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

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 endedDecember 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 ofMercantile Bank Corporation and its consolidated subsidiaries, includingMercantile Bank of Michigan ("our bank") and our bank's subsidiaryMercantile Insurance Center, Inc. , atMarch 31, 2022 andDecember 31, 2021 and the results of operations for the three months endedMarch 31, 2022 andMarch 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" includeMercantile Bank Corporation and its consolidated subsidiaries referred to above. Critical Accounting Policies Accounting principles generally accepted inthe 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 endedDecember 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. InJune 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 afterDecember 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 orDecember 31, 2020 . The Consolidated Appropriations Act, 2021, that was enacted inDecember 2020 , provided for a further extension of the required CECL adoption date toJanuary 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 untilJanuary 1, 2022 , and continued to use our incurred loan loss reserve model as permitted throughDecember 31, 2021 . We adopted CECL effectiveJanuary 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 afterJanuary 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. -------------------------------------------------------------------------------- 50
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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. AtMarch 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. -------------------------------------------------------------------------------- 51
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Table of ContentsMERCANTILE BANK CORPORATION
--------------------------------------------------------------------------------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 theSmall 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 theSmall 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 onAugust 8, 2020 . We originated approximately 2,200 loans aggregating$553 million . As ofMarch 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 onMay 31, 2021 . Under the Second Draw, we originated approximately 1,200 loans aggregating$208 million . As ofMarch 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. -------------------------------------------------------------------------------- 52
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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 inApril 2020 ,$600 inJanuary 2021 and$1,400 inMarch 2021 . ? Troubled Debt Restructuring Relief FromMarch 1, 2020 through 60 days after the end of the National Emergency (orDecember 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 toJanuary 1, 2022 . We elected to suspend GAAP principles and regulatory determinations as permitted up toDecember 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 orDecember 31, 2020 . We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date toJanuary 1, 2022 . We adopted the CECL methodology effectiveJanuary 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 ofMarch 31, 2022 , compared to 57.1% atDecember 31, 2021 . The new commercial loan pipeline remains strong, and as ofMarch 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 ofMarch 31, 2022 . Accruing loans past due 30 to 89 days remain very low, and we had no foreclosed properties as ofMarch 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, onJanuary 1, 2022 , resulted in a$0.4 million one-time reduction to the allowance for credit losses. -------------------------------------------------------------------------------- 53
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-------------------------------------------------------------------------------- Interest-earning balances, primarily consisting of excess funds deposited at theFederal 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 atMarch 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 inDecember 2021 and a$15.0 million follow-on issuance inmid-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 ofMarch 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 ofMarch 31, 2022 , compared to 57.1% atDecember 31, 2021 . -------------------------------------------------------------------------------- 54
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-------------------------------------------------------------------------------- As ofMarch 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 ofMarch 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 ofMarch 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 atMarch 31, 2022 totaled$28.7 million , or 0.8% of total loans. Other consumer-related loans comprised 0.9% of total loans as ofDecember 31, 2021 . We expect this loan portfolio segment to decline in future periods as scheduled principal payments exceed origination volumes. The following table summarizes our loan portfolio over the past twelve months: 3/31/22 12/31/21 9/30/21 6/30/21 3/31/21 Commercial: Commercial & Industrial (1)$ 1,153,814,000 $ 1,137,419,000
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
million in loans taken out under the
31, 2022,
31 2021, respectively.
(2) For
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 ofMarch 31, 2022 , compared to$2.5 million (0.05% of total assets) as ofDecember 31, 2021 . The following tables provide a breakdown of nonperforming assets by collateral type: NONPERFORMING LOANS 3/31/22 12/31/21 9/30/21 6/30/21 3/31/21Residential Real Estate : Land Development$ 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 2,328,000Commercial 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 -------------------------------------------------------------------------------- 56
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-------------------------------------------------------------------------------- OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS 3/31/22 12/31/21 9/30/21 6/30/21 3/31/21Residential 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 11,000Commercial 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 ofMarch 31, 2022 . We adopted CECL effectiveJanuary 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 afterJanuary 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 atDecember 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 ofMarch 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 atMarch 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 ofMarch 31, 2022 had been subject to previous partial charge-offs aggregating$0.4 million over the past several years. As ofMarch 31, 2022 , there were no specific reserves allocated to loans that had been subject to a previous partial charge-off.
