FIRST MERCHANTS CORPORATION ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The historical consolidated financial data discussed below reflects our historical results of operations and financial condition and should be read in conjunction with our financial statements and related notes thereto presented in Item 8 of this Annual Report on Form 10-K. In addition to historical financial data, this discussion includes certain forward-looking statements regarding events and trends that may affect our future results. Such statements are subject to risks and uncertainties that could cause our actual results to differ materially. See our cautionary "Statement Regarding Forward-Looking Statements." For a more complete discussion of the factors that could affect our future results, see "Risk Factors" under Item 1A of this Annual Report on Form 10-K.
OVERVIEW
First Merchants Corporation (the "Corporation") is a financial holding company headquartered inMuncie, Indiana and was organized inSeptember 1982 . The Corporation's common stock is traded on the Nasdaq's Global Select Market System under the symbol FRME. The Corporation conducts its banking operations throughFirst Merchants Bank (the "Bank"), a wholly-owned subsidiary that opened for business inMuncie, Indiana , inMarch 1893 . The Bank also operatesFirst Merchants Private Wealth Advisors (a division ofFirst Merchants Bank ). The Bank includes 122 banking locations inIndiana ,Ohio ,Michigan andIllinois . In addition to its branch network, the Corporation offers comprehensive electronic and mobile delivery channels to its customers. The Corporation's business activities are currently limited to one significant business segment, which is community banking. Through the Bank, the Corporation offers a broad range of financial services, including accepting time, savings and demand deposits; making consumer, commercial, agri-business, public finance and real estate mortgage loans; providing personal and corporate trust services; offering full-service brokerage and private wealth management; and providing letters of credit, repurchase agreements and other corporate services.
HIGHLIGHTS FOR 2022
•Net income available to common stockholders for the year endedDecember 31, 2022 was$220.7 million compared to$205.5 million for the year ended 2021, an increase of 7.4 percent. Earnings per fully diluted common share totaled$3.81 for 2022 and 2021. •The acquisition ofLevel One Bancorp, Inc. ("Level One"), with 17 banking center locations inMichigan , became effective onApril 1, 2022 , with the core system integration being completed inAugust 2022 . •Adjusted net income available to common stockholders for 2022, excluding income on Paycheck Protection Program ("PPP") loans and acquisition-related costs of the Level One acquisition, was$243.4 million and adjusted diluted earnings per common share totaled$4.20 , compared to$182.2 million and$3.38 , respectively, in 2021. These adjusted net income and earnings per share amounts are non-GAAP measures. For reconciliations of non-GAAP measures to their most comparable GAAP measures, see "NON-GAAP FINANCIAL MEASURES" within the "Results of Operations" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations. •Total loans grew$2.8 billion during 2022, which included$1.6 billion from the acquisition of Level One. Excluding the forgiveness of$145.3 million in PPP loans, organic loan growth totaled$1.3 billion , or 13.9 percent during the year.
•Net interest income totaled
•Return on average assets was 1.29 percent and the return on average equity was 11.19 percent.
COVID-19 AND RELATED LEGISLATIVE AND REGULATORY ACTIONS
OnJanuary 30, 2020 , theWorld Health Organization ("WHO") announced that the outbreak of COVID-19 constituted a public health emergency of international concern. OnMarch 11, 2020 ,WHO declared COVID-19 to be a global pandemic and, onMarch 13, 2020 , the President ofthe United States declared the COVID-19 outbreak a national emergency. In the two years since then, the pandemic has dramatically impacted global health and the economic environment, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, and market volatility. In response to the COVID-19 outbreak, theU.S. Congress , through the enactment of the CARES Act inMarch 2020 , and the federal banking agencies, though rulemaking, interpretive guidance and modifications to agency policies and procedures, took a series of actions to provide emergency economic relief measures including, among others, the following: Paycheck Protection Program. The CARES Act established the PPP, which is administered by theSmall Business Administration ("SBA"), to fund payroll and operational costs of eligible businesses, organizations and self-employed persons during the pandemic. The Bank actively participated in assisting its customers with PPP funding during all phases of the program. The application period for new PPP loans endedMay 31, 2021 . The vast majority of the Bank's PPP loans made in 2020 had two-year maturities, while the loans made in 2021 had five-year maturities. Loans under the program earn interest at a fixed rate of 1 percent. Consistent with the terms of the program, virtually all of the Corporation's PPP loans have been forgiven by the SBA. As ofDecember 31, 2022 , the Corporation had$4.7 million of PPP loans outstanding compared to theDecember 31, 2021 balance of$106.6 million . Loan Modifications and Troubled Debt Restructures. The CARES Act, as amended by the 2021 CAA, allowed banks to suspend requirements under GAAP, effectively, throughJanuary 1, 2022 , for certain loan modifications related to the COVID-19 pandemic. The federal banking agencies also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 or offer other borrower friendly options. In accordance with such guidance, the Bank made various short-term modifications for borrowerswho were current and otherwise not past due. These included short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that were insignificant. The Corporation did not have any COVID-19 modifications outstanding as ofDecember 31, 2022 or 2021. 35 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Regulatory Capital . The CARES Act, the 2021 CAA, and certain actions by federal
banking regulators resulted in modifications to, or delays in implementation of,
various regulatory capital rules applicable to banking organizations. See "-
Capital Adequacy Guidelines for Bank Holding Companies (Basel III)" above for
additional information.
CRITICAL ACCOUNTING ESTIMATES
Generally accepted accounting principles require management to apply significant judgment to certain accounting, reporting and disclosure matters. Management must use assumptions and estimates to apply those principles where actual measurement is not possible or practical. The judgments and assumptions made are based upon historical experience or other factors that management believes to be reasonable under the circumstances. Because of the nature of the judgments and assumptions, actual results could differ from estimates, which could have a material effect on our financial condition and results of operations. For a complete discussion of the Corporation's significant accounting policies see NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Allowance for Credit Losses - Loans As discussed in NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, the allowance for credit losses on loans is a contra-asset valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected. The amount of allowance represents management's best estimate of current expected credit losses on loans considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, the Corporation qualitatively adjusts model results for risk factors that are not inherently considered in the quantitative modeling process, but are nonetheless relevant in assessing the expected credit losses within the loan portfolio. These adjustments may increase or decrease the estimate of expected credit losses based upon the assessed level of risk for each qualitative factor. The various risks that may be considered in making qualitative adjustments include, among other things, the impact of (i) changes in the nature and volume of the loan portfolio, (ii) changes in the existence, growth and effect of any concentrations in credit, (iii) changes in lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries, (iv) changes in the quality of the credit review function, (v) changes in the experience, ability and depth of lending management and staff, and (vi) other environmental factors such as regulatory, legal and technological considerations, as well as competition. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond management's control, which includes, but is not limited to, the performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. Business Combinations Business combinations are accounted for under the acquisition method of accounting. Under the acquisition method, assets and liabilities of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the fair value of the net tangible and intangible assets acquired recorded as goodwill. The Corporation uses significant estimates and assumptions to value such items, including projected cash flows, repayment rates, default rates and losses assuming default, discount rates and realizable collateral values. The allowance for credit losses for PCD loans is recognized within acquisition accounting. The allowance for credit losses for non-PCD assets is recognized as provision for credit losses in the same period as the acquisition. Fair value adjustments are amortized or accreted into the income statement over the estimated life of the acquired assets or assumed liabilities. The purchase date valuations and any subsequent adjustments determine the amount of goodwill recognized in connection with the acquisition. The use of different assumptions could produce significantly different valuation results, which could have a positive or negative effect on the Corporation's results of operations. The determination of fair values is based on valuations using management's assumptions of future growth rates, future attrition, discount rate, and other relevant factors. In addition, third party specialists are used to assist in the development of fair values. Preliminary estimates of fair values may be adjusted for a period of time subsequent to the acquisition date if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. Adjustments recorded during this period are recognized in the current reporting period. The Corporation uses various valuation methodologies to estimate the fair value of assets and liabilities, and often involves a significant degree of judgment, particularly when liquid markets do not exist for the particular item being valued. Changes in these factors as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying value of assets, including goodwill and liabilities, which could result in impairment losses affecting the financial statements. Results of operations of Level One are included in the income statement from the date of acquisition. Details of the Corporation's acquisitions are included in NOTE 2. ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
RESULTS OF OPERATIONS - 2022
The Corporation reported net income available to common stockholders and diluted earnings per common share for the year ended 2022 of$220.7 million and$3.81 per diluted common share, respectively, compared to$205.5 million and$3.81 per diluted common share, respectively, for the year ended 2021. Adjusted net income available to common stockholders for the year ended 2022, excluding income on PPP loans and Level One acquisition-related expenses, was$243.4 million and adjusted diluted earnings per common share totaled$4.20 , compared to$182.2 million and$3.38 , respectively, for the year ended 2021. These adjusted net income and earnings per share amounts are non-GAAP measures. For reconciliations of non-GAAP measures to their most comparable GAAP measures, see "NON-GAAP FINANCIAL MEASURES" within the "Results of Operations" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations. 36 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
As of December 31, 2022 , total assets equaled $17.9 billion , an increase of $2.5
billion from December 31, 2021 . The Corporation acquired Level One on April 1,
2022 , which added $2.5 billion in assets at acquisition. Details of the
acquisition are discussed within NOTE 2. ACQUISITIONS of the Notes to
Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K.
Cash and due from banks and interest-bearing deposits decreased from December
31, 2021 by $44.6 million and $348.1 million , respectively, as excess cash was
used to fund organic loan growth. Total investment securities decreased $260.6
million from December 31, 2021 . The net unrealized gain on the Corporation's
available for sale investment securities portfolio of $75.9 million at December
31, 2021 changed to a net unrealized loss of $296.7 million as of December 31,
2022 . The change to a net unrealized loss position was due to changes in
interest rates and not credit quality. Additional details of the changes in the
Corporation's investment securities portfolio are discussed within NOTE 4.
INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included
in Item 8 of this Annual Report on Form 10-K.
The Corporation's total loan portfolio grew $2.8 billion since December 31,
2021 , of which, $1.6 billion was the result of the Level One acquisition. At
acquisition, Level One's loan portfolio included $43.5 million of PPP loans. As
of December 31, 2022 , the Corporation's PPP loan portfolio, which included PPP
loans from Level One, were primarily in the commercial and industrial loans
class and totaled $4.7 million , a decrease of $145.3 million from the December
31, 2021 balance of $106.6 million plus the additional $43.5 million from Level
One. Excluding the decline in PPP loans and the effect of Level One's acquired
loans at acquisition date, the Corporation experienced organic loan growth of
$1.3 billion , or 13.9 percent since December 31, 2021 . All loan classes
experienced increases from December 31, 2021 , with the exception of agricultural
land, production and other loans to farmers, and the largest increases were in
residential real estate, commercial and industrial loans and construction real
estate. Additional details of the changes in the Corporation's loan portfolio
are discussed within NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes
to Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K, and the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS"
section of this Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The Corporation's allowance for credit losses - loans ("ACL - loans") totaled
$223.3 million as of December 31, 2022 and equaled 1.86 percent of total loans,
compared to $195.4 million and 2.11 percent of total loans at December 31,
2021 . The ACL - loans increased $16.6 million in connection with the Level One
acquisition for CECL Day 1 purchased credit deteriorated ("PCD") loans and
provision expense of $14.0 million was recorded for CECL Day 1 non-PCD loans.
