# Midland States Bancorp, Inc. (MSBI) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Midland States Bancorp, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1466026/000146602623000006/msbi-20221231.htm
Accession: 0001466026-23-000006
Filing date: 2023-02-24
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/MSBI/
All MD&A years: /company/MSBI/mda/
Previous year: /company/MSBI/mda/fy2021/ (FY 2021)
Next year: /company/MSBI/mda/fy2023/ (FY 2023)

ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto, included in Item 8 - "Financial Statements and Supplementary Data", and other financial data appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995,” Item 1A – "Risk Factors” and elsewhere in this report, may cause actual results to differ materially from those projected in the forward-looking statements. We assume no obligation to update any of these forward-looking statements. Readers of our Annual Report on Form 10-K should therefore consider these risks and uncertainties in evaluating forward-looking statements and should not place undue reliance on forward-looking statements.

Overview

Midland States Bancorp, Inc. is a diversified financial holding company headquartered in Effingham, Illinois. Its wholly-owned banking subsidiary, Midland States Bank, has branches across Illinois and in Missouri, and provides a full range of commercial and consumer banking products and services, business equipment financing, merchant credit card services, and trust and investment management services and insurance and financial planning services. As of December 31, 2022, we had assets of $7.86 billion, deposits of $6.36 billion and shareholders’ equity of $758.6 million.

Our strategic plan is focused on building a performance-based, customer-centric culture, creating revenue diversification, seeking accretive acquisitions, achieving operational excellence and maintaining a robust enterprise-wide risk management program. Over the past several years, we have grown organically and through a series of acquisitions, with an over-arching focus on enhancing shareholder value and building a platform for scalability. Most recently, on June 17, 2022, the Company completed its acquisition of the deposits and certain loans and other assets associated with FNBC's branches in

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Mokena and Yorkville, Illinois. The Company acquired $79.8 million in assets, including $60.3 million in cash and $16.6 million in loans, and assumed $79.8 million in deposits. On June 1, 2021, the Company completed its acquisition of substantially all of the trust assets of ATG Trust, a trust company based in Chicago, Illinois. Additional information on recent acquisitions is presented in Note 2 to the consolidated financial statements in Item 8 of this Form 10-K.

Our principal lines of business include traditional community banking and wealth management. Our traditional community banking business primarily consists of commercial and retail lending and deposit taking. Our wealth management group provides a comprehensive suite of trust and wealth management products and services, and has $3.51 billion of assets under administration as of December 31, 2022.

Our principal business activity has been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We have derived income principally from interest charged on loans and leases and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as: fees received in connection with various lending and deposit services; wealth management services; commercial FHA mortgage loan servicing; residential mortgage loan originations and sales; and, from time to time, gains on sales of assets. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for credit losses and income tax expense.

Material Trends and Developments

Community Banking. We believe the most important trends affecting community banks in the United States over the foreseeable future will be related to heightened regulatory capital requirements, increasing regulatory burdens generally, including the implementation of the Dodd-Frank Act and the regulations promulgated and to be promulgated thereunder, and net interest margin compression. We expect that community banks will face increased competition for lower cost capital as a result of regulatory policies that may offer larger financial institutions greater access to government assistance than is available for smaller institutions, including community banks. We expect that troubled community banks will continue to face significant challenges when attempting to raise capital. We also believe that heightened regulatory capital requirements will make it more difficult for even well-capitalized, healthy community banks to grow in their communities. We believe these trends will favor community banks that have sufficient capital, a diversified business model and a strong deposit franchise, and we believe we possess these characteristics.

We also believe that increased regulatory burdens will have a significant adverse effect on smaller community banks, which often lack the personnel, experience and technology to efficiently comply with new regulations in a variety of areas in the banking industry, including in the areas of deposits, lending, compensation, information security and overdraft protection. We believe the increased costs to smaller community banks from a more complex regulatory environment, coupled with challenges in the real estate lending area, present attractive acquisition opportunities for larger community banks that have already made significant investments in regulatory compliance and risk management and can acquire and quickly integrate these smaller institutions into their existing platform. Furthermore, we believe that, as a result of our significant operational investments and our experience acquiring other institutions and quickly integrating them into our organization, we are well positioned to capitalize on the challenges facing smaller community banks.

