgage loans originated for sale
totaled $196 million, or approximately 80% of total mortgage loans originated.



Noninterest expense totaled $25.7 million during the first quarter of 2022,
compared to $25.1 million during the first quarter of 2021. Overhead costs
during the first three months of 2021 included write-downs of former branch
facilities totaling $0.5 million. Excluding these transactions, noninterest
expense increased $1.2 million, or 4.8%, during the first quarter of 2022
compared to the respective 2021 period. The higher level of expense primarily
resulted from increased salary costs, mainly depicting annual merit pay
increases, lower residential mortgage loan deferred salary costs stemming from
decreased production, and higher stock-based compensation expense. Increased
data processing costs, in large part reflecting higher transaction volume and
software support costs, also contributed to the increase in overhead costs
during the first three months of 2022.



During the first quarter of 2022, we recorded income before federal income tax
of $14.3 million and a federal income tax expense of $2.8 million. During the
first quarter of 2021, we recorded income before federal income tax of $17.6
million and a federal income tax expense of $3.4 million. The decrease in
federal income tax expense during the first quarter of 2022 compared to the
prior-year first quarter resulted from the lower level of income before federal
income tax. Our effective tax rate was 19.8% and 19.0% during the first quarters
of 2022 and 2021, respectively.

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