# FIRST MERCHANTS CORP (FRME) FY 2023 MD&A Verbatim Item 7 Management's Discussion and Analysis from FIRST MERCHANTS CORP's 10-K for fiscal year 2023. SEC filing source: https://www.sec.gov/Archives/edgar/data/712534/000071253424000071/frme-20231231.htm Accession: 0000712534-24-000071 Filing date: 2024-02-29 Report date: 2023-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/FRME/ All MD&A years: /company/FRME/mda/ Previous year: /company/FRME/mda/fy2022/ (FY 2022) Next year: /company/FRME/mda/fy2024/ (FY 2024) 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. RECENT DEVELOPMENTS Correction of Prior Period Error As disclosed in NOTE 10. QUALIFIED AFFORDABLE HOUSING INVESTMENTS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, the Corporation identified a prior period accounting error substantially in the form of an immaterial understatement of other assets and other liabilities, solely related to the Corporation’s Low-Income Housing Tax Credit (“LIHTC”) partnerships. In general, the unfunded commitment related to these agreements was being carried off balance sheet and should have been recorded as part of the investment asset and unfunded commitment liability. The financial reporting periods affected by this error include the Corporation’s previously reported audited consolidated financial statements for the fiscal year ended December 31, 2022 and 2021, and the Corporation’s previously reported interim unaudited consolidated financial statements for each of the quarterly and year-to-date periods ended March 31, 2021, June 30, 2021, September 30, 2021, March 31, 2022, June 30, 2022, September 30, 2022, March 31, 2023, June 30, 2023 and September 30, 2023 (collectively the “previously reported financial statements”). This correction impacted the Consolidated Balance Sheets as other assets and other liabilities were understated by $96.4 million and $63.9 million as of December 31, 2023 and 2022, respectively. There was a nominal impact to income tax expense in the Consolidated Statement of Operations for the years ended December 31, 2023, 2022 and 2021. The Corporation concluded based on quantitative and qualitative analysis that this error was not material, on an individual or aggregate basis, to the Company’s previously reported financial statements and correction of the error would not be material to the current year financial statements, including any interim periods. However, the Corporation corrected this error as a voluntary immaterial revision to the accompanying consolidated financial statements of this Annual Report on Form 10-K, as of and for the fiscal years ended December 31, 2023, 2022 and 2021, in the periods in which the error occurred. In addition, the Corporation expects to present the corrected interim 2023 amounts as a voluntary immaterial revision in its 2024 consolidated interim financial statements on a quarterly basis and a year-to-date basis upon the filing of its Quarterly Reports on Form 10-Q. As a result, the financial results in the periods presented within the Management’s Discussion and Analysis of Financial Condition and Results of Operations, set forth below, have been revised to give effect to the correction of this error. OVERVIEW First Merchants Corporation (the “Corporation”) is a financial holding company headquartered in Muncie, Indiana and was organized in September 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 through First Merchants Bank (the “Bank”), a wholly-owned subsidiary that opened for business in Muncie, Indiana, in March 1893. The Bank also operates First Merchants Private Wealth Advisors (a division of First Merchants Bank). The Bank includes 116 banking locations in Indiana, Ohio, Michigan and Illinois. 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 2023 •Net income available to common stockholders for the year ended December 31, 2023 was $221.9 million compared to $220.7 million for the year ended 2022, an increase of 0.6 percent. Earnings per fully diluted common share totaled $3.73 for 2023 and $3.81 for 2022. •Adjusted net income available to common stockholders for 2023, excluding income on PPP loans, Level One acquisition-related expenses and non-core expenses, was $231.5 million and adjusted diluted earnings per common share totaled $3.89, compared to $243.4 million and $4.20, respectively, in 2022. 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 $492.0 million or 4.1 percent during the year ended December 31, 2023. •Net interest income totaled $545.4 million in 2023, an increase of $25.2 million, or 4.8 percent over 2022. •Return on average assets was 1.23 percent and the return on average equity was 10.43 percent for the year ended December 31, 2023. 36 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. RESULTS OF OPERATIONS - 2023 The Corporation reported net income available to common stockholders and diluted earnings per common share for the year ended 2023 of $221.9 million and $3.73 per diluted common share, respectively, compared to $220.7 million and $3.81 per diluted common share, respectively, for the year ended 2022. Adjusted net income available to common stockholders for the year ended 2023, excluding income on PPP loans, Level One acquisition-related expenses and other non-core expenses, was $231.5 million and adjusted diluted earnings per common share totaled $3.89, compared to $243.4 million and $4.20, respectively, for the year ended 2022. 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. As of December 31, 2023, total assets equaled $18.4 billion, an increase of $403.7 million or 2.2 percent from December 31, 2022. Cash and due from banks and interest-bearing deposits increased from December 31, 2022 by $300.1 million, primarily due to deposit growth and proceeds from investment securities principal and interest cashflows in addition to sales, which were held in cash for liquidity purposes. Total investment securities decreased $452.4 million from December 31, 2022, primarily due to the sales of $395.2 million of investment securities during the year ended December 31, 2023. Scheduled paydowns and maturities decreased investment securities by $161.2 million, which was offset by a decrease of $77.0 million in unrealized losses in the available for sale portfolio during 2023. Currently, the Corporation is using cashflows from the investment portfolio to fund loan growth and pay down borrowings. The investment portfolio as a percentage of total assets was 20.8 percent at December 31, 2023 compared to 23.8 percent at December 31, 2022. This decrease reflects progress towards a more normalized earning asset mix. 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 $492.0 million or 4.1 percent since December 31, 2022. The loan classes that experienced the largest increases from December 31, 2022 were in commercial and industrial, residential real estate, and construction real estate loans. The loan classes that experienced the largest decreases from December 31, 2022 were in owner occupied commercial real estate and home equity loans. 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. 