We continue to believe we have significant opportunities for further growth through additional acquisitions of banks, branches, wealth management firms and trust departments of community banks, selective de novo opportunities, continued expansion of our wealth management operations, the hiring of commercial banking and wealth management professionals from other organizations and organic growth within our existing branch network. We also believe we have the necessary experience, management and infrastructure to take advantage of these growth opportunities.

Credit Reserves. One of our key operating objectives has been, and continues to be, maintenance of an appropriate level of reserve protection against estimated losses in our loan portfolio. Our allowance for credit losses on loans totaled $61.1 million, or 0.97% of total loans, and $51.1 million, or 0.98% of total loans, at December 31, 2022 and 2021, respectively.

Regulatory Environment. As a result of regulatory changes, including the Dodd-Frank Act and the Basel III Rule, we expect to be subject to more restrictive capital requirements, more stringent asset concentration and growth limitations and new and potentially heightened examination and reporting requirements. We also expect to face a more challenging environment for customer loan demand due to the increased costs that could be ultimately borne by borrowers, and to incur higher costs to comply with these new regulations. This uncertain regulatory environment could have a detrimental impact on our ability to manage our business consistent with historical practices and cause difficulty in executing our growth plan. See Item 1A - "Risk Factors—Legal, Accounting and Compliance Risks” and Item 1 - "Business—Supervision and Regulation.”

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Additional Factors Affecting Comparability

Each factor listed below affects the comparability of our results of operations and financial condition in 2022 and 2021, and may affect the comparability of financial information we report in future fiscal periods.

Preferred Stock Issuance. On August 24, 2022, the Company issued and sold 4,600,000 depositary shares, each representing a 1/40th ownership interest in a share of the Company’s 7.75% fixed rate reset non-cumulative, non-convertible, perpetual preferred stock, Series A. A total of 115,000 shares of Series A preferred stock was issued. The Series A preferred stock qualifies as Tier 1 capital for purposes of the regulatory capital calculations. The gross proceeds were $115.0 million while net proceeds from the issuance of the Series A preferred stock, after deducting $4.5 million of offering costs including the underwriting discount and other expenses, were $110.5 million.

Termination of hedged interest rate swaps. On October 24, 2022, the Company terminated the $140.0 million notional amount of future starting pay-fixed, receive-variable interest rate swaps on certain Federal Home Loan Bank ("FHLB") or other fixed-rate advances. The Company realized a $17.5 million net gain upon termination.

Commercial FHA Mortgage Loan Servicing Rights. During the third quarter of 2022, we committed to a plan to sell the commercial servicing rights asset and transferred $24.0 million of commercial FHA loan servicing rights to held for sale. Servicing rights held for sale are recorded at the lower of their carrying amount or fair value less estimated costs to sell. Impairment expense of $1.3 million and losses on mortgage servicing rights held for sale of $3.3 million was recognized in 2022.

Recent Acquisitions. On June 17, 2022, the Company completed its acquisition of the deposits and certain loans and other assets associated with FNBC's branches in Mokena and Yorkville, Illinois. The Company acquired $79.8 million in assets, including $60.3 million in cash and $16.6 million in loans, and assumed $79.8 million in deposits.

On June 1, 2021, the Company completed its acquisition of substantially all of the trust assets of ATG Trust, a trust company based in Chicago, Illinois, with $399.7 million in assets under management.

Redemption of Subordinated Notes. On October 15, 2022, the Company redeemed the outstanding Fixed-to-Floating Rate Subordinated Notes due October 15, 2027, having an aggregate principal amount of $40.0 million, in accordance with the terms of the notes. The aggregate redemption price was 100% of the aggregate principal amount of the subordinated notes, plus accrued and unpaid interest. The interest rate on the subordinated notes was 6.25%.

On June 18, 2021, the Company redeemed all of its outstanding fixed-to-floating rate subordinated notes due June 18, 2025, having an aggregate principal amount of $31.1 million, in accordance with the terms of the notes. The aggregate redemption price was 100% of the aggregate principal amount of the subordinated notes, plus accrued and unpaid interest. The interest rate on the subordinated notes was 4.54%.