Additionally, provision expense of $2.8 million was recorded for CECL Day 1
unfunded commitments, which increased other liabilities. The Corporation did not
recognize any provision expense during 2022 and 2021 other than CECL Day 1
expense. During the year ended December 31, 2022 , the Corporation recognized
$2.7 million of net charge-offs, compared to net charge-offs of $9.3 million for
the year ended December 31, 2021 . Non-accrual loans totaled $42.3 million , a
decrease of $738,000 from December 31, 2021 , but when considering the
non-accrual loans acquired from Level One of $9.4 million , non-accruals
decreased $10.1 million . The coverage ratio of ACL - Loans to non-accrual loans
is a robust 527.5 percent. Additional details of the Corporation's allowance
methodology and asset quality are discussed within NOTE 5. LOANS AND ALLOWANCE
FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in
Item 8 of this Annual Report on Form 10-K and within the "LOAN QUALITY AND
PROVISION FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion
and Analysis of Financial Condition and Results of Operations.
Several additional asset categories increased from December 31, 2021 primarily
due to the acquisition of Level One, including premises and equipment of $11.5
million , FHLB stock of $9.8 million , interest receivable of $27.9 million ,
goodwill of $166.6 million , other intangibles of $10.4 million and cash
surrender value of life insurance of $17.3 million .
OREO totaled $6.4 million as of December 31, 2022 and increased $5.9 million
from the December 31, 2021 balance of $558,000 , primarily due to a $5.8 million
student housing property that was moved into OREO during the first quarter of
2022. A loss on this project is not expected.
The Corporation's tax asset, deferred and receivable increased from $35.6
million at December 31, 2021 to $111.2 million at December 31, 2022 , which
included the Corporation's net deferred tax asset increasing from $24.3 million
at December 31, 2021 to $109.5 million at December 31, 2022 . The $85.2 million
increase in the Corporation's net deferred tax asset was primarily due to
accounting for unrealized gains and losses on available for sale securities and
an increase in CECL from the acquisition of Level One.
The Corporation's other assets increased $81.5 million from December 31, 2021 .
The Corporation's derivative assets (recorded in other assets) and derivative
liabilities (recorded in other liabilities) increased $51.9 million and $50.8
million , respectively, from December 31, 2021 . The increase in valuations are
due to an increase in the total notional amount outstanding, continual increases
in the FOMC's target fed funds rate resulting in higher nominal rates and
increased forward rate expectations. The remaining increases in other assets
relate to the Corporation's investments in community redevelopment funds, which
increased $16.0 million since December 31, 2021 and an increase of $3.9 million
in receivables due to pending settlements related to asset sales. The Level One
acquisition contributed to an increase in the right of use lease asset of $5.8
million related to the addition of Level One's leased facilities and an increase
in mortgage servicing rights of $3.4 million related to Level One's mortgage
servicing portfolio.
Deposits increased $1.7 billion from December 31, 2021 , of which, the
acquisition of Level One contributed $1.9 billion in deposits. When excluding
the deposits related to the acquisition, the Corporation experienced an organic
deposit decline of $280.6 million , or 2.2 percent. Additional details regarding
the acquisition are discussed within NOTE 2. ACQUISITIONS of the Notes to
Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K. The majority of the organic deposit decline was due to decreases in
non-maturity deposits of $513.5 million , which was offset by increases in
maturity deposits of $232.9 million when compared to December 31, 2021 . Higher
interest rates have resulted in customers migrating funds from non-maturity
products into maturity time deposit products.
Total borrowings increased $679.7 million as of December 31, 2022 , compared to
December 31, 2021 . Federal funds purchased and Federal Home Loan Bank advances
increased $171.6 million and $489.6 million , respectively, compared to December
31, 2021 as the Corporation utilized liquidity sources to fund organic loan
growth. The Level One acquisition contributed to the increase in borrowings due
to the assumption of $160.0 million of Federal Home Loan Bank advances and $32.6
million of subordinated debentures. Additional details of the Corporation's
borrowings are discussed within NOTE 11. BORROWINGS of the Notes to Consolidated
Financial Statements included in Item 8 of this Annual Report on Form 10-K.
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CONDITION AND RESULTS OF OPERATIONS
The Corporation's other liabilities as of December 31, 2022 increased $28.3
million compared to December 31, 2021 . As noted above, the derivative hedge
liability increased $50.8 million from December 31, 2021 . At December 31, 2021 ,
the Corporation accrued $46.1 million of trade date accounting related to loan
and investment securities purchases, of which, there was no accrual at December
31, 2022 . The Corporation's liability related to mortgages sold in the secondary
market, but with the servicing retained, increased $11.6 million from December
31, 2021 . The Level One acquisition contributed to an increase in the lease
liability of $5.7 million related to the addition of Level One's leased
facilities and an additional $2.8 million for CECL Day 1 allowance for credit
losses on off-balance sheet credit exposures recorded in liabilities.
As part of the Level One acquisition, each outstanding share of 7.5 percent
non-cumulative perpetual preferred stock, Series B, of Level One was exchanged
for one share of a newly created 7.5 percent non-cumulative perpetual preferred
stock, Series A, of the Corporation with a liquidation preference of $2,500 per
share. As a result, the Corporation issued 10,000 shares of Series A preferred
stock at the acquisition date resulting in $25.0 million of outstanding
preferred stock at December 31, 2022 .
The Corporation continued to maintain all regulatory capital ratios in excess of
the regulatory definition of "well-capitalized." Details of the Stock Repurchase
Program and regulatory capital ratios are discussed within the "CAPITAL" section
of this Management's Discussion and Analysis of Financial Condition and Results
of Operations.
RESULTS OF OPERATIONS - 2021
Net income available to stockholders for the year ended December 31, 2021 was
$205.5 million compared to $148.6 million for the year ended 2020. Earnings per
fully diluted common share for 2021 totaled $3.81 compared to $2.74 for 2020.
As of December 31, 2021 , total assets equaled $15.5 billion , an increase of $1.4
billion , or 9.9 percent, from December 31, 2020 . The Corporation experienced
organic loan growth of $566.4 million , or 6.6 percent during 2021. This was
offset by SBA forgiveness of PPP loans of $560.5 million , resulting in net loan
growth of $5.9 million from December 31, 2020 . At December 31, 2021 , the
Corporation's PPP loan portfolio, primarily included in the commercial and
industrial loan class, totaled $106.6 million , a decrease of $560.5 million from
the December 31, 2020 balance of $667.1 million .
The largest loan classes that experienced increases from December 31, 2020 were
public finance and other commercial loans, real estate construction loans and
commercial real estate (owner occupied) loans. As noted above, PPP loans, which
are primarily included in the commercial and industrial loan class, decreased
$560.5 million from December 31, 2020 , and when coupled with organic commercial
and industrial loan growth of $498.4 million , the net decrease in the commercial
and industrial loan class was $62.1 million . Other loan classes that experienced
significant decreases from December 31, 2020 were commercial real estate
(non-owner occupied) loans, residential real estate loans and agricultural land,
production and other loans to farmers. Additional details of the changes in the
Corporation's loan portfolio are discussed within NOTE 5. LOANS AND ALLOWANCE
FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in
Item 8 of this Annual Report on Form 10-K, and the "LOAN QUALITY AND PROVISION
FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis
of Financial Condition and Results of Operations.
Total investment securities increased $1.4 billion , or 43.8 percent, from
December 31, 2020 . The Corporation purchased investment securities by utilizing
excess liquidity from deposit growth, which was held in interest-bearing
deposits and cash and cash equivalents, in addition to liquidity from SBA
forgiveness of PPP loans. Additional details of the Corporation's investment
securities portfolio are discussed within NOTE 4. INVESTMENT SECURITIES of the
Notes to Consolidated Financial Statements included in Item 8 of this Annual
Report on Form 10-K.
The Corporation's allowance for credit losses - loans totaled $195.4 million as
of December 31, 2021 and equaled 2.11 percent of total loans. The Corporation
adopted the current expected credit losses ("CECL") model for calculating the
allowance for credit losses on January 1, 2021 . CECL replaces the previous
"incurred loss" model for measuring credit losses, which encompassed allowances
for current known and inherent losses within the portfolio, with an "expected
loss" model for measuring credit losses, which encompasses allowances for losses
expected to be incurred over the life of the portfolio. The new CECL model
requires the measurement of all expected credit losses for financial assets
measured at amortized cost and certain off-balance sheet credit exposures based
on historical experiences, current conditions, and reasonable and supportable
forecasts. CECL also requires enhanced disclosures related to the significant
estimates and judgments used in estimating credit losses, as well as credit
quality and underwriting standards of an organization's portfolio. The impact of
the adoption was an increase to the Allowance for Credit Losses - Loans of $74.1
million . Additional details of the Allowance methodology are discussed within
NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated
Financial Statements included in Item 8 of this Annual Report on Form 10-K.
The Corporation did not recognize any provision expense during the year ended
December 31, 2021 , compared to provision expense of $58.7 million for the year
ended 2020. The provision expense taken in 2020 primarily reflected the
Corporation's view of increased credit risk related to the COVID-19 pandemic.
The Corporation recognized net charge-offs during 2021 of $9.3 million , compared
to $8.3 million in 2020. Non-accrual loans totaled $43.1 million , a decrease of
$18.4 million from December 31, 2020 , resulting in a coverage ratio of 453.8
percent. Additional details of the Corporation's credit quality are discussed
within the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS" section of
this Management's Discussion and Analysis of Financial Condition and Results of
Operations.
In 2020, the Corporation announced a banking delivery transformation strategy,
which included the consolidation of seventeen banking centers across its
footprint by April 30, 2021 . As those consolidations finalized in the second
quarter of 2021, the fair value of the closed banking centers of $4.5 million
was moved from premises and equipment to assets held for sale (recorded in other
assets) while they are marketed for sale.
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CONDITION AND RESULTS OF OPERATIONS
The Corporation's tax asset, deferred and receivable increased from $12.3
million at December 31, 2020 to $35.6 million at December 31, 2021 . The
Corporation's net deferred tax asset increased from $4.3 million at December 31,
2020 to $24.3 million at December 31, 2021 . The $20.0 million increase in the
Corporation's net deferred tax asset was due to a combination of an increase in
deferred tax assets and a decrease in deferred tax liabilities. The largest
deferred tax asset increases were associated with the tax effect of the
implementation and accounting for CECL of $21.1 million and accounting for
unrealized gains and losses on available for sale securities of $7.5 million .