37 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Corporation’s allowance for credit losses - loans (“ACL - loans”) totaled $204.9 million as of December 31, 2023 and equaled 1.64 percent percent of total loans, compared to $223.3 million and 1.86 percent of total loans at December 31, 2022. During the year ended December 31, 2023, the Corporation recognized $25.6 million of net charge-offs, compared to net charge-offs of $2.7 million for the year ended December 31, 2022. The increase in net charge-offs is primarily related to a charge-off of a previously reported nonaccrual loan to a syndicated specialty finance company resulting from alleged fraud that impacted our borrower’s ability to repay. The effect of the charge-offs on the ACL - loans was offset by provision expense on loans of $7.3 million for the year ended December 31, 2023. Reserves for unfunded commitments were reduced by $3.8 million, resulting in a net provision expense of $3.5 million as of December 31, 2023. As of December 31, 2022, 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, the reserve for unfunded commitments increased $2.8 million for CECL Day 1 unfunded commitments as of December 31, 2022. The Corporation did not recognize any provision expense during 2022 other than CECL Day 1 expense. Nonaccrual loans as of December 31, 2023 totaled $53.6 million, an increase of $11.3 million from December 31, 2022. The coverage ratio of ACL - Loans to nonaccrual loans is 382.5 percent at December 31, 2023. 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. The Corporation’s premises and equipment increased $16.8 million from December 31, 2022 primarily due to the $15.9 million purchase of an Indianapolis regional headquarters building in the third quarter of 2023. The Corporation’s tax asset, deferred and receivable decreased from $111.2 million at December 31, 2022 to $99.9 million at December 31, 2023. The primary drivers of the decrease from December 31, 2022, were declines in the deferred tax asset for unrealized gains and losses on available for sale securities and the deferred tax asset related to loan losses, of $16.2 million and $6.8 million, respectively. These declines were offset by an increase of $16.5 million in the income tax refundable when compared to December 31, 2022. The Corporation’s other assets increased $36.8 million from December 31, 2022. The Corporation’s continual investment in community redevelopment funds resulted in an increase of $37.8 million when compared to December 31, 2022. Additionally, the prepaid pension asset at December 31, 2023 increased by $4.1 million compared to the same period in 2022. Additional details of the Corporation’s investments in community redevelopment funds and pension plan are discussed in NOTE 10. QUALIFIED AFFORDABLE HOUSING INVESTMENTS and NOTE 19. PENSION AND OTHER POST RETIREMENT BENEFIT PLANS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The Corporation’s derivative assets (recorded in other assets) and derivative liabilities (recorded in other liabilities) decreased $13.7 million and $13.8 million respectively, from December 31, 2022. The decreases in valuations from December 31, 2022 were primarily driven by forward interest rate fluctuations, existing trades getting closer to maturity, terminations and maturities of existing trades which were partially offset by new production in 2023. Deposits increased $438.7 million from December 31, 2022. Total deposits less time deposits greater than $100,000, or core deposits, represented 90.5 percent of the deposit portfolio at December 31, 2023. Noninterest bearing deposits represents 16.9 percent of the deposit portfolio, which is a decline from December 31, 2022 of 22.1 percent. The decline is the result of a mix shift occurring across the industry as clients move into higher yielding deposit products. The Corporation experienced increases from December 31, 2022 in certificates and other time deposits of $100,000 or more of $666.4 million, other certificates and time deposits of $381.2 million and brokered certificates of deposit of $14.7 million. Demand and savings accounts decreased from December 31, 2022 by $482.9 million and $140.7 million, respectively. The average account within the deposit portfolio totals only $34,000. Insured deposits totaled 72.1 percent of total deposits, with the State of Indiana’s Public Deposit Insurance Fund, which insures certain public deposits, providing insurance to 15.1 percent of deposits and the FDIC providing insurance to the remaining 57.0 percent. Only 27.9 percent of deposits are uninsured and our available liquidity is ample to cover those when considering both on balance sheet sources of liquidity and unused capacity from the Federal Reserve Discount Window, FHLB and unsecured borrowing sources. Total borrowings decreased $285.2 million as of December 31, 2023, compared to December 31, 2022. Federal funds purchased and Federal Home Loan Bank advances decreased $171.6 million and $110.8 million, respectively, compared to December 31, 2022 as the Corporation utilized liquidity sources to pay down borrowings in 2023. Additionally, there was a decrease in securities sold under repurchase agreements of $10.1 million when compared to December 31, 2022. Slightly offsetting these decreases was a $7.3 million increase in subordinated debt and other borrowings due to a secured borrowing acquired in conjunction with the purchase of the Indianapolis regional headquarters building. Additional details of the Corporation’s borrowings are discussed within NOTE 12. BORROWINGS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The Corporation’s other liabilities as of December 31, 2023 increased $25.8 million from the same period in 2022, primarily due to an increase in unfunded commitments related to the Corporation’s LIHTC partnerships $32.5 million. The increase in other liabilities was offset by a decrease in the derivative liability of $13.8 million, as noted in the other assets section above. The Corporation continued to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized.” Details of the regulatory capital ratios are discussed within the “CAPITAL” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations. 38 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. As of December 31, 2022, total assets equaled $18.0 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 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 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. Nonaccrual loans totaled $42.3 million, a decrease of $738,000 from December 31, 2021, but when considering the nonaccrual loans acquired from Level One of $9.4 million, nonaccruals decreased $10.1 million. The coverage ratio of ACL - Loans to nonaccrual 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 $145.4 million from December 31, 2021. The Corporation’s continual investment in community redevelopment funds resulted in an increase of $72.6 million when compared to December 31, 2021. Additionally, 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. 39 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 nonmaturity 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 nonmaturity 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 12. BORROWINGS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The Corporation’s other liabilities as of December 31, 2022 increased $92.2 million compared to December 31, 2021. As noted above, the Corporation continues to invest in community redevelopment funds and as a result the Corporation’s unfunded commitment liability increased by $63.9 million from December 31, 2021. Also 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. 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 loan income, acquisition-related expenses and non-core 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. 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. 