Lakeland Financial Corp: Form 10-Q for the period ended Sep 30, 2024

OVERVIEW

Net income in the first nine months of 2024 was $69.3 million, which increased $5.1 million, or 8.0%, from $64.1 million for the comparable period of 2023. Diluted income per common share was $2.69 in the first nine months of 2024, an increase of 8.0% from $2.49 in the comparable period of 2023. The increase in net income for 2024 was primarily due to an increase to noninterest income of $12.3 million, or 37.7%, and a decrease in noninterest expense of $6.8 million, or 6.7%. Offsetting these effects was an increase in the provision for credit losses of $7.5 million, or 135.3%, and a decrease to net interest income of $3.5 million, or 2.3%. Pretax pre-provision earnings, a non-GAAP measure calculated by adding net interest income to noninterest income and subtracting noninterest expense, were $95.5 million in the first nine months of 2024, an increase of $15.7 million, or 19.7%, compared to $79.8 million for the comparable period of 2023.

Annualized return on average total equity was 14.21% in the first nine months of 2024 versus 14.44% in the comparable period of 2023. Annualized return on average total assets was 1.40% in the first nine months of 2024 versus 1.33% for the comparable period of 2023. The Company's average equity to average assets ratio was 9.84% in the first nine months of 2024 versus 9.21% in the comparable period of 2023.

Net income in the third quarter of 2024 was $23.3 million, down $1.9 million, or 7.6%, from $25.3 million for the comparable period of 2023. Diluted earnings per common share was $0.91 in the third quarter of 2024, down 7.1% from $0.98 in the comparable period of 2023. The decrease was driven primarily by an increase in provision for credit losses of $2.7 million and an increase in noninterest expense of $1.3 million, or 4.5%. Offsetting these effects was an increase in noninterest income of $1.1 million, or 10.0%, and an increase in net interest income of $880,000, or 1.8%. Pretax pre-provision earnings in the third quarter of 2024 were $30.8 million, an increase of $666,000, or 2.2%, compared to $30.1 million for the comparable period of 2023.

Annualized return on average total equity was 13.85% in the third quarter of 2024 versus 16.91% in the comparable period of 2023. Annualized return on average total assets was 1.39% in the third quarter of 2024 versus 1.54% in the comparable period of 2023. The average equity to average assets ratio was 10.07% in the third quarter of 2024 versus 9.12% in the comparable period of 2023.

The Company’s tangible common equity to tangible assets ratio, which is a non-GAAP financial measure, was 10.47% at September 30, 2024, compared to 8.62% at September 30, 2023 and 9.91% at December 31, 2023. Unrealized losses from available-for-sale investment securities were $154.5 million at September 30, 2024, compared to $266.4 million at September 30, 2023 and $174.6 million at December 31, 2023. When excluding the impact of accumulated other comprehensive income (loss) ("AOCI") on tangible common equity and tangible assets, the Company's adjusted tangible common equity to adjusted tangible assets ratio, which is a non-GAAP financial measure, was 12.29% at September 30, 2024, compared to 11.74% at September 30, 2023 and 11.99% at December 31, 2023.

Total assets were $6.645 billion as of September 30, 2024 versus $6.524 billion as of December 31, 2023, an increase of $121.3 million, or 1.9%. Total loans, net of the allowance for credit losses, increased $153.8 million, or 3.2%, which was the primary driver of balance sheet expansion between December 31, 2023 and September 30, 2024. Offsetting the increase to loans, net of the allowance of credit losses, was a decrease in available-for-sale securities of $35.1 million, or 3.3%. Total deposits increased by $116.8 million, or 2.0%, between December 31, 2023 and September 30, 2024. Total equity increased $49.4 million, or 7.6%, from $649.8 million at December 31, 2023 to $699.2 million at September 30, 2024. Retained earnings increased $31.8 million, or 4.6%, primarily as a result of net income of $69.3 million and reduced by dividends declared and paid of $37.0 million. AOCI increased $17.1 million, or 11.0%, from improvement in the fair market values of available-for-sale investment securities during the nine months ended September 30, 2024.

CRITICAL ACCOUNTING POLICIES

The Company’s accounting policies are described in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2023.

Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for credit losses. See “Note 4 – Allowance for Credit Losses and Credit Quality” for more information on this critical accounting policy.

RESULTS OF OPERATIONS

Overview

Selected income statement information for the three and nine months ended September 30, 2024 and 2023 is presented in the following table:

(dollars in thousands)

(1) Noninterest expense (c) / (Net interest income (a) + Noninterest income (b)) = Efficiency Ratio

(2) Non-GAAP financial measure. Calculated by subtracting intangible assets, net of deferred tax, from total assets and total equity. Management believes this is an important measure because it is useful for planning and forecasting purposes. See reconciliation on the following pages.

(3) Non-GAAP financial measure. Calculated by removing the fair market value adjustment impact of the available-for-sale investment securities portfolio included in accumulated other comprehensive income (loss) ("AOCI") from tangible equity and tangible assets. Management believes this is an important measure because it provides better comparability to periods preceding the recent significant rise in prevailing interest rates and demonstrates long-term trends capital strength. See reconciliation on the following pages.

(4) Non-GAAP financial measure. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Management believes this is an important measure because it may enable investors to identify the trends in the Company's earnings exclusive of the effects of tax and provision expense, which may vary significantly from period to period. See reconciliation on the following pages.