FHLB Advance Prepayments. During 2021, the Company pre-paid FHLB advances of $50.0 million in the first quarter, $85.0 million in the second quarter and $130.0 million in the fourth quarter. As a result, we paid prepayment fees of $8.5 million in 2021.

Tax Settlement. On June 29, 2021, the Company announced the settlement of a prior tax issue related to the treatment of gains recognized on FDIC-assisted transactions that resulted in a $6.8 million tax benefit that was recognized in the second quarter of 2021. The Company also recognized approximately $3.6 million in consulting and legal expenses related to the settlement of the tax issue, resulting in an after-tax gain of approximately $2.9 million.

Purchased Loans. Our net interest margin benefits from accretion income associated with purchase accounting discounts established on the purchased loans included in our acquisitions. Our reported net interest margins for 2022 and 2021 were 3.57% and 3.33%, respectively. Accretion income associated with accounting discounts established on loans acquired totaled $2.0 million and $4.3 million in 2022 and 2021, respectively, increasing the reported net interest margins by 3 and 7 basis points for each respective period.

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Results of Operations

For discussion of the results of operations for the year ended December 31, 2021 compared with the year ended December 31, 2020, refer to Item 7 of the Company’s 2021 Annual Report on Form 10-K, filed with the SEC on February 25, 2022.

Overview. The following table sets forth condensed income statement information of the Company for the years ended December 31, 2022, 2021 and 2020:

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

In 2022, we generated net income available to common shareholders of $95.9 million, or $4.23 per diluted share, compared to net income of $81.3 million, or $3.57 per diluted share in 2021. Earnings in 2022 increased primarily due to a $38.1 million increase in net interest income and a $10.0 million increase in noninterest income. These results were partially offset by a $16.7 million increase in provision for credit losses, a $0.6 million increase in noninterest expense and a $13.0 million increase in income tax expense. These are discussed in further detail below.

Net Interest Income and Margin. Our primary source of revenue is net interest income, which is the difference between interest income from interest-earning assets (primarily loans and securities) and interest expense of funding sources (primarily interest-bearing deposits and borrowings). Net interest income is influenced by many factors, primarily the volume and mix of interest-earning assets, funding sources, and interest rate fluctuations. Noninterest-bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. Net interest margin is calculated as net interest income divided by average interest-earning assets. Net interest margin is presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to a pretax-equivalent income, assuming a federal income tax rate of 21% for 2022 and 2021.

On December 14, 2022, the Federal Reserve announced an increase to its benchmark federal-funds rate by 0.50% to a range between 4.25% and 4.50%. Along with the increase came an indication that the Federal Reserve expects to keep rates higher through next year, with no reductions until 2024. This was the seventh rate increase announced in 2022. The year began with a federal-funds rate range of 0.00%-0.25%.

In 2022, net interest income, on a tax-equivalent basis, increased to $247.0 million with a tax-equivalent net interest margin of 3.57% compared to net interest income, on a tax-equivalent basis, of $209.2 million and a tax-equivalent net interest margin of 3.33% in 2021.

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Average Balance Sheet, Interest and Yield/Rate Analysis. The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the years ended December 31, 2022, 2021 and 2020. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments.