40 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [[GREPCENT_TABLE]] [["ADJUSTED NET INCOME AND DILUTED EARNINGS PER COMMON SHARE - non-GAAP"],["(Dollars In Thousands, Except Per Share Amounts)"],["","December 31, 2023","","December 31, 2022","","December 31, 2021"],["Net Income Available to Common Stockholders - GAAP","$","221,911","","","$","220,683","","","$","205,531"],["Adjustments:"],["PPP loan income","(49)","","","(3,207)","","","(30,900)"],["Acquisition-related expenses","\u2014","","","16,531","","","\u2014"],["Acquisition-related provision expense","\u2014","","","16,755","","","\u2014"],["Non-core expenses 1","12,682","","","\u2014","","","\u2014"],["Tax on adjustment","(3,078)","","","(7,376)","","","7,577"],["Adjusted Net Income Available to Common Stockholders - non-GAAP","$","231,466","","","$","243,386","","","$","182,208"],["Average Diluted Common Shares Outstanding (in thousands)","59,489","","","57,950","","","53,984"],["Diluted Earnings Per Common Share - GAAP","$","3.73","","","$","3.81","","","$","3.81"],["Adjustments:"],["PPP loan income","\u2014","","","(0.06)","","","(0.57)"],["Acquisition-related expenses","\u2014","","","0.28","","","\u2014"],["Acquisition-related provision expense","\u2014","","","0.30","","","\u2014"],["Non-core expenses","0.21","","","\u2014","","","\u2014"],["Tax on adjustment","(0.05)","","","(0.13)","","","0.14"],["Adjusted Diluted Earnings Per Common Share - non-GAAP","$","3.89","","","$","4.20","","","$","3.38"],["1 Non-core expenses include one-time charges consisting of $6.3 million from early retirement and severance costs, $4.3 million from the FDIC special assessment, and $2.1 million from a lease termination."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["TANGIBLE COMMON EQUITY TO TANGIBLE ASSETS - non-GAAP"],["(Dollars in thousands, except per share amounts)"],["","December 31, 2023","","December 31, 2022"],["Total Stockholders' Equity (GAAP)","$","2,247,713","","","$","2,034,770"],["Less: Preferred stock (GAAP)","(25,125)","","","(25,125)"],["Less: Intangible assets (GAAP)","(739,101)","","","(747,844)"],["Tangible common equity (non-GAAP)","$","1,483,487","","","$","1,261,801"],["Total assets (GAAP)","$","18,405,887","","","$","18,002,199"],["Less: Intangible assets (GAAP)","(739,101)","","","(747,844)"],["Tangible assets (non-GAAP)","$","17,666,786","","","$","17,254,355"],["Stockholders' Equity to Assets (GAAP)","12.21","%","","11.30","%"],["Tangible common equity to tangible assets (non-GAAP)","8.40","%","","7.31","%"],["Tangible common equity (non-GAAP)","$","1,483,487","","","$","1,261,801"],["Plus: Tax benefit of intangibles (non-GAAP)","5,819","","","7,702"],["Tangible common equity, net of tax (non-GAAP)","$","1,489,306","","","$","1,269,503"],["Common Stock outstanding (in thousands)","59,424","","","59,171"],["Book Value (GAAP)","$","37.40","","","$","33.96"],["Tangible book value - common (non-GAAP)","$","25.06","","","$","21.45"]] [[/GREPCENT_TABLE]] 41 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [[GREPCENT_TABLE]] [["TANGIBLE EARNINGS PER SHARE, RETURN ON TANGIBLE ASSETS AND RETURN ON TANGIBLE EQUITY - non-GAAP"],["(Dollars in thousands, except per share amounts)"],["","December 31, 2023","","December 31, 2022","","December 31, 2021"],["Average goodwill (GAAP)","$","712,002","","","$","671,485","","","$","545,374"],["Average other intangibles (GAAP)","31,331","","","35,885","","","27,590"],["Average deferred tax on other intangibles (GAAP)","(6,731)","","","(7,567)","","","(5,452)"],["Intangible adjustment (non-GAAP)","$","736,602","","","$","699,803","","","$","567,512"],["Average stockholders' equity (GAAP)","$","2,127,262","","","$","1,972,445","","","$","1,866,632"],["Average preferred stock (GAAP)","(25,125)","","","(18,875)","","","(125)"],["Intangible adjustment (non-GAAP)","(736,602)","","","(699,803)","","","(567,512)"],["Average tangible capital (non-GAAP)","$","1,365,535","","","$","1,253,767","","","$","1,298,995"],["Average assets (GAAP)","$","18,186,507","","","$","17,220,002","","","$","14,830,397"],["Intangible adjustment (non-GAAP)","(736,602)","","","(699,803)","","","(567,512)"],["Average tangible assets (non-GAAP)","$","17,449,905","","","$","16,520,199","","","$","14,262,885"],["Net income available to common stockholders (GAAP)","$","221,911","","","$","220,683","","","$","205,531"],["Other intangible amortization, net of tax (GAAP)","6,907","","","6,537","","","4,540"],["Preferred stock dividend","1,875","","","1,406","","","\u2014"],["Tangible net income available to common stockholders (non-GAAP)","$","230,693","","","$","228,626","","","$","210,071"],["Per Share Data:"],["Diluted net income available to common stockholders (GAAP)","$","3.73","","","$","3.81","","","$","3.81"],["Diluted tangible net income available to common stockholders (non-GAAP)","$","3.85","","","$","3.95","","","$","3.89"],["Ratios:"],["Return on average GAAP capital (ROE)","10.43","%","","11.19","%","","11.01","%"],["Return on average tangible capital","16.76","%","","18.12","%","","16.17","%"],["Return on average assets (ROA)","1.23","%","","1.29","%","","1.39","%"],["Return on average tangible assets","1.32","%","","1.38","%","","1.47","%"]] [[/GREPCENT_TABLE]] 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 83.8 percent of revenues for the year ended December 31, 2023. 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 loan 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 tables that follow 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 2023, 2022, and 2021. 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. Net interest margin, on an FTE basis, decreased 6 basis points to 3.35 percent for the year ended December 31, 2023 compared to 3.41 percent for the same period in 2022. Average Balance Sheet Average earning assets for the year ended December 31, 2023 increased $1.0 billion compared to the same period in 2022. The increase for the year ended December 31, 2023 when compared to the same period in 2022 was driven by a $1.4 billion increase in average loans as a result of organic loan growth primarily within the commercial and residential real estate loan portfolios. The increase in average loans was offset by a decrease in average investment securities of $489.3 million when compared to the same period in 2022, which was due to the Corporation selling $395.2 million of securities in 2023, in addition to not reinvesting cashflows into the investment securities portfolio, but rather using the liquidity to fund loan growth and pay down borrowings. The investment portfolio as a percentage of total assets is 20.8 percent at December 31, 2023, which is down from the same period in 2022 of 23.8 percent and down from the peak at December 31, 2021 of 29.3 percent. This reflects progress towards a more normalized earning asset mix. Average interest-bearing deposits for the year ended December 31, 2023 increased $1.0 billion compared to the same period in 2022, with the largest increase in the certificates and other time deposit portfolio. Noninterest bearing deposits represents 16.9 percent of the deposit portfolio, which is a decline from the same period in 2022 of 22.1 percent. The decline is the result of a mix shift occurring across the industry as clients move into higher yielding deposit products. Noninterest bearing deposits act to mitigate deposit yield increases as interest rates rise. 42 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Average borrowings increased $223.1 million for the year ended December 31, 2023 compared to the same period of 2022 as the average balance of FHLB advances increased $243.2 million during 2023. Throughout 2022 and early 2023, the Corporation’s outstanding FHLB advances were increasing, which caused the year ended December 31, 2022 average balance to be less than the actual balance at December 31, 2022. After the March 2023 failures of Silicon Valley Bank and Signature Bank there was general uncertainty and