The Company believes that providing non-GAAP financial measures provides investors with information useful to understanding the Company's financial performance.

Tangible common equity, adjusted tangible common equity, tangible assets, adjusted tangible assets, tangible book value per common share, tangible common equity to tangible assets, adjusted tangible common equity to adjusted tangible assets, and pretax pre-provision earnings are non-GAAP financial measures calculated based on GAAP amounts. Tangible common equity is calculated by excluding the balance of goodwill and other intangible assets from the calculation of equity, net of deferred tax. Tangible assets are calculated by excluding the balance of goodwill and other intangible assets from the calculation of total assets, net of deferred tax. Adjusted tangible assets and adjusted tangible common equity remove the fair market value adjustment impact of the available-for-sale investment securities portfolio in accumulated other comprehensive income (loss) ("AOCI"). Tangible book value per common share is calculated by dividing tangible common equity by the number of shares outstanding less true treasury stock. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Because not all companies use the same calculation of tangible common equity and tangible assets, this presentation may not be comparable to other similarly titled measures calculated by other companies. However, management considers these measures of the company’s value meaningful to understanding of the company’s financial information and performance.

A reconciliation of these non-GAAP financial measures is provided below (dollars in thousands, except per share data).

(dollars in thousands, except per share data)

40

Adjusted core noninterest income, adjusted core noninterest expense, adjusted earnings before income taxes, core operational profitability, core operational diluted earnings per common share and adjusted core efficiency ratio are non-GAAP financial measures calculated based on GAAP amounts. These adjusted amounts are calculated by excluding the impact of the net gain on Visa shares, legal accrual, and wire fraud loss and associated insurance and loss recoveries and adjustments to salaries and employee benefits expense for the periods presented below. Management considers these measures of financial performance to be meaningful to understanding the company’s core business performance for these periods.

A reconciliation of these non-GAAP financial measures is provided below (dollars in thousands, except per share data).

(dollars in thousands, except per share data)

(1) In 2023, long-term, incentive-based compensation accruals were reduced as a result of the wire fraud loss and associated insurance and loss recoveries.

(2) Core operational profitability was $11,000 higher than reported net income for the three months ended September 30, 2024. Core operational profitability was $4.1 million lower than reported net income for the nine months ended September 30, 2024 and 2023, respectively.

Net Income

Net income was $69.3 million in the first nine months of 2024, which increased $5.1 million, or 8.0%, from $64.1 million for the comparable period of 2023. Diluted income per common share was $2.69 in the first nine months of 2024, an increase of 8.0% from $2.49 in the comparable period of 2023. The increase in net income for the first nine months of 2024 was primarily due to an increase to noninterest income of $12.3 million, or 37.7%, and a decrease in noninterest expense of $6.8 million, or 6.7%. Offsetting these effects was a decrease to net interest income of $3.5 million, or 2.3%, and an increase in the provision for credit losses of $7.5 million, or 135.3%.

Net income during the third quarter of 2024 was $23.3 million, down 7.6% from $25.3 million for the comparable period of 2023. Diluted earnings per common share was $0.91 in the third quarter of 2024, down 7.1% from $0.98 in the comparable period of 2023. The decrease was driven primarily by an increase in the provision for credit losses of $2.7 million and an increase in noninterest expense of $1.3 million, or 4.5%, and was offset by an increase in noninterest income of $1.1 million, or 10.0% and an increase in net interest income of $880,000, or 1.8%.

Net Interest Income

The following tables set forth consolidated information regarding average balances and rates:

(fully tax equivalent basis, dollars in thousands)

(1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $3.6 million and $4.0 million for the nine-month periods ended September 30, 2024 and September 30, 2023, respectively.

(2) Loan fees, which are immaterial in relation to total taxable loan interest income for the nine months ended September 30, 2024 and 2023, are included as taxable loan interest income.

(3) Nonaccrual loans are included in the average balance of taxable loans.

(fully tax equivalent basis, dollars in thousands)

(1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $1.1 million and $1.3 million in the three-month periods ended September 30, 2024 and September 30, 2023, respectively.

(2) Loan fees, which are immaterial in relation to total taxable loan interest income for the three months ended September 30, 2024 and 2023, are included as taxable loan interest income.

(3) Nonaccrual loans are included in the average balance of taxable loans.

Net interest income, on a fully tax equivalent basis, decreased $3.9 million, or 2.5%, to $148.6 million for the nine months ended September 30, 2024, compared to $152.4 million for the first nine months of 2023. The decline in net interest income on a fully tax equivalent basis was driven by an increase in deposit interest expense of $35.4 million, or 37.1%, from $95.6 million to $131.1 million. Securities interest income contributed further to the decline in fully tax equivalent net interest income, declining $1.7 million, or 6.5%. Loan interest income positively impacted fully tax equivalent net interest income, increasing $27.6 million, or 12.1%, from $227.1 million to $254.7 million between the two periods. Borrowings expense declined $4.5 million, or 54.9%.