Offsetting the increases to the net deferred tax asset were net deferred tax
decreases associated with accounting for loan fees and accounting for pensions
and employee benefits of $2.3 million and $3.3 million , respectively.
The Corporation's other assets decreased $5.9 million from December 31, 2020 .
The Corporation's derivative asset (recorded in other assets) and derivative
liability (recorded in other liabilities) related to interest rate contracts
decreased $33.2 million and $34.4 million , respectively, from December 31, 2020 .
The decreases in valuations are due to higher yield curve rates across the
entire term point spectrum. The higher interest rates are the result of higher
inflation expectations, current increases in short-term rate trajectories,
Federal Reserve tapering and increases in term premiums. Offsetting the decrease
in the Corporation's derivative asset was an increase in the Corporation's
prepaid pension of $12.1 million and investments in community redevelopment
funds of $7.4 million .
As of December 31, 2021 , total deposits equaled $12.7 billion , an increase of
$1.4 billion from December 31, 2020 . The Corporation experienced increases from
December 31, 2020 in demand and savings accounts of $883.0 million and $673.1
million , respectively. A portion of the increase is due to PPP loans that have
remained on deposit, in addition to consumer Economic Impact Payments from the
IRS that have also remained on deposit. Offsetting these increases were
decreases in certificates of deposit and brokered deposits of $142.2 million and
$42.9 million , respectively, from December 31, 2020 . The low interest rate
environment has resulted in customers moving funds from maturing time deposit
products into non-maturity products due to similar rates offered for both
products.
Total borrowings decreased $50.7 million as of December 31, 2021 , compared to
December 31, 2020 . Federal Home Loan Bank advances decreased $55.4 million
compared to December 31, 2020 as the Corporation utilized excess liquidity from
deposit growth to pay off maturing advances. Additionally, securities sold under
repurchase agreements increased by $4.5 million .
The Corporation's other liabilities as of December 31, 2021 increased $29.2
million compared to December 31, 2020 . As part of the CECL adoption on January
1, 2021 , the Corporation recorded a $20.5 million allowance for credit losses on
off-balance sheet credit exposures as a liability account. This amount
represents expected credit losses over the contractual period for which the
Corporation is exposed to credit risk resulting from a contractual obligation to
extend credit. The Corporation also accrued $46.1 million of trade date
accounting related to loan and investment securities purchases as of December
31, 2021 , of which, the accrual was $6.2 million as of December 31, 2020 .
Additionally, as noted above, the derivative hedge liability decreased $34.4
million from December 31, 2020 .
The Corporation continued to maintain all regulatory capital ratios in excess of
the regulatory definition of "well-capitalized." Details of the Corporation's
stock repurchase program and regulatory capital ratios are discussed within the
"CAPITAL" section of this Management's Discussion and Analysis of Financial
Condition and Results of Operations.
NON-GAAP FINANCIAL MEASURES
The Corporation's accounting and reporting policies conform to GAAP and general
practices within the banking industry. As a supplement to GAAP, the Corporation
provides non-GAAP performance measures, which management believes are useful
because they assist investors in assessing the Corporation's performance.
Non-GAAP financial measures have inherent limitations, are not required to be
uniformly applied, and are not audited. Although these non-GAAP financial
measures are frequently used by investors to evaluate a company, they have
limitations as analytical tools, and should not be considered in isolation, or
as a substitute for analyses of results as reported under GAAP. Where non-GAAP
financial measures are used, the comparable GAAP financial measure, as well as
the reconciliation to the comparable GAAP financial measure can be found in the
following tables.
Adjusted earnings per share, excluding PPP loans and acquisition-related
expenses, are meaningful non-GAAP financial measures for management, as they
provide a meaningful foundation for period-to-period and company-to-company
comparisons, which management believes will aid both investors and analysts in
analyzing our financial measures and predicting future performance. These
non-GAAP financial measures are also used by management to assess the
performance of the Corporation's business, because management does not consider
these items to be relevant to ongoing financial performance on a per share
basis.
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CONDITION AND RESULTS OF OPERATIONS
Non-GAAP financial measures such as tangible common equity to tangible assets,
tangible earnings per share, return on average tangible assets and return on
average tangible equity are important measures of the strength of the
Corporation's capital and ability to generate earnings on tangible common equity
invested by our shareholders. These non-GAAP measures provide useful
supplemental information and may assist investors in analyzing the Corporation's
financial position without regard to the effects of intangible assets and
preferred stock, but do retain the effect of accumulated other comprehensive
gains (losses) in shareholder's equity. Disclosure of these measures also allows
analysts and banking regulators to assess our capital adequacy on these same
bases.
ADJUSTED EPS EXCLUDING PAYCHECK PROTECTION PROGRAM ("PPP") AND ACQUISITION RELATED EXPENSES -
non-GAAP
(Dollars In Thousands, Except Per Share Amounts)
December 31, December 31, December 31,
2022 2021 2020
Net Income Available to Common Stockholders - GAAP $ 220,683 $ 205,531 $ 148,600 Adjustments:
PPP loan income (3,207) (30,900) (22,418) Acquisition-related expenses 16,531 - - Acquisition-related provision expense 16,755 - - Tax on adjustment (7,376) 7,577 5,497
Adjusted Net Income Available to Common Stockholders - non-GAAP
$ 243,386 $ 182,208 $ 131,679
Average Diluted Common Shares Outstanding (in thousands) 57,950
53,984 54,220
Diluted Earnings Per Common Share - GAAP $ 3.81 $ 3.81 $ 2.74 Adjustments:
PPP loan income (0.06) (0.57) (0.41) Acquisition-related expenses 0.28 - Acquisition-related provision expense 0.30 - Tax on adjustment (0.13) 0.14 0.10
Adjusted Diluted Earnings Per Common Share - non-GAAP
$ 3.38 $ 2.43
TANGIBLE COMMON EQUITY TO TANGIBLE ASSETS - non-GAAP (Dollars in thousands, except per share amounts)
December 31, 2022 December 31, 2021
Total Stockholders' Equity (GAAP) $ 2,034,770 $ 1,912,571
Less: Preferred stock (GAAP) (25,125) (125)
Less: Intangible assets (GAAP) (747,844) (570,860)
Tangible common equity (non-GAAP) $ 1,261,801 $ 1,341,586
Total assets (GAAP) $ 17,938,306 $ 15,453,149
Less: Intangible assets (GAAP) (747,844) (570,860)
Tangible assets (non-GAAP) $ 17,190,462 $ 14,882,289
Stockholders' Equity to Assets (GAAP) 11.34 % 12.38 %
Tangible common equity to tangible assets (non-GAAP) 7.34 % 9.01 %
Tangible common equity (non-GAAP) $ 1,261,801 $ 1,341,586
Plus: Tax benefit of intangibles (non-GAAP) 7,702 4,875
Tangible common equity, net of tax (non-GAAP) $ 1,269,503 $ 1,346,461
Common Stock outstanding (in thousands) 59,171 53,410
Book Value (GAAP) $ 33.96 $ 35.81
Tangible book value - common (non-GAAP) $ 21.45 $ 25.21
40
--------------------------------------------------------------------------------PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONSTANGIBLE EARNINGS PER SHARE, RETURN ON TANGIBLE ASSETS AND RETURN ON TANGIBLE EQUITY - non-GAAP (Dollars in thousands, except per share amounts)
December 31, 2022
$ 671,485 $ 545,374 $ 543,919 Average other intangibles (GAAP)
35,885 27,590 32,106
Average deferred tax on other intangibles (GAAP) (7,567) (5,452) (6,648)
Intangible adjustment (non-GAAP) $ 699,803 $ 567,512 $ 569,377 Average stockholders' equity (GAAP)
$ 1,972,445
(18,875) (125) (125)
Intangible adjustment (non-GAAP) (699,803) (567,512) (569,377)
Average tangible capital (non-GAAP) $ 1,253,767 $ 17,220,002
(699,803) (567,512) (569,377)
Average tangible assets (non-GAAP) $ 16,520,199 $ 205,531 $ 148,600 Other intangible amortization, net of tax (GAAP)
6,537 4,540 4,730
Preferred stock dividend 1,406 - -
Tangible net income available to common stockholders (non-GAAP)
$ 228,626 $ 210,071 $ 153,330 Per Share Data: Diluted net income available to common stockholders (GAAP)
$ 3.81 $ 3.81 $ 2.74
Diluted tangible net income available to common
stockholders (non-GAAP) $ 3.95 $ 3.89 $ 2.83
Ratios:
Return on average GAAP capital (ROE) 11.19 % 11.01 % 8.14 % Return on average tangible capital 18.12 % 16.17 % 12.21 % Return on average assets (ROA) 1.29 % 1.39 % 1.10 % Return on average tangible assets 1.38 % 1.47 % 1.19 % Return on average tangible capital is tangible net income available to common stockholders expressed as a percentage of average tangible capital. Return on average tangible assets is tangible net income available to common stockholders expressed as a percentage of average tangible assets.
NET INTEREST INCOME
Net interest income is the most significant component of the Corporation's earnings, comprising 82.8 percent of revenues for the year endedDecember 31, 2022 . Net interest income and margin are influenced by many factors, primarily the volume and mix of earning assets, funding sources, and interest rate fluctuations. Other factors include the level of accretion income on purchased loans, prepayment risk on mortgage and investment-related assets, and the composition and maturity of earning assets and interest-bearing liabilities. Loans typically generate more interest income than investment securities with similar maturities. Funding from customer deposits generally costs less than wholesale funding sources. Factors such as general economic activity,Federal Reserve Board monetary policy, and price volatility of competing alternative investments, can also exert significant influence on our ability to optimize the mix of assets and funding and the net interest income and margin. Net interest income is the excess of interest received from earning assets over interest paid on interest-bearing liabilities. For analytical purposes, net interest income is also presented on an FTE basis in the table that follows to reflect what our tax-exempt assets would need to yield in order to achieve the same after-tax yield as a taxable asset. The federal statutory rate of 21 percent was used for 2022, 2021, and 2020, adjusted for the TEFRA interest disallowance applicable to certain tax-exempt obligations. The FTE analysis portrays the income tax benefits associated with tax-exempt assets and helps to facilitate a comparison between taxable and tax-exempt assets. Management believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully taxable equivalent basis. Therefore, management believes these measures provide useful information for both management and investors by allowing them to make peer comparisons. For the year ended December, 31 2022, FTE asset yields increased 50 basis points compared to the same period in 2021. Average earning assets for the year endedDecember 31, 2022 increased$2.4 billion compared to the same period in 2021, with loans accounting for$1.8 billion of the increase and investment securities accounting for$852.1 million of the increase. Of the$1.8 billion increase in average loans,$1.6 billion was attributable to the Level One acquisition onApril 1, 2022 , and the remaining increase was due to organic loan growth during the period after excluding PPP loans, which averaged approximately$33.2 million for the year endedDecember 31, 2022 compared to an average of approximately$433.7 million for the same period of 2021. 41 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The increase in interest income, on an FTE basis, of $162.4 million during the
year ended December 31, 2022 compared to the same period in 2021 was primarily
due to an increase in average earning assets, coupled with the FOMC's interest
rate increases of an aggregate 425 basis points in 2022. Approximately $8.0
billion of the Corporation's loan portfolio, or 67 percent, is variable with 40
percent of the portfolio repricing within one month and 50 percent repricing
within three months. Additionally, due to the FOMC interest rate increases in
2022, the yields on new and renewed loans increased for the twelve months ended
December 31, 2022 compared to the same period in 2021. The PPP loans originated
in 2021 and 2020 were recorded at an interest rate of only 1 percent. The
Corporation recognized fee and interest income of $3.2 million on PPP loans in
2022, compared to $30.9 million in 2021, which is included in interest income.