concerns regarding the adequacy of liquidity in the banking sector as a whole. As a result, the Corporation utilized some cash flows from scheduled paydowns, maturities and sales of investment securities to pay down borrowings in the second half of 2023. This resulted in a higher average balance in 2023 when compared to 2022. Interest Income/Expense and Average Yields In the year ended December 31, 2023, FTE asset yields increased 146 basis points compared to the same period in 2022. The increase in interest income, on an FTE basis, of $288.2 million during the year ended December 31, 2023 compared to the same period in 2022 was primarily due to an increase in average earning assets, coupled with the FOMC’s interest rate increases of 525 basis points since March of 2022. The Corporation also recognized fair value accretion income on purchased loans, which is included in interest income, of $8.1 million, which accounted for 5 basis points of net interest margin in the year ended December 31, 2023. Comparatively, the Corporation recognized fair value accretion on purchased loans of $10.1 million, which accounted for 6 basis points of net interest margin in the year ended December 31, 2022. The Corporation’s loan portfolio is 65.5 percent variable with 49.1 percent of the portfolio repricing within one month and 51.7 percent repricing within three months. Additionally, due to the FOMC interest rate increases in 2023 and 2022, the yields on new and renewed loans increased for the year ended December 31, 2023 compared to the same period in 2022. Interest costs increased 195 basis points, which mitigated the 146 basis point increase in asset yields and resulted in a 49 basis point FTE decrease in net interest spread when compared to the same period in 2022. Interest costs increased during the year ended December 31, 2023 due to deposit pricing pressure and deposit portfolio mix changes as a result of customers migrating out of noninterest-bearing deposit products into interest-bearing deposit products. Interest-bearing deposits and borrowing costs for the year ended December 31, 2023 were 2.56 percent and 3.81 percent, respectively, compared to 0.58 percent and 2.46 percent, respectively, during the same period in 2022. Total cost of funds was 267 basis points for the year ended December 31, 2023 compared to 72 basis points during the same period in 2022. 43 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table presents the Corporation’s average balance sheet, interest income/interest expense, and the average rate as a percent of average earning assets/liabilities for the three-year period ended December 31, 2023. [[GREPCENT_TABLE]] [["","Average Balance","","Interest Income / Expense","","Average Rate","","Average Balance","","Interest Income / Expense","","Average Rate","","Average Balance","","Interest Income / Expense","","Average Rate"],["(Dollars in Thousands)","2023","","2022","","2021"],["Assets:"],["Interest-bearing deposits","$","431,581","","","$","17,719","","","4.11","%","","$","296,863","","","$","2,503","","","0.84","%","","$","521,637","","","$","634","","","0.12","%"],["Federal Home Loan Bank stock","41,319","","","3,052","","","7.39","","","35,580","","","1,176","","","3.31","","","28,736","","","597","","","2.08"],["Investment securities: (1)"],["Taxable","1,854,438","","","35,207","","","1.90","","","2,056,586","","","38,354","","","1.86","","","1,751,910","","","29,951","","","1.71"],["Tax-exempt (2)","2,366,475","","","73,566","","","3.11","","","2,653,611","","","85,292","","","3.21","","","2,106,180","","","70,039","","","3.33"],["Total Investment Securities","4,220,913","","","108,773","","","2.58","","","4,710,197","","","123,646","","","2.63","","","3,858,090","","","99,990","","","2.59"],["Loans held for sale","21,766","","","1,292","","","5.94","","","14,715","","","692","","","4.70","","","19,190","","","747","","","3.89"],["Loans: (3)"],["Commercial","8,519,706","","","603,611","","","7.08","","","7,877,271","","","380,621","","","4.83","","","6,818,968","","","276,368","","","4.05"],["Real estate mortgage","2,035,488","","","82,183","","","4.04","","","1,471,802","","","51,853","","","3.52","","","916,314","","","34,783","","","3.80"],["Installment","830,006","","","60,751","","","7.32","","","785,520","","","37,302","","","4.75","","","683,925","","","26,111","","","3.82"],["Tax-exempt (2)","891,008","","","40,448","","","4.54","","","793,743","","","31,803","","","4.01","","","732,253","","","27,987","","","3.82"],["Total Loans","12,297,974","","","788,285","","","6.41","","","10,943,051","","","502,271","","","4.59","","","9,170,650","","","365,996","","","3.99"],["Total Earning Assets","16,991,787","","","917,829","","","5.40","%","","15,985,691","","","629,596","","","3.94","%","","13,579,113","","","467,217","","","3.44","%"],["Total Non-earning Assets","1,194,720","","","","","","","1,234,311","","","","","","","1,251,284"],["Total Assets","$","18,186,507","","","","","","","$","17,220,002","","","","","","","$","14,830,397"],["Liabilities:"],["Interest-bearing deposits:"],["Interest-bearing deposits","$","5,435,733","","","$","138,012","","","2.54","%","","$","5,206,131","","","$","32,511","","","0.62","%","","$","4,769,482","","","$","14,512","","","0.30","%"],["Money market deposits","2,884,271","","","83,777","","","2.90","","","2,915,397","","","19,170","","","0.66","","","2,351,803","","","3,203","","","0.14"],["Savings deposits","1,694,230","","","14,606","","","0.86","","","1,927,122","","","5,019","","","0.26","","","1,754,972","","","1,886","","","0.11"],["Certificates and other time deposits","1,923,268","","","69,697","","","3.62","","","881,176","","","6,239","","","0.71","","","783,733","","","3,718","","","0.47"],["Total Interest-bearing Deposits","11,937,502","","","306,092","","","2.56","","","10,929,826","","","62,939","","","0.58","","","9,659,990","","","23,319","","","0.24"],["Borrowings","1,111,472","","","42,394","","","3.81","","","888,392","","","21,864","","","2.46","","","639,791","","","12,633","","","1.97"],["Total Interest-bearing Liabilities","13,048,974","","","348,486","","","2.67","","","11,818,218","","","84,803","","","0.72","","","10,299,781","","","35,952","","","0.35"],["Noninterest-bearing deposits","2,783,996","","","","","","","3,268,417","","","","","","","2,516,241"],["Other liabilities","226,275","","","","","","","160,922","","","","","","","147,743"],["Total Liabilities","16,059,245","","","","","","","15,247,557","","","","","","","12,963,765"],["Stockholders' Equity","2,127,262","","","","","","","1,972,445","","","","","","","1,866,632"],["Total Liabilities and Stockholders' Equity","$","18,186,507","","","348,486","","","","","$","17,220,002","","","84,803","","","","","$","14,830,397","","","35,952"],["Net Interest Income (FTE)","","","$","569,343","","","","","","","$","544,793","","","","","","","$","431,265"],["Net Interest Spread (FTE) (4)","","","","","2.73","%","","","","","","3.22","%","","","","","","3.09","%"],["Net Interest Margin (FTE):"],["Interest Income (FTE) / Average Earning Assets","","","","","5.40","%","","","","","","3.94","%","","","","","","3.44","%"],["Interest Expense / Average Earning Assets","","","","","2.05","%","","","","","","0.53","%","","","","","","0.26","%"],["Net Interest Margin (FTE) (5)","","","","","3.35","%","","","","","","3.41","%","","","","","","3.18","%"]] [[/GREPCENT_TABLE]] (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 2023, 2022 and 2021. These totals equal $23.9 million, $24.6 million and $20.6 million, 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. 