Total average earning assets were $6.281 billion for the nine months ended September 30, 2024, an increase of $177.1 million, or 2.9%, compared to $6.104 billion for the nine months ended September 30, 2023. Average loans outstanding drove the increase to total average earning assets, increasing $232.1 million, or 4.8%, to $5.024 billion from $4.791 billion for the nine months ended September 30, 2024 and 2023, respectively. Offsetting this increase was a decrease to average investment securities of $75.2 million, or 6.2%, to $1.135 billion from $1.211 billion between the respective periods. Total average interest bearing liabilities were $4.616 billion for the nine months ended September 30, 2024, an increase of $369.5 million, or 8.7%, from $4.247 billion for the nine months ended September 30, 2023. This increase was driven by increased interest bearing deposits of $499.4 million, or 12.4%, from $4.028 billion for the nine months ended September 30, 2023 to $4.528 billion for the nine months ended September 30, 2024. Offsetting the increase to average interest bearing deposits was a decrease in total average borrowings of $130.0 million, or 59.5%, to $88.6 million from $218.6 million for the nine months ended September 30, 2024 and 2023, respectively. Noninterest bearing demand deposits decreased $259.6 million, or 17.2%, to $1.250 billion from $1.509 billion between the two periods.

The tax equivalent net interest margin was 3.16% for the nine months ended September 30, 2024, compared to 3.33% during the first nine months of 2023, representing a 17 basis point contraction between the two periods. The net interest margin contraction was primarily driven by an increase to interest expense as a percentage of average earning assets, which increased to 2.87% for the nine months ended September 30, 2024, up from 2.28% for the comparable period of 2023, for an increase of 59 basis points. This increase was attributable to an increase in the rate for total interest bearing liabilities of 63 basis points from 3.27% to 3.90% between the respective periods. This increase was driven by increased costs associated with the Company's interest bearing deposits, as depositors sought higher rates on interest bearing deposit products while competition for deposits remained high throughout the industry. This increase was offset by reduced borrowing expense due to lower average borrowings. The increase in interest expense for interest bearing deposits was a result of a combination of an increase in average interest bearing deposits of $499.4 million, or 12.4%, from $4.028 billion to $4.528 billion, and an increase in the average rate for interest bearing deposits of 70 basis points, from 3.17% to 3.87% for the nine months ended September 30, 2024 as compared to the comparable period in the prior year. The Company anticipates the cost of funds may continue to remain elevated as a result of market competition and shifts from noninterest bearing deposits into interest bearing deposits. Offsetting the increase to interest expense as a percentage of average earning assets was an increase to interest income as a percentage of average earning assets of 42 basis points, or 7.4%, to 6.03% for the nine months ended September 30, 2024, up from 5.61% for the comparable period of 2023. This increase was attributable to an increase in loan yields, which was driven by the combination of an increase in average loans of $232.1 million, or 4.8%, to $5.024 billion from $4.791 billion, and an increase in average yield of 43 basis points from 6.34% to 6.77% between the respective periods. The Company expects that easing of monetary policy by the Federal Reserve Bank, which commenced in late September 2024, will exert downward pressure on loan yields as variable rate commercial loans reprice lower; however, deposits repricing lower is expected to offset the decline in loan yields.

Net interest income, on a fully tax equivalent basis, increased by $671,000, or 1.3%, for the three months ended September 30, 2024 as compared to the three months ended September 30, 2023. The increase in net interest income on a fully tax equivalent basis was driven by loan interest income, which increased by $6.3 million, or 7.9%, from $80.2 million to $86.5 million, income from short-term investments and interest bearing deposits, which increased $168,000, or 10.5%, and reduced borrowing expense, which decreased by $2.9 million, or 93.9%. Offsetting these positive factors was an increase in deposit interest expense of $8.4 million, or 22.8%, from $37.1 million to $45.6 million and a decrease to securities interest income of $298,000, or 3.6%.

Total average earning assets were $6.329 billion for the third quarter of 2024, an increase of $183.4 million, or 3.0%, compared to $6.146 billion for the third quarter of 2023. The increase in average earning assets was driven by an increase in average loans of $214.6 million, or 4.4%, from $4.850 billion for the third quarter of 2023 to $5.064 billion for the third quarter of 2024. Offsetting the increase in average loans was a decrease in average investment securities, which decreased $42.7 million, or 3.6%, from $1.171 billion for the third quarter of 2023 to $1.129 billion for the third quarter of 2024. Total average interest bearing liabilities were $4.650 billion for the third quarter of 2024, an increase of $267.4 million, or 6.1%, from $4.382 billion for the third quarter of 2023. This increase was driven by growth in interest bearing deposits of $481.2 million, or 11.6%, from $4.155 billion for the third quarter of 2023 to $4.636 billion for the third quarter of 2024. Noninterest bearing demand deposits decreased $173.5 million, or 12.2%, from $1.418 billion for the third quarter of 2023 to $1.244 billion for the third quarter of 2024 and average borrowings decreased $213.8 million, or 94.0%, from $227.6 million for the third quarter of 2023 to $13.8 million for the third quarter of 2024.