The Corporation also recognized fair value accretion income on purchased loans,
which is included in interest income, of $10.1 million , which accounted for 6
basis points of net interest margin in the year ended December 31, 2022 .
Comparatively, the Corporation recognized $7.3 million of accretion income for
the year ended December 31, 2021 , or 5 basis points of net interest margin.
Interest costs increased 37 basis points, which mitigated a majority of the 50
basis point increase in asset yields and resulted in a 13 basis point FTE
increase in net interest spread when compared to the same period in 2021.
Interest costs have increased during the quarter due to deposit pricing pressure
primarily in the municipal deposit space and a strategic focus on relationship
pricing. Average interest-bearing deposits for the year ended December 31, 2022
increased $1.3 billion compared to the same period in 2021 due to the
acquisition of Level One, which included $1.2 billion of interest-bearing
deposits, and the remaining increase due to organic growth. Average non-interest
bearing deposits for the year ended December 31, 2022 increased $752.2 million
when compared to the same period in 2021 as $738.9 million were acquired from
Level One, and the remaining increase due to organic growth. Non-interest
bearing deposits represented 23 percent of the Corporation's total deposit
balance as of December 31, 2022 and acts to mitigate deposit yield increases as
interest rates rise. Average borrowings increased $248.6 million for the year
ended December 31, 2022 compared to the same period of 2021 due to the
additional $194.2 million of borrowings acquired from Level One.
Interest-bearing deposits and borrowing costs for the year ended December 31,
2022 were 0.58 percent and 2.46 percent, respectively, compared to 0.24 percent
and 1.97 percent, respectively, during the same period in 2021. Total cost of
funds was 72 basis points for the year ended December 31, 2022 compared to 35
basis points during the same period in 2021.
Net interest margin, on an FTE basis, increased 23 basis points to 3.41 percent for the year ended December, 31 2022 compared to 3.18 percent for the same period in 2021.
In 2021, the increase in average earning assets of$1.5 billion was primarily attributable to an increase in investment securities of$1.1 billion . Additionally, since the beginning of the PPP inApril 2020 , the Bank originated over$1.2 billion of PPP loans which averaged$433.7 million in 2021 and$601.8 million in 2020. The Corporation's organic loan growth offset the decline in PPP loans and resulted in an increase in average loans of$119.5 million . The liquidity generated from the SBA forgiveness of PPP loans, coupled with excess liquidity generated from deposit growth, resulted in the Corporation's utilization of the liquidity for organic loan growth and investment securities purchases. Asset yields decreased 40 basis points FTE in 2021 compared to 2020. This decrease was primarily a result of theFOMC's interest rate decreases of 50 basis points onMarch 3, 2020 and 100 basis points onMarch 16, 2020 at the Committee's special meetings related to COVID-19. Additionally, one-month LIBOR also saw a significant decline fromJanuary 1, 2020 of 1.73 percent toDecember 31, 2021 of 0.10 percent. The yield of the investment portfolio decreased 28 basis points compared to the same period in 2020 as the current year purchases had a lower yield than the historic yield of the portfolio. The loan portfolio, which generally has an average yield higher than the investment portfolio, was 67.5 percent of earning assets in 2021 compared to 74.7 percent in 2020. Average investment securities were 28.4 percent of total earning assets compared to 22.5 percent in 2020. The PPP loans originated in 2021 and 2020 were recorded at an interest rate of only 1 percent, but the Corporation also recognized fee income of$26.5 million in 2021, compared to$16.2 million in 2020, which is included in interest income. The Corporation also recognized fair value accretion income on purchased loans, which is included in interest income, of$7.3 million , which accounted for 5 basis points of net interest margin for the year endedDecember 31, 2021 . Comparatively, the Corporation recognized$13.5 million of fair value accretion income, which accounted for 11 basis points of net interest margin for the year endedDecember 31, 2020 . Interest costs decreased 35 basis points, which mitigated a majority of the decrease in asset yields and resulted in only a 5 basis point FTE decrease in net interest spread as compared to the same period in 2020. Interest costs have decreased as management aggressively moved deposit rates down as wholesale funding rates declined and market conditions allowed. Interest-bearing deposits and borrowing costs for the twelve months endedDecember 31, 2021 were 0.24 percent and 1.97 percent, respectively, compared to 0.60 percent and 1.91 percent, respectively, during the same period in 2020. Average borrowings decreased$128 million from 2020 as excess liquidity was used to payoff maturing FHLB advances. Average non-interest bearing deposits increased$448.2 million and equated to 20.7 percent of total deposits, compared to 19.3 percent in 2020. This increase, combined with the decrease in interest rates on interest-bearing deposits and debt repayments, resulted in a total cost of funds of 35 basis points compared to 70 basis points in 2020. 42 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONSNet interest margin is a function of net interest income and the level of average earning assets. The following table presents the Corporation's interest income, interest expense, and net interest income as a percent of average earning assets for the three-year period ending in 2022.
Interest Interest Interest
Income / Average Income / Average Income / Average
Average Balance Expense Rate Average Balance Expense Rate Average Balance Expense Rate
(Dollars in Thousands) 2022 2021 2020
Assets:
Interest-bearing deposits $ 296,863 $ 2,503 0.84 % $ 521,637 $ 634 0.12 % $ 319,686 $ 938 0.29 %
Federal Home Loan Bank stock 35,580 1,176 3.31 28,736 597 2.08 28,736 1,042 3.63
Investment Securities : (1)
Taxable 2,056,586 38,354 1.86 1,751,910 29,951 1.71 1,282,827 24,440 1.91
Tax-exempt (2) 2,653,611 85,292 3.21 2,106,180 70,039 3.33 1,440,913 53,596 3.72
Total investment securities 4,710,197 123,646 2.63 3,858,090 99,990 2.59 2,723,740 78,036 2.87
Loans held for sale 14,715 692 4.70 19,190 747 3.89 18,559 781 4.21
Loans: (3)
Commercial (6) 7,877,271 380,621 4.83 6,818,968 276,368 4.05 6,755,215 286,773 4.25
Real estate mortgage 1,471,802 51,853 3.52 916,314 34,783 3.80 889,083 40,002 4.50
Installment 785,520 37,302 4.75 683,925 26,111 3.82 718,815 30,708 4.27
Tax-exempt (2) 793,743 31,803 4.01 732,253 27,987 3.82 669,483 27,194 4.06
Total loans 10,943,051 502,271 4.59 9,170,650 365,996 3.99 9,051,155 385,458 4.26
Total earning assets 15,985,691 629,596 3.94 % 13,579,113 467,217 3.44 % 12,123,317 465,474 3.84 %
Total non-earning assets 1,234,311 1,251,284 1,342,952
Total Assets $ 17,220,002 $ 14,830,397 $ 13,466,269
Liabilities:
Interest-bearing deposits:
Interest-bearing deposit accounts $ 5,206,131 $ 32,511 0.62 % $ 4,769,482 $ 14,512 0.30 % $ 4,009,566 $ 20,239 0.50 %
Money market deposit accounts 2,915,397 19,170 0.66 2,351,803 3,203 0.14 1,769,478 7,810 0.44
Savings deposits 1,927,122 5,019 0.26 1,754,972 1,886 0.11 1,534,069 3,641 0.24
Certificates and other time deposits 881,176 6,239 0.71 783,733 3,718 0.47 1,346,967 20,050 1.49
Total interest-bearing deposits 10,929,826 62,939 0.58 9,659,990 23,319 0.24 8,660,080 51,740 0.60 Borrowings 888,392 21,864 2.46 639,791 12,633 1.97 768,238 14,641 1.91 Total interest-bearing liabilities 11,818,218 84,803 0.72 10,299,781 35,952 0.35 9,428,318 66,381 0.70 Noninterest-bearing deposits 3,268,417 2,516,241 2,068,026 Other liabilities 160,922 147,743 144,790 Total Liabilities 15,247,557 12,963,765 11,641,134 Stockholders' Equity 1,972,445 1,866,632 1,825,135
Total Liabilities and Stockholders' Equity
84,803$ 14,830,397 35,952$ 13,466,269 66,381 Net Interest Income (FTE)$ 544,793 $ 431,265 $ 399,093 Net Interest Spread (FTE) (4) 3.22 % 3.09 %
3.14 %
Net Interest Margin (FTE): Interest Income (FTE) / Average Earning Assets 3.94 % 3.44 % 3.84 % Interest Expense / Average Earning Assets 0.53 % 0.26 % 0.55 % Net Interest Margin (FTE) (5) 3.41 % 3.18 % 3.29 %
(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustment. Annualized amounts are computed using a 30/360 day basis.
(2) Tax-exempt securities and loans are presented on a fully taxable equivalent basis, using a marginal tax rate of 21 percent for 2022, 2021 and 2020. These totals equal$24,590 ,$20,585 and$16,966 , respectively.
(3) Non-accruing loans have been included in the average balances.
(4) Net Interest Spread (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average interest-bearing liabilities.
(5) Net Interest Margin (FTE) is interest income expressed as a percentage of average earning assets minus interest expense expressed as a percentage of average earning assets.