44 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NONINTEREST INCOME Noninterest income totaled $105.6 million in 2023, a decrease of $2.3 million, or 2.2 percent, from 2022. The decrease was primarily due to $6.9 million in net losses realized on the sale of $395.2 million of available for sale securities during the year ended December 31, 2023, compared to $1.2 million in net realized gains during the year ended December 31, 2022. Additionally, gains on life insurance benefits decreased $2.9 million during the year ended December 31, 2023 compared to 2022. Offsetting these declines was an increase of $5.6 million in net gains and fees on sales of loans. Service charges on deposit accounts increased $2.5 million from 2022, primarily due to the Level One acquisition in the second quarter of 2022. Noninterest 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 on April 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. 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. NONINTEREST EXPENSES Noninterest expense totaled $388.3 million in 2023, an increase of $32.6 million, or 9.2 percent from 2022. The largest increase of $21.9 million was in salaries and employee benefits which resulted primarily from the addition of Level One staff for the full year ended December 31, 2023 as compared to only nine months of 2022, and charges of $6.3 million from employee early retirement and severance costs during the fourth quarter of 2023. In addition, occupancy and equipment expenses in 2023 increased by $3.8 million from 2022 as a result of the larger franchise footprint, and a $2.1 million expense from a lease termination during the fourth quarter. The Corporation continues to invest in customer-facing digital solutions that contributed to increases in outside data processing expenses of $3.5 million. FDIC assessments increased $4.4 million in 2023 from 2022 due to an FDIC special assessment of $4.3 million. The increase in other real estate and foreclosure expenses of $2.5 million, when compared to the year ended December 31, 2022, was the result of higher property value write-downs, higher forced-placed insurance expenses, and less credit-related expense recoveries. The increase in other expenses is primarily due to higher customer-related contingent losses during the year ended December 31, 2023 as compared to the year ended December 31, 2022. These increases were offset by a $5.5 million decrease in professional and other outside services due primarily to $7.1 million of expenses related to Level One acquisition that were recorded in 2022. Noninterest 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 noninterest 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. 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. INCOME TAXES The Corporation’s federal statutory income tax rate for 2023 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 13.7 percent in 2023 and 13.1 percent in 2022, 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 2023 was $35.4 million on pre-tax income of $259.2 million, or 13.7 percent. For 2022, income tax expense was $33.6 million on pre-tax income of $255.7 million, or 13.1 percent. The higher effective income tax rate in 2023 compared to 2022 was primarily driven by decreases 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 20. INCOME TAX of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. 45 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Corporation’s tax asset, deferred and receivable decreased from $111.2 million at December 31, 2022 to $99.9 million at December 31, 2023, which included the Corporation’s net deferred tax asset decreasing from $109.5 million at December 31, 2022 to $84.7 million at December 31, 2023. The $24.8 million decrease in the Corporation’s net deferred tax asset was primarily due to accounting for unrealized gains and losses on available for sale securities and accounting for loan losses. CAPITAL 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. The Corporation had $25.0 million of outstanding preferred stock at December 31, 2023 and 2022. During the twelve months ended December 31, 2023, the Corporation declared and paid dividends of $187.52 per share (equivalent to $1.88 per depositary share), equal to $1.9 million. During the twelve months ended December 31, 2022, the Corporation declared and paid dividends of $140.64 per share (equivalent to $1.41 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. As of December 31, 2023 and 2022, the Corporation had approximately 2.7 million shares at an aggregate value of $74.5 million available to repurchase under the program. The Corporation did not repurchase any shares of its common stock pursuant to the repurchase program during 2022 or 2023. 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. 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, 2023, 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. 46 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Corporation’s and Bank’s actual and required capital ratios as of December 31, 2023 and December 31, 2022 were as follows: [[GREPCENT_TABLE]] [["","","","","","Prompt Corrective Action Thresholds"],["","Actual","","Basel III Minimum Capital Required","","Well Capitalized"],["December 31, 2023","Amount","","Ratio","","Amount","","Ratio","","Amount","","Ratio"],["Total risk-based capital to risk-weighted assets"],["First Merchants Corporation","$","2,021,124","","","13.67","%","","$","1,552,685","","","10.50","%","","N/A","","N/A"],["First Merchants Bank","1,931,810","","","13.06","","","1,553,600","","","10.50","","","$","1,479,619","","","10.00","%"],["Tier 1 capital to risk-weighted assets"],["First Merchants Corporation","$","1,703,626","","","11.52","%","","$","1,256,935","","","8.50","%","","N/A","","N/A"],["First Merchants Bank","1,746,299","","","11.80","","","1,257,676","","","8.50","","","$","1,183,695","","","8.00","%"],["Common equity tier 1 capital to risk-weighted assets"],["First Merchants Corporation","$","1,678,626","","","11.35","%","","$","1,035,123","","","7.00","%","","N/A","","N/A"],["First Merchants Bank","1,746,299","","","11.80","","","1,035,733","","","7.00","","","$","961,752","","","6.50","%"],["Tier 1 capital to average assets"],["First Merchants Corporation","$","1,703,626","","","9.64","%","","$","707,091","","","4.00","%","","N/A","","N/A"],["First Merchants Bank","1,746,299","","","9.89","","","706,331","","","4.00","","","$","882,913","","","5.00","%"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","","","","","Prompt Corrective Action Thresholds"],["","Actual","","Basel III Minimum Capital Required","","Well Capitalized"],["December 31, 2022","Amount","","Ratio","","Amount","","Ratio","","Amount","","Ratio"],["Total risk-based capital to risk-weighted assets"],["First Merchants Corporation","$","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","%"]] [[/GREPCENT_TABLE]] 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 of December 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 of December 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. As a result, effective with the April 1, 2022 consummation of the Level One merger, the Corporation began reflecting all of its trust preferred securities, of $49.1 million, as tier 2 capital. On November 1, 2013, the Corporation completed the private issuance and sale to four institutional investors of an aggregate of $70 million of debt comprised of (a) 5.00 percent Fixed-to-Floating Rate Senior Notes due 2028 in the aggregate principal amount of $5 million and (b) 6.75 percent Fixed-to-Floating Rate Subordinated Notes due October 30, 2028 in the aggregate principal amount of $65 million. As of December 31, 2023 the Corporation began the five year phase out (at a rate of 20 percent per year) as defined in the Basel III capital rules, which resulted in a reduction of $13 million in tier 2 capital. Management believes the disclosed capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Traditionally, the banking regulators have assessed bank and bank holding company capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. The Federal Reserve focuses its assessment of capital adequacy on a component of tier 1 capital known as CET1. Because the Federal Reserve has long indicated that voting common shareholders’ equity (essentially tier 1 risk-based capital less preferred stock and non-controlling interest in subsidiaries) generally should be the dominant element in tier 1 risk-based capital, this focus on CET1 is consistent with existing capital adequacy categories. Tier I regulatory capital consists primarily of total stockholders’ equity and subordinated debentures issued to business trusts categorized as qualifying borrowings, less non-qualifying intangible assets and unrealized net securities gains or losses. 