The tax equivalent net interest margin contracted by 5 basis points, or 1.6%, to 3.16% for the third quarter of 2024, compared to 3.21% for the third quarter of 2023. The net interest margin contraction was primarily driven by an increase in interest expense as a percentage of average earning assets, which increased to 2.88% for the three months ended September 30, 2024, up from 2.60% for the comparable period of 2023, for an increase of 28 basis points. This increase was attributable to an increase in the rate for total interest bearing liabilities of 27 basis points, or 7.5%, from 3.64% to 3.91% between the respective periods. This increase was driven by increased costs associated with the Company's interest bearing deposits, as depositors sought higher interest rates on interest bearing deposit products while competition for deposits remained high throughout the industry. This increase was offset by reduced borrowings expense due to lower average borrowings. The increase in rate for interest bearing deposits was a result of an increase in average interest bearing deposits of $481.2 million, or 11.6%, from $4.155 billion to $4.636 billion, and an increase in the average rate for interest bearing deposits of 37 basis points, from 3.54% to 3.91% for the three months ended September 30, 2024, as compared to the comparable period in the prior year. The Company anticipates the cost of funds may continue to remain elevated as a result of market competition, shifts from noninterest bearing deposits to interest bearing deposits, and elevated wholesale funding costs. Offsetting the increase to interest expense as a percentage of average earning assets was an increase to interest income as a percentage of average earning assets of 23 basis points, or 4.0%, to 6.04% for the three months ended September 30, 2024, up from 5.81% for the comparable period of 2023. This increase was attributable to an increase in loan yields, which was driven by an increase in average loans of $214.6 million, or 4.4%, to $5.064 billion from $4.850 billion, and an increase in average yield of 23 basis points from 6.56% to 6.79% between the respective periods. The Company expects that easing of monetary policy by the Federal Reserve Bank will exert downward pressure on loan yields as variable rate commercial loans reprice lower, however the impact of the policy easing on loan yields will partly depend on the extent and timing of future rate cuts.

Provision for Credit Losses

The Company recorded provision for credit losses expense of $13.1 million for the nine months ended September 30, 2024, compared to provision expense of $5.6 million during the comparable period of 2023, an increase of $7.5 million, or 135.3%. Net charge-offs were $1.4 million during the nine month period ended September 30, 2024, compared to $6.1 million during the comparable period of 2023, a decrease of $4.6 million, or 76.8%. The decrease in charge-offs between the respective periods was the result of a charge-off of $5.5 million attributable to a single commercial borrower that occurred during the first quarter of 2023.

The Company recorded provision expense of $3.1 million during the third quarter of 2024, compared to $400,000 during the third quarter of 2023. Provision expense during the quarter was primarily driven by an increase in the specific reserve allocation from the downgrade of a single $43.3 million commercial relationship, an industrial company in Northern Indiana, that was placed on nonperforming status during the second quarter of 2024. Net charge-offs were $143,000 during the third quarter of 2024, compared to $353,000 during the third quarter of 2023.

Additional factors considered by management included key loan quality metrics, including reserve coverage of nonperforming loans and economic conditions in the Company’s markets, and changes in the facts and circumstances of watch list credits, which includes the security position of the borrower. Management’s overall view on current credit quality was also a factor in the determination of the provision for credit losses. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.

Noninterest Income

Noninterest income categories for the three and nine months ended September 30, 2024 and 2023 are shown in the following tables:

(dollars in thousands)

(dollars in thousands)

Noninterest income increased by $12.3 million, or 37.7%, to $45.0 million for the nine months ended September 30, 2024, compared to $32.7 million for the prior year nine-month period. The increase in noninterest income was driven primarily by the net gain on Visa shares of $9.0 million. Additionally, other income increased $2.0 million, or 104.9%, wealth advisory fees increased $1.0 million, or 14.8%, bank owned life insurance income increased $601,000, or 25.1%, and mortgage banking income increased $252,000. Other income increased primarily from improved performance from limited partnership investment income and the receipt of a $1.0 million insurance recovery related to the 2023 wire fraud loss. Improved market performance of the Company's variable bank owned life insurance policies, which are tied to the performance of the equity markets, drove the increase to bank owned life insurance income. Mortgage banking income increased from pipeline expansion and a related positive impact to mortgage rate lock income. Offsetting these increases was a decrease to interest rate swap fee income of $794,000, or 100.0%, due to no new swap fee activity during the period. Adjusted core noninterest income, a non-GAAP financial measure that excludes the effects of certain non-routine events, was $35.0 million for the nine months ended September 30, 2024, an increase of $2.3 million, or 7.1%, compared to $32.7 million for the nine months ended September 30, 2023.

The Company’s noninterest income increased $1.1 million, or 10.0%, to $11.9 million for the third quarter of 2024, compared to $10.8 million for the third quarter of 2023. Wealth advisory fees increased $420,000, or 18.3%, driven by growth in customers and favorable market performance. Other income increased $429,000, or 71.7%, primarily from an improvement to income from the Company's limited partnership investments. Adjusted core noninterest income was $11.9 million for the third quarter of 2024, an increase of $1.1 million, or 10.1%, compared to $10.8 million for the third quarter of 2023.