(6) Commercial loans included$4.7 million ,$106.6 million and$667.1 million of Paycheck Protection Program ("PPP") loans atDecember 31, 2022 , 2021 and 2020, respectively. 43 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONSNON-INTEREST INCOME
Non-interest income totaled$107.9 million in 2022, a decrease of$1.4 million , or 1.3 percent, from 2021. Customer related line items where decreases were experienced included net gains and fees on sales of loans of$9.6 million due to lower mortgage origination volume in 2022 compared to 2021, in addition to the$2.9 million gain on the portfolio mortgage loan sale that occurred in the second quarter of 2021, and in derivative hedge fees which decreased$0.5 million due to the rising interest rate environment. Offsetting these decreases were increases in customer related line items, which totaled$10.2 million , with the most significant increases experienced in service charges on deposit accounts, card payment fees, and fiduciary and wealth management fees, which were all influenced by the larger customer base from the Level One acquisition onApril 1, 2022 . Net realized gains on sales of available for sale securities decreased$4.5 million from 2021 and other income decreased$1.1 million in 2022, when compared to 2021, primarily as a result of a$1.9 million write-down of an equity investment in the third quarter of 2022. Finally, gains on life insurance benefits of$6.0 million increased$3.8 million from 2021 as a result of increased BOLI death benefits. Non-interest income totaled$109.3 million in 2021, a decrease of$0.6 million , or 0.5 percent, from 2020. Customer related line items increased$2.6 million in 2021 compared to 2020 with the largest increase of$4.6 million attributable to fiduciary and wealth management fees of which$3.6 million was organic growth and$1.0 million resulted from the acquisition ofHoosier Trust Company . Additionally, service charges on deposit accounts increased$2.6 million due to both continued organic growth in the deposit customer base and a lesser impact from the COVID-19 pandemic on customer activity than in 2020. Finally, net gains and fees on sales of loans increased$1.4 million during 2021 as volume remained strong and was enhanced by a gain of$2.9 million from a$76.1 million portfolio mortgage loan sale. Offsetting these increases were decreases in customer related line items experienced in derivative hedge fees of$3.1 million and$2.9 million in card payment fees that resulted from the first full-year impact of the Durbin Amendment to the Dodd-Frank Act, which became effective for the Bank onJuly 1, 2020 . Finally, the largest variances in non-customer related line items when comparing 2021 to 2020, were an increase in gains on life insurance benefits of$2.1 million resulting from BOLI death benefits and a decrease in net realized gains on sales of available for sale securities of$6.2 million . Details of theLevel One and Hoosier Trust Company acquisitions can be found in NOTE 2. ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
NON-INTEREST EXPENSES
Non-interest expense totaled$355.7 million in 2022, an increase of$76.5 million , or 27.4 percent from 2021. Level One acquisition-related costs in 2022 totaled$16.5 million , of which$7.1 million was in professional and other outside services,$6.0 million was reflected in salaries and employee benefits, and$2.2 million in equipment expenses and outside data processing expenses. The acquisition-related expenses were primarily contract termination charges, core system conversion expenses, transaction advisory services, and employee retention bonuses and severance. Additionally,$20.0 million of post-acquisition non-interest expenses related to Level One operations were recorded during 2022, which primarily included$13.8 million in salaries and employee benefits and$3.1 million in net occupancy expenses. In addition to the salary and benefits expense increases related to the acquisition of Level One, merit and incentive expense increases contributed to the overall$39.9 million increase in salaries and employee benefits for 2022 compared to 2021. Increases in other expenses of$7.4 million , in 2022 over 2021, were driven by higher customer-related contingent losses, increased customer related travel and entertainment expenses, and increased mortgage servicing rights amortization. Equipment and outside data processing expenses increased$4.5 million and$3.4 million , respectively, as the Corporation's investment in customer-facing digital solutions in 2022, such as online account origination, resulted in increased software costs when compared to 2021. As the Bank continues to grow both organically and via acquisition,FDIC assessments have increased$4.0 million when compared to 2021. Finally, intangible asset amortization increased$2.5 million due to the core deposit intangible and non-compete amortization related to the Level One acquisition. Non-interest expense totaled$279.2 million in 2021, an increase of$15.8 million , or 6.0 percent, over 2020. The largest contributing factor was an$11.1 million increase in salaries and employee benefits primarily due to higher salary and incentive expenses based upon current year financial results along with higher employee benefit costs primarily from rising health insurance costs. Additionally, other outside data processing fees increased$3.9 million in 2021, when compared to 2020, primarily due to increased loan processing expense and digital platform delivery expenses in 2021, due to the Corporation's deployment of online account origination technology. The Corporation also recorded reduced expense in 2020 from the sunsetting of a debit rewards program which contributed to the increase in outside data processing fees in 2021. Professional and other outside services increased$3.0 million in 2021 as projects that were delayed in 2020, due to the onset of the COVID-19 pandemic, were resumed. The Corporation also recorded$0.5 million of expense directly related to the acquisition of Level One which contributed to the increase in professional and other outside services in 2021 over 2020. Finally, other expenses increased$1.3 million primarily due to a$1.4 million increase in amortization of mortgage servicing rights as the mortgage servicing portfolio increased in 2021 resulting from a$76.1 million portfolio mortgage loan sale and an increase in held for sale loans being sold with servicing rights retained. The$3.4 million decline in net occupancy expenses in 2021 compared to 2020 was primarily driven by elevated expense in 2020, which included a charge of$3.8 million in net occupancy expenses related to the consolidation of seventeen banking centers. Details of theLevel One and Hoosier Trust Company acquisitions can be found in NOTE 2. ACQUISITIONS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. 44 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
INCOME TAXES
The Corporation's federal statutory income tax rate for 2022 is 21 percent and
its state tax rate varies from 0 to 9.5 percent depending on the state in which
the subsidiary company operates. The Corporation's effective tax rate, which was
13.1 percent in 2022 and 14.6 percent in 2021, is lower than the blended
effective statutory federal and state rates primarily due to the Corporation's
income on tax-exempt securities and loans, income generated by the subsidiaries
operating in a state with no state or local income tax, income tax credits
generated from investments in affordable housing projects, and tax-exempt
earnings from bank-owned life insurance contracts.
Income tax expense in 2022 was $33.6 million on pre-tax income of $255.7
million , or 13.1 percent. For 2021, income tax expense was $35.3 million on
pre-tax income of $240.8 million , or 14.6 percent. The lower effective income
tax rate in 2022 compared to 2021 was primarily driven by an increases in
tax-exempt earnings and gains on life insurance, which are also non-taxable. The
detailed reconciliation of federal statutory to actual tax expense is shown in
NOTE 19. INCOME TAX of the Notes to Consolidated Financial Statements included
in Item 8 of this Annual Report on Form 10-K.
The Corporation's tax asset, deferred and receivable increased from $35.6
million at December 31, 2021 to $111.2 million at December 31, 2022 , which
included the Corporation's net deferred tax asset increasing from $24.3 million
at December 31, 2021 to $109.5 million at December 31, 2022 . The $85.2 million
increase in the Corporation's net deferred tax asset was primarily due to
accounting for unrealized gains and losses on available for sale securities and
an increase in CECL from the acquisition of Level One.
CAPITAL
Stockholders' Equity - CECL Adjustment
The Corporation adopted the current expected credit losses ("CECL") model for
calculating the allowance for credit losses on January 1, 2021 . CECL replaces
the previous "incurred loss" model for measuring credit losses, which
encompassed allowances for current known and inherent losses within the
portfolio, with an "expected loss" model for measuring credit losses, which
encompasses allowances for losses expected to be incurred over the life of the
portfolio. As of the adoption and day one measurement date of January 1, 2021 ,
the Corporation recorded a one-time cumulative-effect adjustment to retained
earnings, net of income taxes, of $68.0 million .
Preferred Stock
As part of the Level One acquisition, the Corporation issued 10,000 shares of
newly created 7.5 percent non-cumulative perpetual preferred stock, with a
liquidation preference of $2,500 per share, in exchange for the outstanding
Level One Series B preferred stock, and as part of that exchange, each
outstanding Level One depositary share representing a 1/100th interest in a
share of the Level One preferred stock was converted into a depositary share of
the Corporation representing a 1/100th interest in a share of its newly issued
preferred stock. As a result of the issuance, the Corporation had $25.0 million
of outstanding preferred stock at December 31, 2022 . During the twelve months
ended December 31, 2022 , the Corporation declared and paid dividends of $46.88
per share (equivalent to $0.4688 per depositary share) equal to $1.4 million .
The Series A preferred stock qualifies as Tier 1 capital for purposes of the
regulatory capital calculations.
Stock Repurchase Program
On January 27, 2021 , the Board of Directors of the Corporation approved a stock
repurchase program of up to 3,333,000 shares of the Corporation's outstanding
common stock; provided, however, that the total aggregate investment in shares
repurchased under the program may not exceed $100,000,000 . On a share basis, the
amount of common stock subject to the repurchase program represented
approximately 6 percent of the Corporation's outstanding shares at the time the
program became effective. During 2022, the Corporation did not repurchase any
shares of its common stock pursuant to the repurchase program. As of December
31, 2022 , the Corporation had approximately 2.7 million shares at a maximum
aggregate value of $74.5 million available to repurchase under the program.
In August 2022 , the Inflation Reduction Act of 2022 (the "IRA") was enacted.
Among other things, the IRA imposes a new 1 percent excise tax on the fair
market value of stock repurchased after December 31, 2022 by publicly traded
U.S. corporations (like the Corporation). With certain exceptions, the value of
stock repurchased is determined net of stock issued in the year, including
shares issued pursuant to compensatory arrangements.
Regulatory Capital
Capital adequacy is an important indicator of financial stability and
performance. The Corporation and the Bank are subject to various regulatory
capital requirements administered by the federal banking agencies and are
assigned to a capital category. The assigned capital category is largely
determined by four ratios that are calculated according to the regulations:
total risk-based capital, tier 1 risk-based capital, CET1, and tier 1 leverage
ratios. The ratios are intended to measure capital relative to assets and credit
risk associated with those assets and off-balance sheet exposures of the entity.
The capital category assigned to an entity can also be affected by qualitative
judgments made by regulatory agencies about the risk inherent in the entity's
activities that are not part of the calculated ratios.
There are five capital categories defined in the regulations, ranging from "well
capitalized" to "critically undercapitalized". Classification of a bank in any
of the undercapitalized categories can result in actions by regulators that
could have a material effect on a bank's operations. Quantitative measures
established by regulation to ensure capital adequacy require the Bank to
maintain minimum amounts and ratios of total risk-based capital, tier 1 capital
and common equity tier 1 capital, in each case, to risk-weighted assets, and of
tier 1 capital to average assets, or leverage ratio, all of which are calculated
as defined in the regulations. Banks with lower capital levels are deemed to be
"undercapitalized", "significantly undercapitalized" or "critically
undercapitalized", depending on their actual levels. The appropriate federal
regulatory agency may also downgrade a bank to the next lower capital category
upon a determination that the bank is in an unsafe or unsound practice. Banks
are required to monitor closely their capital levels and to notify their
appropriate regulatory agency of any basis for a change in capital category.
45
--------------------------------------------------------------------------------PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Basel III requires the Corporation and the Bank to maintain the minimum capital
and leverage ratios as defined in the regulation and as illustrated in the table
below, which capital to risk-weighted asset ratios include a 2.5 percent capital
conservation buffer. Under Basel III, in order to avoid limitations on capital
distributions, including dividends, the Corporation must hold a 2.5 percent
capital conservation buffer above the adequately capitalized CET1 to
risk-weighted assets ratio (which buffer is reflected in the required ratios
below). Under Basel III, the Corporation and Bank elected to opt-out of
including accumulated other comprehensive income in regulatory capital. As of
December 31, 2022 , the Bank met all capital adequacy requirements to be
considered well capitalized under the fully phased-in Basel III capital rules.