47 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS A reconciliation of GAAP measures to regulatory measures (non-GAAP) are detailed in the following table for the periods indicated. [[GREPCENT_TABLE]] [["","December 31, 2023","","December 31, 2022"],["(Dollars in Thousands)","First Merchants Corporation","","First Merchants Bank","","First Merchants Corporation","","First Merchants Bank"],["Total Risk-Based Capital"],["Total Stockholders' Equity (GAAP)","$","2,247,713","","","$","2,291,788","","","$","2,034,770","","","$","2,119,316"],["Adjust for Accumulated Other Comprehensive (Income) Loss (1)","175,970","","","174,103","","","239,151","","","237,094"],["Less: Preferred Stock","(25,125)","","","(125)","","","(25,125)","","","(125)"],["Add: Qualifying Capital Securities","25,000","","","\u2014","","","25,000","","","\u2014"],["Less: Disallowed Goodwill and Intangible Assets","(731,315)","","","(730,867)","","","(738,206)","","","(737,758)"],["Add: Modified CECL Transition Amount","11,514","","","11,514","","","23,028","","","23,028"],["Less: Disallowed Deferred Tax Assets","(131)","","","(114)","","","(337)","","","(345)"],["Total tier 1 Capital (Regulatory)","1,703,626","","","1,746,299","","","1,558,281","","","1,641,210"],["Qualifying Subordinated Debentures","132,174","","","\u2014","","","143,103","","","\u2014"],["Allowance for Loan Losses Includible in tier 2 Capital","185,324","","","185,511","","","180,870","","","181,086"],["Total Risk-Based Capital (Regulatory)","$","2,021,124","","","$","1,931,810","","","$","1,882,254","","","$","1,822,296"],["Net Risk-Weighted Assets (Regulatory)","$","14,787,474","","","$","14,796,189","","","$","14,392,671","","","$","14,410,136"],["Average Assets (Regulatory)","$","17,677,268","","","$","17,658,269","","","$","17,118,953","","","$","17,092,008"],["Total Risk-Based Capital Ratio (Regulatory)","13.67","%","","13.06","%","","13.08","%","","12.65","%"],["Tier 1 Capital to Risk-Weighted Assets (Regulatory)","11.52","%","","11.80","%","","10.83","%","","11.39","%"],["Tier 1 Capital to Average Assets (Regulatory)","9.64","%","","9.89","%","","9.10","%","","9.60","%"],["Common Equity tier 1 Capital Ratio"],["Total tier 1 Capital (Regulatory)","$","1,703,626","","","$","1,746,299","","","$","1,558,281","","","$","1,641,210"],["Less: Qualified Capital Securities","(25,000)","","","\u2014","","","(25,000)","","","\u2014"],["Common Equity tier 1 Capital (Regulatory)","$","1,678,626","","","$","1,746,299","","","$","1,533,281","","","$","1,641,210"],["Net Risk-Weighted Assets (Regulatory)","$","14,787,474","","","$","14,796,189","","","$","14,392,671","","","$","14,410,136"],["Common Equity tier 1 Capital Ratio (Regulatory)","11.35","%","","11.80","%","","10.65","%","","11.39","%"]] [[/GREPCENT_TABLE]] (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 8.40 percent at December 31, 2023, and 7.31 percent at December 31, 2022. The increase in tangible common equity and tangible assets is primarily due to earnings growth and the recapture or increase in mark-to-market values associated with the available for sale investment securities portfolio. At December 31, 2023 and 2022, the Corporation had net unrealized losses of $219.7 million and $296.7 million, respectively, 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. 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 December 31, 2023 and December 31, 2022. 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. 48 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Loan Quality The quality of the loan portfolio and the amount of nonperforming 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 December 31, 2023, nonperforming loans totaled $53.6 million, an increase of $11.0 million from December 31, 2022. Non-accrual loans totaled $53.6 million at December 31, 2023, an increase of $11.3 million from December 31, 2022. The primary increase was in the residential portfolio of $11.5 million. Other real estate owned and repossessions, totaling $4.8 million at December 31, 2023, decreased $1.6 million from December 31, 2022. 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 $500,000 and consumer loans, with the exception of troubled debt restructures, are not individually evaluated. The determination for individual evaluation is made based on current information or events that may suggest it is probable that not all amounts due of principal and interest, according to the contractual terms of the loan agreement, will be substantially collected. The Corporation’s nonperforming assets plus accruing loans 90 days or more delinquent and individually evaluated loans are presented in the table below. [[GREPCENT_TABLE]] [["(Dollars in Thousands)","December 31, 2023","","December 31, 2022"],["Nonperforming assets:"],["Nonaccrual loans","$","53,580","","","$","42,324"],["Renegotiated loans(1)","\u2014","","","224"],["Nonperforming loans (NPL)","53,580","","","42,548"],["OREO and Repossessions","4,831","","","6,431"],["Nonperforming assets (NPA)","58,411","","","48,979"],["Loans 90-days or more delinquent and still accruing","172","","","1,737"],["NPAs and loans 90-days or more delinquent","$","58,583","","","$","50,716"]] [[/GREPCENT_TABLE]] (1) As a result of the adoption of ASU 2022-02 on January 1, 2023, the renegotiated classification is no longer applicable. The composition of nonperforming assets plus accruing loans 90-days or more delinquent is reflected in the following table. [[GREPCENT_TABLE]] [["(Dollars in Thousands)","December 31, 2023","","December 31, 2022"],["Nonperforming assets and loans 90-days or more delinquent:"],["Commercial and industrial loans","$","9,136","","","$","4,439"],["Agricultural land, production and other loans to farmers","58","","","54"],["Real estate loans"],["Construction","520","","","12"],["Commercial real estate, non-owner occupied","16,652","","","25,494"],["Commercial real estate, owner occupied","3,041","","","3,550"],["Residential","25,178","","","14,315"],["Home equity","3,945","","","2,742"],["Individual's loans for household and other personal expenditures","19","","","110"],["Public finance and other commercial loans","34","","","\u2014"],["Nonperforming assets and loans 90-days or more delinquent","$","58,583","","","$","50,716"]] [[/GREPCENT_TABLE]] 49 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PROVISION 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, excluding loans held for sale, increased $482.1 million, ending December 31, 2023 at $12.5 billion. At December 31, 2023, the allowance for credit