Noninterest Expense

Noninterest expense categories for the three and nine months ended September 30, 2024 and 2023 are shown in the following tables:

(dollars in thousands)

(dollars in thousands)

Noninterest expense decreased by $6.8 million, or 6.7%, for the nine months ended September 30, 2024, to $94.4 million compared to $101.3 million for the nine months ended September 30, 2023. The $18.1 million wire fraud loss recorded during the second quarter of 2023 was the primary driver of the decrease between the comparative periods. Offsetting this decrease were increases to salaries and employee benefits expense of $6.1 million, or 13.9%, other expense of $3.2 million or 41.0%, data processing fees of $1.1 million, or 10.8%, and professional fees of $391,000, or 6.2%. The increase to salaries and benefits expense resulted primarily from increases to salaries and wages of $2.3 million, performance-based incentive compensation of $2.2 million, health insurance expense of $695,000 and variable deferred compensation related to the Company's variable bank owned life insurance of $536,000. Other expense increased due to the recognition of a $4.5 million legal accrual during the second quarter of 2024. The increase for data processing fees resulted from continued investment in customer-facing and operational technology solutions. Professional fees increased due to higher costs to implement technology solutions. Adjusted core noninterest expense, a non-GAAP financial measure that excludes the impact of certain non-routine events, was $89.9 million for the nine months ended September 30, 2024, an increase of $4.8 million, or 5.7%, from $85.1 million recorded during the comparable period of 2023.

Noninterest expense increased $1.3 million, or 4.5%, to $30.4 million for the third quarter of 2024, compared to $29.1 million during the third quarter of 2023. Driving the third quarter 2024 increase to noninterest expense were increases to salaries and benefits expense of $499,000, or 3.1%, data processing fees and supplies expense of $389,000, or 11.5%, and corporate and business development expense of $168,000, or 14.0%, as compared to the third quarter of 2023. Adjusted core noninterest expense was $30.4 million for the third quarter of 2024, an increase of $1.3 million, or 4.5%, compared to $29.1 million for the third quarter of 2023.

The Company's income tax expense increased $3.0 million, or 30.1%, to $13.2 million in the nine months ended September 30, 2024, compared to $10.1 million for the same period in 2023. The effective tax rate was 16.0% in the nine months ended September 30, 2024, compared to 13.6% for the comparable period of 2023. The year-to-date effective tax rate was increased due to adoption of ASU 2023-02, to account for the Company's investment in low-income housing tax credit structures, as well as a reduction in the tax benefit recognized from stock-based compensation vesting of shares for plan participants.

FINANCIAL CONDITION

Overview

Total assets were $6.645 billion as of September 30, 2024 versus $6.524 billion as of December 31, 2023, an increase of $121.3 million, or 1.9%. Total loans, net of the allowance for credit losses, increased $153.8 million, or 3.2%, between December 31, 2023 and September 30, 2024. Offsetting the increase to loans, net of the allowance for credit losses, was a decrease in available-for-sale securities of $35.1 million, or 3.3%. Total deposits increased $116.8 million, or 2.0%, between December 31, 2023 and September 30, 2024. The increase in total deposits was driven by an increase in interest bearing deposits of $185.7 million, or 4.3%, and was offset by a decrease in noninterest bearing deposits of $69.0 million, or 5.1%. Total equity increased $49.4 million, or 7.6%, from $649.8 million at December 31, 2023 to $699.2 million at September 30, 2024. Retained earnings increased $31.8 million, or 4.6%, as a result of net income of $69.3 million but was reduced by dividends declared and paid of $37.0 million. Accumulated other comprehensive income (loss), increased $17.1 million, or 11.0%, due primarily to an improvement in available-for-sale securities fair market values during the nine months ended September 30, 2024.

Uses of Funds

Total Cash and Cash Equivalents

Total cash and cash equivalents increased by $8.4 million, or 5.5%, to $160.2 million at September 30, 2024, from $151.8 million at December 31, 2023. Cash and cash equivalents include short-term investments. The fluctuation in cash and cash equivalents at September 30, 2024 was driven by an increase in cash and due from banks of $16.3 million, or 23.2%, and a decrease in interest bearing short-term investment accounts of $8.0 million, or 9.8%.

Investment Portfolio

The amortized cost and the fair value of securities as of September 30, 2024 and December 31, 2023 were as follows:

(dollars in thousands)

48

At September 30, 2024 and December 31, 2023, there were no holdings of securities of any one issuer, other than the U.S. government agencies and government sponsored entities, in an amount greater than 10% of stockholders’ equity. Management is aware that the directional change in the fair value of the available-for-sale investment securities portfolio is inversely related to the directional movement of the interest rate environment, with the resulting impact being reflected in the unrealized gain (loss) of the available-for-sale investment securities portfolio. Since the majority of the bonds in the investment portfolio are fixed-rate, with only a few adjustable-rate bonds, we would expect our investment portfolio to follow this market value pattern. This is taken into consideration when evaluating the gain or loss of investment securities in the portfolio and the potential for an allowance for credit losses.

There were no purchases of available-for-sale securities in the first nine months of 2024. Investment securities represented 17.3% of total assets on September 30, 2024, compared to 18.1% of total assets on December 31, 2023. The ratio of investment securities as a percentage of total assets remains elevated over historical levels of approximately 12% to 14%. The Company expects the investment securities portfolio as a percentage of assets to continue to decrease over time as the proceeds from pay downs, sales and maturities are used to fund loan portfolio growth and for general liquidity purposes. Tax equivalent adjusted effective duration for the investment securities portfolio was 6.3 years at September 30, 2024 and 6.5 years at December 31, 2023. Tax equivalent adjusted effective duration of the portfolio remains elevated as compared to 4.0 at December 31, 2019, prior to the deployment of excess liquidity to the investment portfolio and the rise in interest rates from the recent tightening cycle by the Federal Reserve. Paydowns from prepayments and scheduled payments of $44.6 million were received in the first nine months of 2024, and the amortization of premiums, net of the accretion of discounts, was $3.6 million. Sales of available-for-sale investment securities totaled $7.1 million in the first nine months of 2024 and resulted in net losses of $46,000. No allowance for credit losses was recognized for available-for-sale or held-to-maturity securities as of September 30, 2024 and December 31, 2023. The Company anticipates receiving principal and interest cash flows of approximately $26.4 million throughout the remainder of 2024 from its investment securities portfolio.