There is no threshold for well capitalized status for bank holding companies.
As part of a March 27, 2020 joint statement of federal banking regulators, an
interim final rule that allowed banking organizations to mitigate the effects of
the CECL accounting standard on their regulatory capital was announced. Banking
organizations could elect to mitigate the estimated cumulative regulatory
capital effects of CECL for up to two years. This two-year delay was to be in
addition to the three-year transition period that federal banking regulators had
already made available. While the 2021 CAA provided for a further extension of
the mandatory adoption of CECL until January 1, 2022 , the federal banking
regulators elected to not provide a similar extension to the two year mitigation
period applicable to regulatory capital effects. Instead, the federal banking
regulators require that, in order to utilize the additional two-year delay,
banking organizations must have adopted the CECL standard no later than December
31, 2020 , as required by the CARES Act. As a result, because implementation of
the CECL standard was delayed by the Corporation until January 1, 2021 , it began
phasing in the cumulative effect of the adoption on its regulatory capital, at a
rate of 25 percent per year, over a three-year transition period that began on
January 1, 2021 . Under that phase-in schedule, the cumulative effect of the
adoption will be fully reflected in regulatory capital on January 1, 2024 .
The Corporation's and Bank's actual and required capital ratios as of
Prompt Corrective Action Thresholds
Actual Basel III Minimum Capital Required Well Capitalized
December 31, 2022 Amount Ratio Amount Ratio Amount Ratio
Total risk-based capital to risk-weighted assets First Merchants Corporation$ 1,882,254 13.08 %$ 1,511,230 10.50 % N/A N/A First Merchants Bank 1,822,296 12.65 1,513,064 10.50$ 1,441,014 10.00 % Tier 1 capital to risk-weighted assets First Merchants Corporation$ 1,558,281 10.83 %$ 1,223,377 8.50 % N/A N/A First Merchants Bank 1,641,210 11.39 1,224,862 8.50$ 1,152,811 8.00 % Common equity tier 1 capital to risk-weighted assets First Merchants Corporation$ 1,533,281 10.65 %$ 1,007,487 7.00 % N/A N/A First Merchants Bank 1,641,210 11.39 1,008,710 7.00$ 936,659 6.50 % Tier 1 capital to average assets First Merchants Corporation$ 1,558,281 9.10 %$ 684,758 4.00 % N/A N/A First Merchants Bank 1,641,210 9.60 683,680 4.00$ 854,600 5.00 % Prompt Corrective Action Thresholds Actual Basel III Minimum Capital Required Well Capitalized December 31, 2021 Amount Ratio Amount Ratio Amount Ratio Total risk-based capital to risk-weighted assets First Merchants Corporation$ 1,582,481 13.92 %$ 1,193,840 10.50 % N/A N/A First Merchants Bank 1,453,358 12.74 1,197,515 10.50$ 1,140,490 10.00 % Tier 1 capital to risk-weighted assets First Merchants Corporation$ 1,374,240 12.09 %$ 966,442 8.50 % N/A N/A First Merchants Bank 1,309,685 11.48 969,417 8.50$ 912,392 8.00 % Common equity tier 1 capital to risk-weighted assets First Merchants Corporation$ 1,327,634 11.68 %$ 795,893 7.00 % N/A N/A First Merchants Bank 1,309,685 11.48 798,343 7.00$ 741,319 6.50 % Tier 1 capital to average assets First Merchants Corporation$ 1,374,240 9.30 %$ 590,758 4.00 % N/A N/A First Merchants Bank 1,309,685 8.88 589,994 4.00$ 737,493 5.00 % OnApril 9, 2020 , federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program. The interim final rule, which became effectiveApril 13, 2020 , clarified that PPP loans receive a zero percent risk weight for purposes of determining risk-weighted assets and the CET1, tier 1 and total risk-based capital ratios. AtDecember 31, 2022 and 2021, risk-weighted assets included$4.7 million and$106.6 million , respectively, of PPP loans at a zero risk weight. Basel III permits banks with less than$15 billion in assets to continue to treat trust preferred securities as tier 1 capital. This treatment is permanently grandfathered as tier 1 capital even if the Corporation should ever exceed$15 billion in assets due to organic growth but not following certain mergers or acquisitions. As a result, while the Corporation's total assets exceeded$15 billion as ofDecember 31, 2021 , the Corporation has continued to treat its trust preferred securities as tier 1 capital as of such date. However, under certain amendments to the "transition rules" of Basel III, if a bank holding company that held less than$15 billion of assets as ofDecember 31, 2009 (which would include the Corporation) acquires a bank holding company with under$15 billion in assets at the time of acquisition (which would include Level One), and the resulting organization has total consolidated assets of$15 billion or more as reported on the resulting organization's call report for the period in which the transaction occurred, the resulting organization must begin reflecting its trust preferred securities as tier 2 capital at such time. 46 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
As a result, effective with the
Management believes the disclosed capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Traditionally, the banking regulators have assessed bank and bank holding company capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. TheFederal Reserve focuses its assessment of capital adequacy on a component of tier 1 capital known as CET1. Because theFederal Reserve has long indicated that voting common shareholders' equity (essentially tier 1 risk-based capital less preferred stock and non-controlling interest in subsidiaries) generally should be the dominant element in tier 1 risk-based capital, this focus on CET1 is consistent with existing capital adequacy categories. Tier I regulatory capital consists primarily of total stockholders' equity and subordinated debentures issued to business trusts categorized as qualifying borrowings, less non-qualifying intangible assets and unrealized net securities gains or losses.
A reconciliation of GAAP measures to regulatory measures (non-GAAP) are detailed in the following table for the periods indicated.
December 31, 2022 December 31, 2021 First Merchants First
Merchants
Corporation Bank Corporation Bank
Total Risk-Based Capital
Total Stockholders' Equity (GAAP) $ 2,034,770 $
2,119,316
239,151 237,094 (55,113) (57,352)
Less: Preferred Stock (25,125) (125) (125) (125)
Add: Qualifying Capital Securities 25,000 - 46,606 -
Less: Disallowed Goodwill and Intangible
Assets (738,206) (737,758) (564,002) (563,554)
Add: Modified CECL Transition Amount 23,028 23,028 34,542 34,542
Less: Disallowed Deferred Tax Assets (337) (345) (239) (219)
Total Tier 1 Capital (Regulatory) 1,558,281 1,641,210 1,374,240 1,309,685
Qualifying Subordinated Debentures 143,103 - 65,000 -
Allowance for Loan Losses Includible in
Tier 2 Capital 180,870 181,086 143,241 143,673
Net Risk-Weighted Assets (Regulatory)
$ 17,118,953 $
17,092,008
Total Risk-Based Capital Ratio (Regulatory) 13.08 % 12.65 % 13.92 % 12.74 % Tier 1 Capital to Risk-Weighted Assets 10.83 % 11.39 % 12.09 % 11.48 % Tier 1 Capital to Average Assets 9.10 % 9.60 % 9.30 % 8.88 % Common Equity Tier 1 Capital Ratio Total Tier 1 Capital (Regulatory)$ 1,558,281 $
1,641,210
(25,000) - (46,606) -
Common Equity Tier 1 Capital (Regulatory)
Net Risk-Weighted Assets (Regulatory)
10.65 % 11.39 % 11.68 % 11.48 %
(1) Includes net unrealized gains or losses on available for sale securities,
net gains or losses on cash flow hedges, and amounts resulting from the
application of the applicable accounting guidance for defined benefit and other
postretirement plans.
In management's view, certain non-GAAP financial measures, when taken together
with the corresponding GAAP financial measures and ratios, provide meaningful
supplemental information regarding our performance. We believe investors benefit
from referring to these non-GAAP financial measures and ratios in assessing our
operating results and related trends, and when forecasting future periods.
However, these non-GAAP financial measures should be considered in addition to,
and not a substitute for or preferable to, financial measures and ratios
presented in accordance with GAAP.
The Corporation's tangible common equity measures are capital adequacy metrics
that are meaningful to the Corporation, as well as analysts and investors, in
assessing the Corporation's use of equity and in facilitating period-to-period
and company-to-company comparisons. Tangible common equity to tangible assets
ratio was 7.34 percent at December 31, 2022 , and 9.01 percent at December 31,
2021 . The decrease in tangible common equity and tangible assets is primarily
due to the decline in mark-to-market values associated with our available for
sale investment securities portfolio. At December 31, 2021 , the available for
sale portfolio had a net unrealized gain of $75.9 million compared to a net
unrealized loss of $296.7 million at December 31, 2022 . This decline in value is
due to interest rate changes and not due to credit quality.
Non-GAAP financial measures such as tangible common equity to tangible assets,
tangible earnings per share, return on average tangible assets and return on
average tangible equity are important measures of the strength of the
Corporation's capital and ability to generate earnings on tangible common equity
invested by our shareholders. These non-GAAP measures provide useful
supplemental information and may assist investors in analyzing the Corporation's
financial position without regard to the effects of intangible assets and
preferred stock, but retain the effect of accumulated other comprehensive gains
(losses) in shareholder's equity. Disclosure of these measures also allows
analysts and banking regulators to assess our capital adequacy on these same
bases.
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--------------------------------------------------------------------------------PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The tables within the "NON-GAAP FINANCIAL MEASURES" section of this Management's
Discussion and Analysis of Financial Condition and Results of Operations
reconcile traditional GAAP measures to these non-GAAP financial measures at
LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS
The Corporation's primary lending focus is small business and middle market commercial, commercial real estate, public finance and residential real estate, which results in portfolio diversification. Commercial loans are individually underwritten and judgmentally risk rated. They are periodically monitored and prompt corrective actions are taken on deteriorating loans. Consumer loans are typically underwritten with statistical decision-making tools and are managed throughout their life cycle on a portfolio basis.
Loan Quality
The quality of the loan portfolio and the amount of non-performing loans may increase or decrease as a result of acquisitions, organic portfolio growth, problem loan recognition and resolution through collections, sales or charge-offs. The performance of any loan can be affected by external factors such as economic conditions, or internal factors specific to a particular borrower, such as the actions of a customer's internal management.