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","","2022","","2021","","2020"],["(tax-equivalent basis, dollars in thousands)","","Average Balance","","Interest & Fees","","Yield/ Rate","","Average Balance","","Interest & Fees","","Yield/ Rate","","Average Balance","","Interest & Fees","","Yield / Rate"],["Interest-earning assets:"],["Federal funds sold and cash investments","","$","256,221","","","$","3,907","","","1.52","%","","$","518,804","","","$","728","","","0.14","%","","$","433,965","","","$","1,479","","","0.34","%"],["Investment securities:"],["Taxable investment securities","","694,269","","","15,801","","","2.28","","","646,079","","","13,898","","","2.15","","","533,985","","","14,789","","","2.77"],["Investment securities exempt from federal income tax (1)","","104,949","","","3,476","","","3.31","","","130,495","","","4,222","","","3.24","","","119,612","","","4,471","","","3.74"],["Total securities","","799,218","","","19,277","","","2.41","","","776,574","","","18,120","","","2.33","","","653,597","","","19,260","","","2.95"],["Loans:"],["Loans (2)","","5,743,525","","","274,617","","","4.78","","","4,821,718","","","213,922","","","4.44","","","4,622,651","","","217,459","","","4.70"],["Loans exempt from federal income tax (1)","","67,878","","","2,635","","","3.88","","","81,730","","","3,127","","","3.38","","","99,173","","","3,937","","","3.97"],["Total loans","","5,811,403","","","277,252","","","4.77","","","4,903,448","","","217,049","","","4.43","","","4,721,824","","","221,396","","","4.69"],["Loans held for sale","","12,669","","","404","","","3.19","","","37,638","","","1,115","","","2.96","","","52,233","","","1,881","","","3.60"],["Nonmarketable equity securities","","38,543","","","2,198","","","5.70","","","47,045","","","2,348","","","4.99","","","49,623","","","2,638","","","5.32"],["Total earning assets","","6,918,054","","","303,038","","","4.38","%","","6,283,509","","","239,360","","","3.81","%","","5,911,242","","","246,654","","","4.17","%"],["Noninterest-earning assets","","618,593","","","","","","","598,083","","","","","","","617,984"],["Total assets","","$","7,536,647","","","","","","","$","6,881,592","","","","","","","$","6,529,226"],["Interest-bearing liabilities:"],["Checking and money market deposits","","$","2,877,392","","","$","31,156","","","1.08","%","","$","2,467,288","","","$","3,020","","","0.12","%","","$","2,330,657","","","$","7,879","","","0.34","%"],["Savings deposits","","703,341","","","540","","","0.08","","","655,735","","","164","","","0.02","","","567,398","","","245","","","0.04"],["Time deposits","","625,307","","","4,161","","","0.67","","","690,558","","","7,373","","","1.07","","","712,344","","","12,760","","","1.79"],["Brokered deposits","","16,592","","","204","","","1.23","","","32,419","","","400","","","1.23","","","24,387","","","614","","","2.52"],["Total interest-bearing deposits","","4,222,632","","","36,061","","","0.85","","","3,846,000","","","10,957","","","0.28","","","3,634,786","","","21,498","","","0.59"],["Short-term borrowings","","58,688","","","104","","","0.18","","","68,986","","","86","","","0.12","","","60,306","","","178","","","0.30"],["FHLB advances and other borrowings","","355,282","","","9,335","","","2.63","","","473,371","","","8,443","","","1.78","","","650,683","","","12,033","","","1.85"],["Subordinated debt","","131,203","","","7,495","","","5.71","","","153,126","","","8,705","","","5.68","","","169,748","","","9,730","","","5.73"],["Trust preferred debentures","","49,678","","","3,025","","","6.09","","","49,098","","","1,951","","","3.97","","","48,554","","","2,313","","","4.76"],["Total interest-bearing liabilities","","4,817,483","","","56,020","","","1.16","%","","4,590,581","","","30,142","","","0.66","%","","4,564,077","","","45,752","","","1.00","%"],["Noninterest-bearing liabilities:"],["Noninterest-bearing deposits","","1,965,749","","","","","","","1,568,005","","","","","","","1,255,031"],["Other noninterest-bearing liabilities","","65,539","","","","","","","80,308","","","","","","","75,123"],["Total noninterest-bearing liabilities","","2,031,288","","","","","","","1,648,313","","","","","","","1,330,154"],["Shareholders\u2019 equity","","687,876","","","","","","","642,698","","","","","","","634,995"],["Total liabilities and shareholders\u2019 equity","","$","7,536,647","","","","","","","$","6,881,592","","","","","","","$","6,529,226"],["Net interest income / net interest margin (3)","","","","$","247,018","","","3.57","%","","","","$","209,218","","","3.33","%","","","","$","200,902","","","3.40","%"]]
[[/GREPCENT_TABLE]]

(1)Interest income and average rates for tax-exempt loans and securities are presented on a tax-equivalent basis, assuming a statutory federal income tax rate of 21%. Tax-equivalent adjustments totaled $1.3 million, $1.5 million and $1.8 million for the years ended December 31, 2022, 2021 and 2020, respectively.

(2)Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.

(3)Net interest margin during the periods presented represents: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.