The fair value of the available-for-sale investment securities portfolio as of September 30, 2024 included net unrealized losses of $154.5 million, compared to net unrealized losses of $174.6 million as of December 31, 2023. Unrealized losses in the available-for-sale investment securities portfolio resulted from the declines in market values of the investment securities. The improvement in market value seen since December 31, 2023 was driven partly by the commencement of monetary policy easing by the Federal Reserve during the third quarter of 2024, but available-for-sale securities fair values remain depressed compared to fair values prior to the policy tightening cycle during 2022 and 2023.

The investment portfolio is managed by a third-party firm to provide for an appropriate balance between liquidity, credit risk, interest rate risk management and investment return and to limit the Company’s exposure to credit risk in the investment securities portfolio. The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds under what is commonly referred to as the “Volcker Rule” of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Real Estate Mortgage Loans Held-for-Sale

Real estate mortgage loans held-for-sale increased by $2.0 million, or 171.8%, to $3.1 million at September 30, 2024, from $1.2 million at December 31, 2023. The balance of this asset category is subject to a high degree of variability depending on, among other factors, recent mortgage loan rates and the timing of loan sales into the secondary market. The Company generally sells conforming qualifying mortgage loans it originates on the secondary market. Proceeds from sales of residential mortgages totaled $12.7 million in the first nine months of 2024, compared to $6.1 million in the first nine months of 2023. Management expects the volume of loans originated for sale in the secondary market could increase due to lower market rates for mortgage loans, however any uptick in activity may be encumbered by limited inventory, and existing homeowners being locked in at historically low rates. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others were $315.5 million and $333.1 million, as of September 30, 2024 and December 31, 2023, respectively.

Loan Portfolio

The loan portfolio by portfolio segment as of September 30, 2024 and December 31, 2023 is summarized as follows:

(dollars in thousands)

Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, increased by $153.8 million, or 3.2%, to $4.998 billion at September 30, 2024 from $4.845 billion at December 31, 2023. The increase was primarily driven by originations of loans concentrated in the commercial and industrial and commercial real estate and multi-family residential loans categories and was offset by paydowns in the agri-business and agricultural loans segment which traditionally experiences seasonal fluctuations in activity.

The following table summarizes the Company’s non-performing assets as of September 30, 2024 and December 31, 2023:

(dollars in thousands)

Total nonperforming assets increased by $41.9 million, or 260.4%, to $58.1 million during the nine month period ended September 30, 2024. The ratio of nonperforming assets to total assets increased 62 basis points from 0.25% at December 31, 2023 to 0.87% at September 30, 2024. The increase in nonperforming assets was primarily driven by the downgrade of a single $43.3 million commercial relationship, an industrial company in Northern Indiana, that was moved to nonperforming status in late June during the second quarter of 2024.

A loan is individually analyzed when full payment under the original loan terms is not expected. The analysis for smaller loans that are similar in nature and which are not in nonaccrual or modified status, such as residential mortgage, consumer, and credit card loans, is determined based on the class of loans. If a loan is individually analyzed, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows or at the fair value of collateral if repayment is expected solely from the collateral. Total individually analyzed loans increased by $61.5 million, or 381.6%, to $77.7 million at September 30, 2024 from $16.1 million at December 31, 2023. The increase to individually analyzed loans was primarily related to the downgrade of two commercial relationships.

Loans are charged against the allowance for credit losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb current expected credit losses relating to specifically identified loans based on an evaluation of the loans by management, as well as other current expected losses in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. General allowance is determined after considering the following factors: application of loss percentages using a probability of default/loss given default approach subject to a floor, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans: Substandard, Doubtful and Loss. The regulations also contain a Special Mention category. Special Mention applies to loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as Substandard, Doubtful or Loss but do possess credit deficiencies or potential weaknesses deserving management’s close attention. The Company’s policy is to establish a specific allowance for credit losses for any assets where management has identified conditions or circumstances that indicate an asset is nonperforming. If an asset or portion thereof is classified as a loss, the Company’s policy is to either establish specified allowances for credit losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount.

At September 30, 2024, the allowance for credit losses was 1.65% of total loans, an increase of 19 basis points from 1.46% at December 31, 2023. At September 30, 2024, management believed the allowance for credit losses was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions deteriorate, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for credit losses. The process of identifying credit losses is a subjective process.

The Company has a relatively high percentage of commercial and commercial real estate loans, which are extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing relatively conservative credit structures, by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and market area. The Company has limited exposure to commercial office space borrowers, all of which are located in the Bank's Indiana markets. Loans totaling $102.6 million for this sector represented 2.0% of total loans at September 30, 2024. Additionally, commercial real estate loans secured by multi-family residential properties and secured by non-farm non-residential properties were approximately 210% of the Bank's risk-based capital at September 30, 2024.