At
Other real estate owned and repossessions, totaling$6.4 million atDecember 31, 2022 , increased$5.9 million fromDecember 31, 2021 . The increase is primarily related to a student housing property with a carrying value of$5.8 million . For other real estate owned, current appraisals are obtained to determine fair value as management continues to aggressively market these real estate assets. According to applicable accounting guidance, loans that no longer exhibit similar risk characteristics are individually evaluated to determine if there is a need for a specific reserve. Commercial loans under$500,000 and consumer loans, with the exception of troubled debt restructures, are not individually evaluated. The determination for individual evaluation is made based on current information or events that may suggest it is probable that not all amounts due of principal and interest, according to the contractual terms of the loan agreement, will be substantially collected. The Corporation's non-performing assets plus accruing loans 90 days or more delinquent and individually evaluated loans are presented in the table below. December 31, December 31, (Dollars in Thousands) 2022 2021 Non-Performing Assets: Non-accrual loans$ 42,324 $ 43,062 Renegotiated loans 224 329 Non-performing loans (NPL) 42,548 43,391 OREO and Repossessions 6,431 558 Non-performing assets (NPA) 48,979 43,949 Loans 90-days or more delinquent and still accruing 1,737 963 NPAs and loans 90-days or more delinquent$ 50,716 $ 44,912
The non-accrual balances in the table above include troubled debt loan
restructures totaling
The composition of non-performing assets plus accruing loans 90-days or more delinquent is reflected in the following table.
December 31, December 31,
(Dollars in Thousands) 2022 2021
Non-performing assets and loans 90-days or more delinquent: Commercial and industrial loans
$ 4,439 $ 8,273 Agricultural land, production and other loans to farmers 54 631 Real estate loans Construction 12 885 Commercial real estate, non-owner occupied 25,494 23,125 Commercial real estate, owner occupied 3,550 432 Residential 14,315 9,723 Home equity 2,742 1,840
Individual's loans for household and other personal expenditures 110
3
Non-performing assets and loans 90-days or more delinquent
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--------------------------------------------------------------------------------PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONSPROVISION EXPENSE AND ALLOWANCE FOR CREDIT LOSSES ON LOANS
The Corporation adopted FASB Accounting Standards Update (ASU) No. 2016-13,
Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments ("CECL") on January 1, 2021 . CECL replaces the previous
"incurred loss" model with an "expected loss" model of measuring credit losses,
which encompasses allowances for losses expected to be incurred over the life of
the portfolio. The new CECL model requires the measurement of all expected
credit losses for financial assets measured at amortized cost based on
historical experiences, current conditions and reasonable and supportable
economic forecasts. CECL also requires enhanced disclosures related to the
significant estimates and judgments used in estimating credit losses, as well as
credit quality and underwriting standards of an organization's portfolio.
Additional details of the Corporation's methodology for measuring expected
credit losses on loans is discussed in NOTE 5. LOANS AND ALLOWANCE FOR CREDIT
LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of
this Annual Report on Form 10-K.
The CECL allowance is maintained through the provision for credit losses, which
is a charge against earnings. Based on management's judgment as to the
appropriate level of the allowance, the amount provided in any period may be
greater or less than net loan losses for the same period. The determination of
the provision amount and the adequacy of the allowance in any period is based on
management's continuing review and evaluation of the loan portfolio.
The Corporation's total loan balance increased $2.8 billion , ending December 31,
2022 at $12.0 billion . The Level One acquisition added $1.6 billion to the total
loan balance. Through the acquisition of Level One, the Bank acquired an
additional $43.5 million of PPP loans as of the acquisition date. As of December
31, 2022 , the Corporation had $4.7 million of PPP loans outstanding compared to
the December 31, 2021 balance of $106.6 million . The Corporation will continue
to monitor legislative, regulatory, and supervisory developments related to the
PPP. However, it anticipates that the majority of the Bank's remaining PPP loans
will be forgiven by the SBA in accordance with the terms of the program.
Additional details of the Level One acquisition are included in NOTE 2.
ACQUISITIONS of these Notes to Consolidated Financial Statements.
At December 31, 2022 , the allowance for credit losses totaled $223.3 million ,
which represents an increase of $27.9 million from December 31, 2021 . The
acquisition of Level One added $16.6 million in allowance for credit losses on
PCD loans and an additional $14.0 million in provision for credit losses on
non-PCD loans. The allowance was offset by $2.7 million in net charge offs for
the twelve months ended December 31, 2022 . As a percentage of loans, the
allowance for credit losses was 1.86 percent at December 31, 2022 , compared to
2.11 percent at December 31, 2021 and 1.41 percent at December 31, 2020 . The
allowance for credit losses as a percentage of total loans less PPP loans was
1.86 percent as of December 31, 2022 . The Corporation deems the current estimate
for loan portfolio credit exposure as appropriate.
The Corporation's credit loss experience is presented in the table below for the
years indicated.
(Dollars in Thousands) 2022 2021 2020
Allowance for loan/credit losses:
Balances, December 31, 2021 $ 195,397 Impact of adopting ASC 326 - 74,055 - Balances, January 1, 2021 Post-ASC 326 adoption - 204,703 - Loans charged off 6,601 11,884 10,485 Recoveries on loans 3,927 2,578 2,176 Net charge-offs 2,674 9,306 8,309 Provision for loan/credit losses - - 58,673 CECL Day 1 non-PCD provision for credit losses 13,955 - - CECL Day 1 PCD ACL 16,599 - - Ending balance, December 31, 2021$ 223,277
0.02 % 0.10 % 0.09 %
Ratio of allowance for credit losses - loans to non-accrual loans
527.5 % 453.8 % 212.5 %
Ratio of allowance for credit losses - loans to total loans
outstanding 1.86 % 2.11 % 1.41 %
There was
49
--------------------------------------------------------------------------------PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Net charge-offs totaling $2.7 million , $9.3 million , and $8.3 million were
recognized for the twelve months ended December 31, 2022 , 2021, and 2020,
respectively. For the twelve months ended December 31, 2022 , there was one
individual charge-off greater than $500,000 that totaled $2.8 million . For the
twelve months ended December 31, 2022 , there were two individual recoveries
greater than $500,000 that totaled $1.2 million . For the twelve months ended
December 31, 2021 , there were four individual charge-offs greater than $500,000
that totaled $9.0 million . For the twelve months ended December 31, 2020 , there
were two individual charge-offs greater than $500,000 that totaled $7.3 million .
For the twelve months ending December 31, 2021 and 2020, there were not any
individual recoveries greater than $500,000 . The distribution of the net
charge-offs (recoveries) for the twelve months ended December 31, 2022 , 2021,
and 2020 are reflected in the following table.
December 31, December 31, December 31,
(Dollars in Thousands) 2022 2021 2020
Net charge-offs:
Commercial and industrial loans $ 347 $ 5,185 $ 7,794
Agricultural land, production and other farm loans (4) (60) (2)
Real estate loans
Construction (863) 5 (101)
Commercial real estate, non-owner occupied 2,817 3,334 (148)
Commercial real estate, owner occupied (896) 619 56
Residential (4) (283) (160)
Home equity 526 157 487Individuals loans for household and other personal expenditures
751 349 383
Public finance and other commercial loans - - -
Total net charge-offs $ 2,674 $ 9,306 $ 8,309
Management continually evaluates the commercial loan portfolio by including
consideration of specific borrower cash flow analysis and estimated collateral
values, types and amounts on non-performing loans, past and anticipated credit
loss experience, changes in the composition of the loan portfolio, and the
current condition and amount of loans outstanding. The determination of the
provision for credit losses in any period is based on management's continuing
review and evaluation of the loan portfolio, and its judgment as to the impact
of current economic conditions on the portfolio.
As ofOctober 1, 2022 andOctober 1, 2021 , the Corporation performed its annual goodwill impairment testing and in each valuation, the fair value exceeded the Corporation's carrying value; therefore, it was concluded goodwill was not impaired as of either date. The Level One acquisition onApril 1, 2022 resulted in$166.6 million of goodwill. In addition, the Hoosier acquisition on April, 1, 2021 resulted in$1.5 million of additional goodwill during that year. Details regarding the Level One and Hoosier acquisitions are discussed in NOTE 2. ACQUISITIONS of these Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
LIQUIDITY
Liquidity management is the process by which the Corporation ensures that adequate liquid funds are available for the holding company and its subsidiaries. These funds are necessary in order to meet financial commitments on a timely basis. These commitments include withdrawals by depositors, funding credit obligations to borrowers, paying dividends to stockholders, paying operating expenses, funding capital expenditures, and maintaining deposit reserve requirements. Liquidity is monitored and closely managed by the asset/liability committee. The Corporation's liquidity is dependent upon the receipt of dividends from the Bank, which is subject to certain regulatory limitations and access to other funding sources. Liquidity of the Bank is derived primarily from core deposit growth, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources. The principal source of asset-funded liquidity is investment securities classified as available for sale, the market values of which totaled$2.0 billion atDecember 31, 2022 , a decrease of$367.9 million , or 15.7 percent, fromDecember 31, 2021 . Securities classified as held to maturity that are maturing within a short period of time can also be a source of liquidity. Securities classified as held to maturity and that are maturing in one year or less totaled$13.7 million atDecember 31, 2022 . In addition, other types of assets such as cash and interest-bearing deposits with other banks, federal funds sold and loans maturing within one year are sources of liquidity. The most stable source of liability-funded liquidity for both the long-term and short-term is deposit growth and retention in the core deposit base. Federal funds purchased and securities sold under agreements to repurchase are also considered a source of liquidity. In addition, FHLB advances are utilized as a funding source. AtDecember 31, 2022 , total borrowings from the FHLB were$823.7 million . The Bank has pledged certain mortgage loans and investments to the FHLB. The total available remaining borrowing capacity from the FHLB atDecember 31, 2022 was$617.6 million . The Corporation and the Bank receive outside credit ratings from Moody's. Both the Corporation and the Bank currently have Issuer Ratings of Baa1 with a Rating Outlook of Stable. Additionally, the Bank has a Baseline Credit Assessment Rating of a3. Management considers these ratings to be indications of a sound capital base and strong liquidity and believes that these ratings would help ensure the ready marketability of its commercial paper. Because of the Corporation's and Bank's current levels of long-term debt, management believes it could generate additional liquidity from various sources should the need arise. 50 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table presents the Corporation's material cash requirements from
known contractual and other obligations at
Payments Due In
(Dollars in Thousands) One Year or Less Over One Year Total
Deposits without stated maturity $ 13,105,937 $ - $ 13,105,937
Certificates and other time deposits 1,148,819 127,989 1,276,808
Securities sold under repurchase agreements 167,413 - 167,413
Federal Home Loan Bank advances 460,097 363,577 823,674
Federal Funds Purchased 171,560 - 171,560
Subordinated debentures and term loans 1,183 150,115 151,298
Total $ 15,055,009 $ 641,681 $ 15,696,690
For further details related to the Corporation's deposits and borrowings, see
NOTE 10. DEPOSITS and NOTE 11. BORROWINGS of the Notes to Consolidated Financial
Statements included in Item 8 of this Annual Report on Form 10-K.
Also, in the normal course of business, the Bank is a party to a number of other
off-balance sheet activities that contain credit, market and operational risk
that are not reflected in whole or in part in the consolidated financial
statements. These activities primarily consist of traditional off-balance sheet
credit-related financial instruments such as loan commitments and standby
letters of credit.