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Interest Rates and Operating Interest Differential. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. Changes which are not due solely to volume or rate have been allocated proportionally to the change due to volume and the change due to rate.

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[[/GREPCENT_TABLE]]

Interest Income. Interest income, on a tax-equivalent basis, increased $63.7 million to $303.0 million in 2022 as compared to 2021 primarily due to the growth in our average loan balances. The yield on earning assets increased 57 basis points to 4.38% from 3.81%, due to the impact of both the growth in earning assets and the increase in market interest rates.

Average earning assets increased to $6.92 billion in 2022 from $6.28 billion in 2021. An increase in average loans of $908.0 million was partially offset by a decrease of $262.6 million in federal funds sold and cash investments.

Average commercial loans decreased $24.6 million for the twelve months ended December 31, 2022 compared to the same period of 2021. Commercial FHA warehouse lines and Paycheck Protection Program ("PPP") loans accounted for $95.9 million and $127.1 million, respectively, of this decrease. Excluding the changes in the commercial FHA warehouse line and PPP loan portfolios, average commercial loans increased $198.4 million in 2022 compared to 2021.

Average commercial real estate loans increased in 2022 by $707.5 million, compared to 2021. Average balances in our consumer loans, construction loans and lease portfolios also increased by $198.4 million, $21.1 million and $35.7 million, respectively, compared to the prior year. These increases were partially offset by payoffs and repayments in the residential real

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estate portfolio. Consumer loan growth was primarily the result of our new relationship with an additional consumer loan origination firm and our continuing relationship with GreenSky. On January 24, 2023, we notified GreenSky of our intent to terminate our participation in their loan origination program in October 2023, our required notice period. Following the termination, GreenSky is expected to continue servicing all loans originated through the program.

Interest Expense. Interest expense increased $25.9 million to $56.0 million in 2022 compared to 2021. The cost of interest-bearing liabilities increased to 1.16% in 2022 compared to 0.66% for the prior year due to the increase in deposit costs as a result of the rate increases enacted by the Federal Reserve.

Interest expense on deposits increased to $36.1 million in 2022 from $11.0 million in 2021. The increase was primarily due to an increase in rates paid on deposits. Average balances of interest-bearing deposit accounts increased $376.6 million, or 9.8%, to $4.22 billion for the year ended December 31, 2022 compared to 2021. The increase in volume was attributable to increases of retail deposits, commercial deposits and brokered deposits of $97.2 million, $107.8 million and $65.1 million, respectively. In addition, our Insured Cash Sweep product balances increased $78.1 million.

Interest expense on FHLB advances and other borrowings increased $0.9 million for the year ended December 31, 2022, from the comparable period in 2021. While average balances decreased $118.1 million in 2022 compared to 2021, this was offset by interest rate increases throughout 2022.

Interest expense on subordinated debt decreased $1.2 million in 2022 from 2021 primarily due to the redemption of $40.0 million of subordinated debt on October 15, 2022. The interest rate on the subordinated notes was 6.25%. In addition, the Company redeemed $31.1 million of subordinated debt on June 18, 2021. The interest rate on these redeemed notes was 4.54%.

Interest expense on trust preferred debentures increased $1.1 million in 2022 compared to 2021 due to interest rate increases, as these debt instruments reprice quarterly.

Provision for Credit Losses. The Company's provision for credit losses was $20.1 million in 2022. The provision for credit losses on loans and unfunded commitments was $18.8 million and $1.6 million, respectively, partially offset by the recognition of expense reversal of $0.2 million related to investment securities. Provision expense recognized in 2021 totaled $3.4 million, with $4.0 million attributable to loans and expense reversals of $0.4 million related to unfunded loan commitments and $0.1 million related to investment securities. The increase in the provision for credit losses on loans in 2022 compared to prior year was primarily due to the growth of and mix in our loan portfolio coupled with a declining economic forecast.

The provision for credit losses on loans recognized during 2022 and 2021 was made at a level deemed necessary by management to absorb estimated losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for credit losses is completed quarterly by management, the results of which are used to determine provision for credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and reasonable and supportable forecasts along with other qualitative and quantitative factors.