As of September 30, 2024, based on management’s review of the loan portfolio, the Company had 91 credit relationships totaling $267.6 million on the classified loan list versus 68 credit relationships totaling $183.1 million as of December 31, 2023. As of September 30, 2024, the Company had $181.2 million of assets classified as Special Mention, $42.1 million classified as Substandard, $44.3 million classified as Doubtful and $0 classified as Loss as compared to $143.6 million, $39.4 million, $0 and $0, respectively, at December 31, 2023. Watch list loans as a percentage of total loans increased to 5.27% as of September 30, 2024 from 3.72% as of December 31, 2023. The increase to the classified loan listing during 2024 was primarily driven by downgrades to four commercial relationships individually greater than $10.0 million, net of paydowns, payoffs and upgrades to other relationships.

Allowance estimates are developed by management after taking into account actual loss experience adjusted for current economic conditions and a reasonably supportable forecast period. The Company has annual discussions regarding this methodology with regulatory authorities. Allowance estimates are considered a prudent measurement of the risk in the Company’s loan portfolio based upon loan segment. In accordance with applicable accounting guidance, the allowance is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. For a more thorough discussion of the allowance for credit losses methodology see the "Critical Accounting Policies" section of this Item 2.

The allowance for credit losses increased $11.7 million, or 16.2%, from $72.0 million at December 31, 2023 to $83.6 million at September 30, 2024. The increase was a result of provision expense of $13.1 million which was offset by net charge-offs of $1.4 million. Provision expense recorded during the nine months ended September 30, 2024 was primarily attributable to an increase in the specific reserve allocation from the downgrade of a single $43.3 million commercial relationship, an industrial company in Northern Indiana, that was placed on nonperforming status during the second quarter of 2024. As the bulk of the Company’s lending activity is concentrated in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits, management has historically considered growth and portfolio composition when determining credit loss allocations.

Sources of Funds

The Company's sources of funds include a diversified deposit base gathered throughout the Company's footprint and includes a growing mix of commercial, retail and public funds deposit accounts. While the traditional base of core deposits represents the primary source of funding for the Company, the Company has access to a robust array of other liquidity sources, including secured borrowings available from the Federal Home Loan Bank and the Federal Reserve Bank Discount Window. In addition, the Company has access to unsecured borrowing capacity through long established relationships within the brokered deposit markets, Federal Funds lines from correspondent bank partners and Insured Cash Sweep (ICS) one-way buy funds available from the Intrafi network. As of September 30, 2024, the Company had access to $3.66 billion in unused liquidity available from these aggregate sources as compared to $3.41 billion at December 31, 2023.

The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the nine months ended September 30, 2024 and 2023 are summarized in the following table:

(dollars in thousands)

Average total deposits were $5.777 billion for the nine months ended September 30, 2024, an increase of $239.9 million, or 4.3%, from the comparable period in 2023. Average total borrowings were $88.6 million for the nine months ended September 30, 2024, a decrease of $130.0 million, or 59.5%, from the comparable period in 2023. Total average deposit costs increased 72 basis points from 2.31% for the nine months ended September 30, 2023, to 3.03% for the nine months ended September 30, 2024. Total average borrowing costs increased 56 basis points from 5.05% for the nine months ended September 30, 2023 to 5.61% for the nine months ended September 30, 2024. As a result, total funding costs increased by 66 basis points from 2.41% for the nine months ended September 30, 2023, to 3.07% for the nine months ended September 30, 2024. This increase was driven by an increase in rates on interest bearing deposits and a shift from noninterest bearing deposits to interest bearing deposits.

Deposits and Borrowings

As of September 30, 2024, total deposits increased by $116.8 million, or 2.0%, from December 31, 2023. Core deposits, which excludes brokered deposits, increased by $155.7 million, or 2.8%, to $5.741 billion as of September 30, 2024 from $5.585 billion as of December 31, 2023. Total brokered deposits were $96.5 million at September 30, 2024, compared to $135.4 million at December 31, 2023, a decrease of $38.9 million, or 28.7%.

The following table summarizes deposit composition at September 30, 2024 and December 31, 2023:

(dollars in thousands)

Core deposits, which excludes brokered deposits, expanded $155.7 million, or 2.8%, during the first nine months of 2024. Utilization of brokered deposits as a wholesale funding alternative has returned to pre-pandemic levels. On September 30, 2024, commercial deposits represented 39.5% of total deposits versus 38.9% at December 31, 2023. Retail deposits represented 29.3% at September 30, 2024 versus 31.4% at December 31, 2023. Public Funds deposits represented 29.6% at September 30, 2024 versus 27.3% at December 31, 2023. Brokered deposits represented 1.6% of total deposits at September 30, 2024 versus 2.4% at December 31, 2023. Commercial deposits expanded $76.9 million, or 3.5%, from $2.23 billion at December 31, 2023 to $2.30 billion at September 30, 2024; retail deposits contracted $85.1 million, or 4.7%, from $1.79 billion at December 31, 2023 to $1.71 billion at September 30, 2024; and public funds deposits expanded $163.9 million, or 10.5%, from $1.56 billion at December 31, 2023 to $1.73 billion at September 30, 2024.

Deposits not covered by FDIC deposit insurance were 61% as of September 30, 2024, versus 57% at December 31, 2023. Deposits not covered by FDIC deposit insurance or the Indiana Public Deposit Insurance Fund (which insures public fund deposits in Indiana), were 32% of total deposits as of September 30, 2024, versus 31% as of December 31, 2023. As of September 30, 2024 and December 31, 2023, 98% of deposit accounts had deposit balances less than $250,000.