Summarized credit-related financial instruments at December 31, 2022 are as
follows:
(Dollars in Thousands) December 31, 2022
Amounts of Commitments:
Loan commitments to extend credit $ 4,950,724
Standby letters of credit 40,784
$ 4,991,508
Since many of the commitments are expected to expire unused or be only partially
used, the total amount of unused commitments in the preceding table does not
necessarily represent future cash requirements.
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK
Asset/Liability management has been an important factor in the Corporation's ability to record consistent earnings growth through periods of interest rate volatility and product deregulation. Management and the Board of Directors monitor the Corporation's liquidity and interest sensitivity positions at regular meetings to review how changes in interest rates may affect earnings. Decisions regarding investment and the pricing of loan and deposit products are made after analysis of reports designed to measure liquidity, rate sensitivity, the Corporation's exposure to changes in net interest income given various rate scenarios and the economic and competitive environments. It is the objective of the Corporation to monitor and manage risk exposure to net interest income caused by changes in interest rates. It is the goal of the Corporation's Asset/Liability management function to provide optimum and stable net interest income. To accomplish this, management uses two asset liability tools. GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation Modeling are constructed, presented and monitored quarterly. Management believes that the Corporation's liquidity and interest sensitivity position atDecember 31, 2022 remained adequate to meet the Corporation's primary goal of achieving optimum interest margins while avoiding undue interest rate risk. 51 --------------------------------------------------------------------------------
PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table presents the Corporation's interest rate sensitivity
analysis as of
December 31, 2022
(Dollars in Thousands) 1-180 Days 181-365 Days 1-5 Years Beyond 5 Years Total
Rate-Sensitive Assets:
Interest-bearing deposits $ 126,061 $ - $ - $ - $ 126,061
Investment securities 97,873 105,060 997,075 3,063,780 4,263,788
Loans 6,512,836 482,345 2,985,969 2,031,838 12,012,988
Federal Home Loan Bank stock - - 38,525 -
38,525
Total rate-sensitive assets$ 6,736,770 $ 587,405 $ 4,021,569 $ 5,095,618 $ 16,441,362 Rate-Sensitive Liabilities: Interest-bearing deposits$ 9,880,678 $ 760,835 $ 118,931 $ 448,884 $ 11,209,328 Federal funds purchased 171,560 - - - 171,560 Securities sold under repurchase agreements 167,413 - - -
167,413
Federal Home Loan Bank advances 375,000 85,000 285,000 78,674
823,674
Subordinated debentures and term loans 50,039 - - 101,259
151,298
Total rate-sensitive liabilities$ 10,644,690
$ (3,907,920)
$ (3,907,920) $ (4,166,350) $ (548,712) $ 3,918,089 Cumulative rate sensitivity gap ratio at December 31, 2022 63.3 % 63.7 % 95.4 % 131.3 % at December 31, 2021 60.3 % 63.8 % 85.0 % 134.0 %
The Corporation had a cumulative negative gap of
Net interest income simulation modeling, or earnings-at-risk, measures the sensitivity of net interest income to various interest rate movements. The Corporation's asset liability process monitors simulated net interest income under three separate interest rate scenarios; base, rising and falling. Estimated net interest income for each scenario is calculated over a twelve-month horizon. The immediate and parallel changes to the base case scenario used in the model are presented below. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may introduce into the earnings of the Corporation. The base scenario is highly dependent on numerous assumptions embedded in the model, including assumptions related to future interest rates. While the base sensitivity analysis incorporates management's best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact will likely differ from that projected. For certain assets, the base simulation model captures the expected prepayment behavior under changing interest rate environments. Assumptions and methodologies regarding the interest rate or balance behavior of indeterminate maturity products, such as savings, money market, interest-bearing and demand deposits, reflect management's best estimate of expected future behavior. Historical retention rate assumptions are applied to non-maturity deposits for modeling purposes. The comparative rising 200 basis points and falling 100 basis points scenarios below, as ofDecember 31, 2022 , assume further interest rate changes in addition to the base simulation discussed above. These changes are immediate and parallel changes to the base case scenario. Results for rising 200 basis points and falling 100 basis points interest rate scenarios are listed below based upon the Corporation's rate sensitive assets and liabilities atDecember 31, 2022 . The change from the base case represents cumulative net interest income over a twelve-month time horizon. Balance sheet assumptions used for the base scenario are the same for the rising and falling simulations. December 31, 2022 December 31, 2021 Rising 200 basis points from base case 2.8% 1.4 % Falling 100 basis points from base case (2.3)%
(0.9) %
52
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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
EARNING ASSETS
The following table presents the earning asset mix as of December 31, 2022 and
December 31, 2021 . Earning assets increased by $2.2 billion , or 15.1 percent,
during the twelve months ended December 31, 2022 . The April 1, 2022 acquisition
of Level One contributed to increases in several categories. Additional details
of the Level One acquisition can be found in NOTE 2. ACQUISITIONS of the Notes
to Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K.
Interest bearing deposits decreased
Total investment securities decreased$260.6 million fromDecember 31, 2021 . The net unrealized gain on the Corporation's available for sale investment securities portfolio of$75.9 million atDecember 31, 2021 changed to a net unrealized loss of$296.7 million as ofDecember 31, 2022 . The change to a net unrealized loss position was due to changes in interest rates and not credit quality. Additional details of the changes in the Corporation's investment securities portfolio are discussed within NOTE 4. INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The Corporation's total loan portfolio increased$2.8 million fromDecember 31, 2021 , with$1.6 billion of the increase resulting from the acquisition of Level One. AtDecember 31, 2022 , the Corporation's PPP loan portfolio, which included PPP loans from Level One, were primarily in the commercial and industrial loan class and totaled$4.7 million , a decrease of$145.4 million from theDecember 31, 2021 balance of$106.6 million plus the additional$43.5 million from Level One. Excluding the decline in PPP loans and the effect of Level One's acquired loans at acquisition date, the Corporation experienced organic loan growth of$1.3 billion , or 13.9 percent sinceDecember 31, 2021 . All loan classes experienced increases fromDecember 31, 2021 , with the exception of agricultural land, production and other loans to farmers, and the largest increases were in residential real estate, commercial and industrial loans and construction real estate. Additional details of the changes in the Corporation's loan portfolio are discussed within NOTE 5. LOANS AND ALLOWANCE FOR CREDIT LOSSES of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and the "LOAN QUALITY AND PROVISION FOR CREDIT LOSSES ON LOANS" section of this Management's Discussion and Analysis of Financial Condition and Results of Operations.
Federal Home Loan
December 31, December 31,
(Dollars in Thousands) 2022 2021
Interest-bearing deposits $ 126,061 $ 474,154 Investment securities available for sale 1,976,661 2,344,551 Investment securities held to maturity 2,287,127 2,179,802 Loans held for sale
9,094 11,187
Loans 12,003,894 9,241,861
Federal Home Loan Bank stock 38,525 28,736
$ 16,441,362 $ 14,280,291
DEPOSITS AND BORROWINGS
The table below reflects the level of deposits and borrowed funds (repurchase
agreements, FHLB advances, subordinated debentures and term loans) at
December 31, December 31,
(Dollars in Thousands) 2022 2021
Deposits:
Demand deposits $ 8,448,797 $ 7,704,190
Savings deposits 4,657,140 4,334,802
Certificates and other time deposits of $100,000 or more 742,539 273,379
Other certificates and time deposits 468,712 389,752
Brokered deposits 65,557 30,454
Total deposits 14,382,745 12,732,577
Federal funds purchased 171,560 -
Securities sold under repurchase agreements 167,413 181,577
Federal Home Loan Bank advances 823,674 334,055
Subordinated debentures and term loans 151,298 118,618
$ 15,696,690 $ 13,366,827
Deposits increased $1.7 billion from December 31, 2021 . The acquisition of Level
One contributed $1.9 billion in deposits, resulting in an organic deposit
decline of $280.6 million , or 2.2 percent. Additional details regarding the
acquisition are discussed within NOTE 2. ACQUISITIONS of the Notes to
Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10-K. The majority of the organic deposit decline was due to decreases in
non-maturity deposits of $513.5 million , which was offset by increases in
maturity deposits of $232.9 million when compared to December 31, 2021 . Higher
interest rates have resulted in customers migrating funds from non-maturity
products into maturity time deposit products.
53
--------------------------------------------------------------------------------PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Federal Home Loan Bank advances increased $489.6 million compared to December
31, 2021 as the Corporation utilized liquidity from FHLB advances to fund
organic loan growth. The Corporation has leveraged its capital position with
FHLB advances, as well as repurchase agreements, which are pledged against
acquired investment securities as collateral for the borrowings. Further
discussion regarding FHLB advances is included in NOTE 11. BORROWINGS of the
Notes to Consolidated Financial Statements included in Item 8 of this Annual
Report on Form 10K and Management's Discussion and Analysis of Financial
Condition and Results of Operations under the heading "LIQUIDITY". Additionally,
the interest rate risk is included as part of the Corporation's interest
simulation discussed in this Management's Discussion and Analysis of Financial
Condition and Results of Operations under the heading "INTEREST SENSITIVITY AND
DISCLOSURES ABOUT MARKET RISK".
Subordinated debentures and term loans increased $32.7 million compared to
December 31, 2021 due to the acquisition of Level One. Additional details
regarding Level One's subordinated debentures and other borrownings are
discussed within NOTE 2. ACQUISITIONS and NOTE 11. BORROWINGS of the Notes to
Consolidated Financial Statements included in Item 8 of this Annual Report on
Form 10K.
INFLATION
The Corporation's financial statements are presented in accordance with GAAP,
which requires the measurement of financial position and operating results
primarily in terms of historic dollar values. Changes in the relative value of
money due to inflation or recession are generally not considered. Historically,
changes in interest rates have affected the financial condition of a financial
institution to a far greater degree than changes in the inflation rate. However,
with inflation reaching the highest level in decades, the impact of such on the
financial institution is more direct. The most direct effect of inflation on the
Corporation's operations is reflected in increased operating costs. The impact
of inflation on operating costs in 2022 is reflected primarily in higher labor
and vendor costs. During 2022, the Federal Reserve engaged in the tightening of
monetary policy to address inflation by increasing the target federal funds rate
by 425 basis points. The Corporation's sensitivity to interest rate changes are
presented in this Management's Discussion and Analysis of Financial Condition
and Results of Operations under the heading "INTEREST SENSITIVITY AND
DISCLOSURES ABOUT MARKET RISK". This rapid increase in interest rates can impact
consumer spending as goods and services cost more thereby causing deposit
balances to decline. In addition, the Corporation's loan growth could moderate
as customers respond to the impact of higher interest rates, high costs and a
slowing economy.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The quantitative and qualitative disclosures about market risk information are presented in the "INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK" section of Management's Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.
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