losses totaled $204.9 million, which represents a decrease of $18.3 million from December 31, 2022. The allowance decreased primarily due to $25.6 million of net charge-offs during the twelve months ended December 31, 2023. The increase in net charge-offs was primarily related to two large commercial and industrial charge-offs of $13.7 million and $5.4 million in the third quarter of 2023. The larger charge-off involved fraudulent activity by the borrower and was idiosyncratic in nature and not indicative of a larger portfolio credit issue. As a percentage of loans, the allowance for credit losses was 1.64 percent at December 31, 2023, compared to 1.86 percent at December 31, 2022 and 2.11 percent at December 31, 2021. The Corporation deems the current estimate for loan portfolio credit exposure as appropriate. The Corporation’s credit loss experience is presented in the table below for the years indicated. [[GREPCENT_TABLE]] [["(Dollars in Thousands)","2023","","2022","","2021"],["Allowance for credit losses:"],["Balances, December 31, 2022","$","223,277","","","$","195,397","","","$","130,648"],["Impact of adopting ASC 326","\u2014","","","\u2014","","","74,055"],["Balances, January 1, 2021 Post-ASC 326 adoption","\u2014","","","\u2014","","","204,703"],["Loans charged off","28,039","","","6,601","","","11,884"],["Recoveries on loans","2,396","","","3,927","","","2,578"],["Net charge-offs","25,643","","","2,674","","","9,306"],["Provision for credit losses - loans","7,300","","","\u2014","","","\u2014"],["CECL Day 1 non-PCD provision for credit losses","\u2014","","","13,955","","","\u2014"],["CECL Day 1 PCD ACL","\u2014","","","16,599","","","\u2014"],["Ending balance, December 31, 2023","$","204,934","","","$","223,277","","","$","195,397"],["Ratio of net charge-offs during the period to average loans outstanding during the period","0.21","%","","0.02","%","","0.10","%"],["Ratio of allowance for credit losses - loans to nonaccrual loans","382.5","%","","527.5","%","","453.8","%"],["Ratio of allowance for credit losses - loans to total loans outstanding","1.64","%","","1.86","%","","2.11","%"]] [[/GREPCENT_TABLE]] In 2023, there was $7.3 million in provision for credit losses - loans, which was offset by a reserve release of $3.8 million related to the allowance for unfunded commitments, resulting in a net provision expense for the year ended December 31, 2023 of $3.5 million. In 2022, the Corporation recorded a $14.0 million provision for credit losses for loans and a $2.8 million provision for credit losses for unfunded commitments, both were related to the Level One acquisition, which resulted in provision expense for the year ended December 31, 2022 of $16.8 million. 50 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net charge-offs totaling $25.6 million, $2.7 million, and $9.3 million were recognized for the twelve months ended December 31, 2023, 2022, and 2021, respectively. For the twelve months ended December 31, 2023, there were three individual charge-offs greater than $500,000 that totaled $21.2 million. For the twelve months ended December 31, 2023, there were not any individual recoveries greater than $500,000. 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 ending 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 ending 2021, there were not any individual recoveries greater than $500,000. The distribution of the net charge-offs (recoveries) for the twelve months ended December 31, 2023, 2022, and 2021 are reflected in the following table. [[GREPCENT_TABLE]] [["(Dollars in Thousands)","December 31, 2023","","December 31, 2022","","December 31, 2021"],["Net charge-offs:"],["Commercial and industrial loans","$","22,269","","","$","347","","","$","5,185"],["Agricultural land, production and other farm loans","\u2014","","","(4)","","","(60)"],["Real estate loans"],["Construction","\u2014","","","(863)","","","5"],["Commercial real estate, non-owner occupied","20","","","2,817","","","3,334"],["Commercial real estate, owner occupied","36","","","(896)","","","619"],["Residential","471","","","(4)","","","(283)"],["Home equity","1,856","","","526","","","157"],["Individuals loans for household and other personal expenditures","991","","","751","","","349"],["Total net charge-offs","$","25,643","","","$","2,674","","","$","9,306"]] [[/GREPCENT_TABLE]] Management continually evaluates the commercial loan portfolio by including consideration of specific borrower cash flow analysis and estimated collateral values, types and amounts on nonperforming 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. The allowance for credit losses remains robust, along with $23.2 million of fair value accretion remaining on the acquired portfolio. The Corporation continues to monitor economic forecast changes, loan growth and credit quality to determine provision needs in the future. GOODWILL During the fourth quarter of 2023 and 2022, 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 on April 1, 2022 resulted in $166.6 million of goodwill. Details regarding the Level One acquisition 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 $1.6 billion at December 31, 2023, a decrease of $349.5 million, or 17.7 percent, from December 31, 2022. 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 $3.0 million at December 31, 2023. 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 and Federal Reserve Discount Window borrowings are utilized as funding sources. At December 31, 2023, total borrowings from the FHLB were $712.9 million and there were no outstanding borrowings from the Federal Reserve Discount Window. The Bank has pledged certain mortgage loans and investments to the FHLB and Federal Reserve. The total available remaining borrowing capacity from the FHLB and Federal Reserve at December 31, 2023 was $664.9 million and $804.6 million, respectively. In March 2023, the Federal Reserve created the Bank Term Funding Program (“BTFP”). The BTFP is a new facility established in response to recent liquidity concerns within the banking industry in part due to recent deposit runs that resulted in a few large bank failures. The BTFP was designed to provide available additional funding to eligible depository institutions in order to help assure that banks have the ability to meet the needs of all their depositors. Under the program, eligible depository institutions can obtain loans of up to one year in length by pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP is intended to eliminate the need for depository institutions to quickly sell their securities when they are experiencing stress on their liquidity. As of December 31, 2023, the Bank had borrowing capacity of $388.8 million and no outstanding balance from the BTFP facility. The Federal Reserve has announced it will discontinue making new loans as scheduled on March 11, 2024. 