Capital

As of September 30, 2024, total stockholders’ equity was $699.2 million, an increase of $49.4 million, or 7.6%, from $649.8 million at December 31, 2023. The increase to total stockholders' equity was driven by net income of $69.3 million and was reduced by dividends declared and paid of $37.0 million and an increase of $17.1 million in accumulated other comprehensive income (loss).

The impact on equity for other comprehensive income (loss) is not included in regulatory capital. The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1, or core capital, as a percentage of average assets, to measure the soundness of a financial institution. In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations. As of September 30, 2024, the Company's capital levels remained characterized as “well-capitalized”.

The actual capital amounts and ratios of the Company and the Bank as of September 30, 2024 and December 31, 2023, are presented in the table below. Capital ratios for September 30, 2024 are preliminary until the Call Report and FR Y-9C are filed.

(dollars in thousands)

54

FORWARD-LOOKING STATEMENTS

This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the federal securities law. Forward-looking statements are not historical facts and are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “project,” “possible,” “continue,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain and, accordingly, the reader is cautioned not to place undue reliance on any forward-looking statement made by the Company. Actual results could differ materially from those addressed in the forward-looking statements as a result of numerous factors, including, without limitation:

• the effects of future economic, business and market conditions and changes, particularly in our Indiana market area, including prevailing interest rates and the rate of inflation;
• governmental monetary and fiscal policies;
• the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand and the values and liquidity of loan collateral, securities and other interest sensitive assets and liabilities;
• changes in borrowers’ credit risks and payment behaviors;
• the failure of assumptions and estimates used in our reviews of our loan portfolio, underlying the establishment of reserves for possible credit losses, our analysis of our capital position and other estimates;
• the performance of our commercial real estate loan portfolio, including the effects of the elevated interest rate environment, the strength of the commercial real estate market in our Indiana markets, and recent changes in retail and office usage patterns;
• the effects of disruption and volatility in capital markets on the value of our investment portfolio;
• risk of cyber-security attacks that could result in damage to the Company's or third-party service providers' networks or data of the Company;
• the timing and scope of any legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators;
• the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
• the effects of war or other conflicts, acts of terrorism or other catastrophic events, including storms, droughts, tornados and flooding, that may affect general economic conditions, including agricultural production and demand and prices for agricultural goods and land used for agricultural purposes, generally and in our markets;
• the impact of litigation and other claims we may be subject to from time to time;
• changes in the scope and cost of FDIC insurance, the state of Indiana’s Public Deposit Insurance Fund and other coverages;
• changes in the prices, values and sales volumes of residential real estate;
• the impact of labor shortages, and changes in trade policy and tariffs;
• the effects of fraud by or affecting employees, customers or third parties;
• changes in the availability and cost of credit and capital in the financial markets;
• changes in technology or products that may be more difficult or costly, or less effective than anticipated;
• the risks related to mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;
• changes in accounting policies, rules and practices; and
• the risks noted in the Risk Factors discussed under Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2023, as well as other risks and uncertainties set forth from time to time in the Company’s other filings with the SEC.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

Interest rate risk represents the Company’s primary market risk exposure. The Company does not have a material exposure to foreign currency exchange risk, does not have a material amount of derivative financial instruments and does not maintain a trading portfolio. The Corporate Risk Committee of the Board of Directors annually reviews and approves the policy used to manage interest rate risk. The policy was last reviewed and approved in July 2024. The policy sets guidelines for balance sheet structure, which are designed to protect the Company from the impact that interest rate changes could have on net income but do not necessarily indicate the effect on future net interest income. The Company, through the Bank's Asset and Liability Committee, manages interest rate risk by monitoring the computer simulated earnings impact of various rate scenarios and general market conditions. The Company then modifies its long-term risk parameters by attempting to generate the types of loans, investments, and deposits that currently fit the Company’s needs, as determined by the Asset and Liability Committee. This computer simulation analysis measures the net interest income impact of various interest rate scenario changes during the next twelve months. The Company continually evaluates the assumptions used in the model. The current balance sheet structure is considered to be within acceptable risk levels.

Interest rate scenarios for the base, falling 300 basis points, falling 200 basis points, falling 100 basis points, falling 50 basis points, falling 25 basis points, rising 25 basis points, rising 50 basis points, rising 100 basis points, rising 200 basis points and rising 300 basis points are listed below based upon the Company’s rate sensitive assets and liabilities at September 30, 2024. The net interest income shown 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.

The base scenario is an annual calculation that is highly dependent on numerous assumptions embedded in the model. While the base sensitivity analysis incorporates management’s best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact will likely differ from that projected. For certain assets, the base simulation model captures the expected prepayment behavior under changing interest rate environments. Assumptions and methodologies regarding the interest rate or balance behavior of indeterminate maturity core deposit products, such as savings, money market, NOW and demand deposits reflect management’s best estimate of expected future behavior.

(dollars in thousands)

56

As required by Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act of 1934, management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of September 30, 2024. Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

During the quarter ended September 30, 2024, there were no changes to the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect its internal control over financial reporting.

There have been no material changes to the risk factors disclosed in Item 1A of Part I of the Company’s Form 10-K for the year ended December 31, 2023. Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.