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-------------------------------------------------------------------------------- The following table provides a breakdown of our loans categorized as troubled debt restructurings: 3/31/22 12/31/21 9/30/21 6/30/21 3/31/21
Performing$ 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 ofMarch 31, 2022 . Purchases ofU.S. Government agency bonds totaled$43.7 million during the first quarter of 2022. There were no purchases ofU.S. Government agency guaranteed mortgage-backed securities during the first three months of 2022; however, we did receive$1.6 million in principal paydowns onU.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 . AtMarch 31, 2022 , the portfolio was primarily comprised ofU.S. Government agency bonds (68%), municipal bonds (26%) andU.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 atMarch 31, 2022 totaled$606 million , including a net unrealized loss of$40.4 million . The net unrealized loss equaled$4.7 million as ofDecember 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 ofU.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 ofMarch 31, 2022 , compared to$18.0 million as ofDecember 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 ourU.S. Government agency bonds, mortgage-backed securities issued or guaranteed byU.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 theFederal 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. -------------------------------------------------------------------------------- 59
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-------------------------------------------------------------------------------- Net premises and equipment equaled$56.1 million atMarch 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 ofMarch 31, 2022 orDecember 31, 2021 . Total deposits decreased$107 million during the first three months of 2022, totaling$3.98 billion atMarch 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 ofMarch 31, 2022 , compared to 0.6% as ofDecember 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 ofMarch 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 ofMarch 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 ofMarch 31, 2022 totaled$932 million , with remaining availability based on collateral equaling$544 million . OnJanuary 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 ofJanuary 30, 2032 , are redeemable by us at our option, in whole or in part, on or afterJanuary 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 untilJanuary 29, 2027 . Commencing onJanuary 30, 2027 and through the stated maturity date ofJanuary 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. OnJanuary 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 onDecember 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 atMarch 31, 2022 , compared to$457 million atDecember 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. -------------------------------------------------------------------------------- 60
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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 ofMarch 31, 2022 , compared to$398 million , or 8.5% of combined deposits and borrowed funds, as ofDecember 31, 2021 . Sweep accounts increased$6.8 million during the first three months of 2022, totaling$204 million as ofMarch 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 ofMarch 31, 2022 and during the first three months of 2022 is as follows: Outstanding balance atMarch 31, 2022 $
204,271,000
Weighted average interest rate atMarch 31, 2022 0.10 % Maximum daily balance three months endedMarch 31, 2022 $
224,345,000
Average daily balance for three months endedMarch 31, 2022 $
198,949,000
Weighted average interest rate for the three months ended
0.10 % FHLBI advances increased$8.3 million during the first quarter of 2022, totaling$382 million as ofMarch 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 ofMarch 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 theFederal 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 theFederal Reserve Bank of Chicago . Using certain municipal bonds as collateral, we could have borrowed up to$31.1 million as ofMarch 31, 2022 . We did not utilize this line of credit during the first three months of 2022 or at any time during the previous 13 fiscal years, and do not plan to access this line of credit in future periods. -------------------------------------------------------------------------------- 61
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-------------------------------------------------------------------------------- The following table reflects, as ofMarch 31, 2022 , significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest: One Year One to Three to Over or Less Three Years Five Years Five Years Total Deposits without a stated maturity$ 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 ofMarch 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 atMarch 31, 2022 , compared to$457 million atDecember 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 finalBASEL III capital rules that became effective onJanuary 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 onJanuary 1, 2019 . We believe that, as ofMarch 31, 2022 , our bank met all capital adequacy requirements under theBASEL III capital rules on a fully phased-in basis. -------------------------------------------------------------------------------- 62
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-------------------------------------------------------------------------------- As ofMarch 31, 2022 , our bank's total risk-based capital ratio was 13.8%, compared to 13.6% atDecember 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 ofMarch 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 ofMarch 31, 2022 andDecember 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 theFederal 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. -------------------------------------------------------------------------------- 63
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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$60,000 in the first quarter of both 2022 and 2021 for this non-GAAP, but industry standard, adjustment. These adjustments equated to increases in our net interest margin of less than one basis point for the first three months of 2022 and the respective 2021 period. -------------------------------------------------------------------------------- 64
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Quarters ended March 31, 2 0 2 2 2 0 2 1 Average Average Average Average Balance Interest Rate Balance Interest Rate (dollars in thousands) ASSETS Loans$ 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 0.11Federal 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 effectiveJanuary 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 afterJanuary 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 ofMarch 31, 2022 , andDecember 31, 2021 , and 1.2% as ofMarch 31, 2021 . Excluding PPP loans, the allowance for loans, as a percentage of total loans, equaled 1.0% as ofMarch 31, 2022 , andDecember 31, 2021 , and 1.3% as ofMarch 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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