51 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Corporation and the Bank receive outside credit ratings from Moody’s. Both the Corporation and the Bank currently have Issuer Ratings of Baa1. Additionally, the Bank has a Baseline Credit Assessment Rating of a3. Management considers these ratings to be indications of a sound capital base and strong liquidity and believes that these ratings would help ensure the ready marketability of its commercial paper. Because of the Corporation’s and Bank’s current levels of long-term debt, management believes it could generate additional liquidity from various sources should the need arise. The following table presents the Corporation’s material cash requirements from known contractual and other obligations at December 31, 2023: [[GREPCENT_TABLE]] [["","Payments Due In"],["(Dollars in Thousands)","One Year or Less","","Over One Year","","Total"],["Deposits without stated maturity","$","12,482,295","","","$","\u2014","","","$","12,482,295"],["Certificates and other time deposits","2,185,566","","","153,592","","","2,339,158"],["Securities sold under repurchase agreements","157,280","","","\u2014","","","157,280"],["Federal Home Loan Bank advances","60,000","","","652,852","","","712,852"],["Subordinated debentures and term loans","1,330","","","157,314","","","158,644"],["Total","$","14,886,471","","","$","963,758","","","$","15,850,229"]] [[/GREPCENT_TABLE]] For further details related to the Corporation’s deposits and borrowings, see NOTE 11. DEPOSITS and NOTE 12. BORROWINGS of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Also, in the normal course of business, the Bank is a party to a number of other off-balance sheet activities that contain credit, market and operational risk that are not reflected in whole or in part in the consolidated financial statements. These activities primarily consist of traditional off-balance sheet credit-related financial instruments such as loan commitments and standby letters of credit. Summarized credit-related financial instruments at December 31, 2023 are as follows: [[GREPCENT_TABLE]] [["(Dollars in Thousands)","December 31, 2023"],["Amounts of Commitments:"],["Loan commitments to extend credit","$","5,025,790"],["Standby letters of credit","65,580"],["","$","5,091,370"]] [[/GREPCENT_TABLE]] 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 at December 31, 2023 remained adequate to meet the Corporation’s primary goal of achieving optimum interest margins while avoiding undue interest rate risk. 52 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, 2023. [[GREPCENT_TABLE]] [["","December 31, 2023"],["(Dollars in Thousands)","1-180 Days","","181-365 Days","","1-5 Years","","Beyond 5 Years","","Total"],["Rate-Sensitive Assets:"],["Interest-bearing deposits","$","436,080","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","436,080"],["Investment securities","122,989","","","108,133","","","1,044,208","","","2,536,034","","","3,811,364"],["Loans","7,021,150","","","628,068","","","3,416,884","","","1,419,925","","","12,486,027"],["Federal Home Loan Bank stock","\u2014","","","\u2014","","","41,769","","","\u2014","","","41,769"],["Total rate-sensitive assets","$","7,580,219","","","$","736,201","","","$","4,502,861","","","$","3,955,959","","","$","16,775,240"],["Rate-Sensitive Liabilities:"],["Interest-bearing deposits","$","11,040,164","","","$","1,129,140","","","$","150,803","","","$","1,284","","","$","12,321,391"],["Federal funds purchased","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Securities sold under repurchase agreements","157,280","","","\u2014","","","\u2014","","","\u2014","","","157,280"],["Federal Home Loan Bank advances","50,000","","","10,000","","","635,000","","","17,852","","","712,852"],["Subordinated debentures and term loans","120,269","","","\u2014","","","\u2014","","","38,375","","","158,644"],["Total rate-sensitive liabilities","$","11,367,713","","","$","1,139,140","","","$","785,803","","","$","57,511","","","$","13,350,167"],["Interest rate sensitivity gap by period","$","(3,787,494)","","","$","(402,939)","","","$","3,717,058","","","$","3,898,448"],["Cumulative rate sensitivity gap","$","(3,787,494)","","","$","(4,190,433)","","","$","(473,375)","","","$","3,425,073"],["Cumulative rate sensitivity gap ratio"],["at December 31, 2023","66.7","%","","66.5","%","","96.4","%","","125.7","%"],["at December 31, 2022","63.3","%","","63.7","%","","95.4","%","","131.3","%"]] [[/GREPCENT_TABLE]] The Corporation had a cumulative negative gap of $4.2 billion in the one-year horizon at December 31, 2023, or 22.9 percent of total assets. 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 nonmaturity deposits for modeling purposes. The comparative rising 200 basis points and falling 100 basis points scenarios below, as of December 31, 2023 and 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 at December 31, 2023 and 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. [[GREPCENT_TABLE]] [["","","December 31, 2023","","December 31, 2022"],["Rising 200 basis points from base case","","4.0%","","2.8","%"],["Falling 100 basis points from base case","","(5.0)%","","(2.3)","%"]] [[/GREPCENT_TABLE]] 53 PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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, 2023 and 2022. [[GREPCENT_TABLE]] [["","December 31,","","December 31,"],["(Dollars in Thousands)","2023","","2022"],["Deposits:"],["Demand deposits","$","7,965,862","","","$","8,448,797"],["Savings deposits","4,516,433","","","4,657,140"],["Certificates and other time deposits of $100,000 or more","1,408,985","","","742,539"],["Other certificates and time deposits","849,906","","","468,712"],["Brokered certificates of deposits","80,267","","","65,557"],["Total deposits","14,821,453","","","14,382,745"],["Federal funds purchased","\u2014","","","171,560"],["Securities sold under repurchase agreements","157,280","","","167,413"],["Federal Home Loan Bank advances","712,852","","","823,674"],["Subordinated debentures and term loans","158,644","","","151,298"],["","$","15,850,229","","","$","15,696,690"]] [[/GREPCENT_TABLE]] Deposits increased $438.7 million from December 31, 2022. The majority of the organic deposit growth was due to increases in maturity deposits of $1.1 billion, which was offset by decreases in nonmaturity deposits of $623.6 million when compared to December 31, 2022. Higher interest rates have resulted in customers migrating funds from nonmaturity products into maturity time deposit products. Federal Home Loan Bank advances decreased $110.8 million compared to December 31, 2022 as the Corporation utilized increased liquidity to pay down FHLB advances in order to increase borrowing capacity. Further discussion regarding FHLB advances is included in NOTE 12. 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 $7.3 million compared to December 31, 2022. During the third quarter of 2023, the Corporation acquired a secured borrowing in conjunction with the purchase of the Indianapolis regional headquarters building. The secured borrowing bears a fixed interest rate of 3.41 percent and had a balance of $7.3 million as of December 31, 2023. During the fourth quarter of 2023, the Corporation issued notice to the holders of the 6.75 percent Fixed-to-Floating Subordinated Debt Notes (“Subordinated Debt”) that it intends to exercise its rights to redeem $40.0 million in principal. The redemption was permitted under the optional redemption provisions of the Subordinated Note Certificate representing the Subordinated Debt and occurred in the first quarter of 2024 on the scheduled interest payment date. Additional details regarding the subordinated debentures and other borrowings are discussed within NOTE 12. 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 purchasing power of money due to inflation are generally not considered. Historically, changes in interest rates have affected the financial condition of this financial institution to a far greater degree than changes in the inflation rate. However, with inflation receding, the impact to the financial institution is lower but still reflective of higher labor and vendor costs. During 2023, the Federal Reserve continued the tightening of monetary policy to address inflation by increasing the target federal funds rate by 100 basis points. As a result, 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”. Finally, the 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.