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Noninterest Income. The following table sets forth the major components of our noninterest income for the years ended December 31, 2022, 2021 and 2020:

[[GREPCENT_TABLE]]
[["","For the years ended December 31,","","2022 Compared to 2021","","2021 Compared to 2020"],["(dollars in thousands)","2022","","2021","","2020","","Increase (decrease)","","Increase (decrease)"],["Noninterest income:"],["Wealth management revenue","$","25,708","","","$","26,811","","","$","22,802","","","$","(1,103)","","","(4.1)","%","","$","4,009","","","17.6","%"],["Commercial FHA revenue","1,663","","","1,414","","","6,007","","","249","","","17.6","","","(4,593)","","","(76.5)"],["Residential mortgage banking revenue","1,509","","","5,526","","","9,812","","","(4,017)","","","(72.7)","","","(4,286)","","","(43.7)"],["Service charges on deposit accounts","9,480","","","8,348","","","8,603","","","1,132","","","13.6","","","(255)","","","(3.0)"],["Interchange revenue","13,879","","","14,500","","","12,266","","","(621)","","","(4.3)","","","2,234","","","18.2"],["(Loss) gain on sales of investment securities, net","(230)","","","537","","","1,721","","","(767)","","","(142.8)","","","(1,184)","","","(68.8)"],["Gain on termination of hedged interest rate swaps","17,531","","","2,159","","","\u2014","","","15,372","","","712.0","","","2,159","","","100.0"],["Impairment on commercial mortgage servicing rights","(1,263)","","","(7,532)","","","(12,337)","","","6,269","","","(83.1)","","","4,805","","","(38.9)"],["Company-owned life insurance","3,584","","","4,496","","","3,581","","","(912)","","","(20.3)","","","915","","","25.6"],["Other income","8,030","","","13,640","","","8,794","","","(5,610)","","","(41.1)","","","4,846","","","55.1"],["Total noninterest income","$","79,891","","","$","69,899","","","$","61,249","","","$","9,992","","","14.3","%","","$","8,650","","","14.1","%"]]
[[/GREPCENT_TABLE]]

Wealth management revenue. Income from our wealth management business for 2022 totaled $25.7 million as compared to $26.8 million in the same period of 2021. Assets under administration decreased to $3.51 billion at December 31, 2022 from $4.10 billion at December 31, 2021, primarily due to a decline in market performance in 2022 and a resulting decrease in revenue.

Residential mortgage banking revenue. Residential mortgage banking revenue for 2022 totaled $1.5 million, compared to $5.5 million in 2021, primarily attributable to a decrease in production. Loans originated for sale into the secondary market in 2022 totaled $77.0 million, with 19% representing refinance transactions versus purchase transactions. Similar loans originated during the prior year totaled $211.6 million with 48% representing refinance transactions.

Impairment of commercial mortgage servicing rights. Impairment of commercial mortgage servicing rights was $1.3 million for 2022 compared to $7.5 million for 2021. The impairment resulted from loan prepayments as borrowers refinanced their loans in the then current low interest rate environment. During the third quarter of 2022, we committed to a plan to sell the servicing rights asset associated with this portfolio and transferred $24.0 million of commercial FHA loan servicing rights to held for sale. Servicing rights held for sale are recorded at the lower of their carrying amount or fair value less estimated costs to sell. Loans serviced for others totaled $2.26 billion and $2.65 billion at December 31, 2022 and 2021, respectively.

Company owned life insurance. In the fourth quarter of 2021, the Company recognized $1.1 million of death benefits due to the passing of its former CEO and President.

Other noninterest income. Other income totaled $8.0 million for 2022, a decrease of $5.6 million, as compared to 2021. In 2021, the Company recognized $4.2 million of unrealized income on equity investments in FinTech-related venture capital funds and SBIC limited partnerships.

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Noninterest Expense. The following table sets forth the major components of noninterest expense for the years ended December 31, 2022, 2021 and 2020:

[[GREPCENT_TABLE]]
[["","","","","","Years Ended December 31,","","2022 Compared to 2021","","2021 Compared to 2020"],["(dollars in thousands)","","","","","","2022","","2021","","","","2020","","Increase (decrease)","","Increase (decrease)"],["Noninterest expense:"],["Salaries and employee benefits","","","","","","","$","90,305","","","$","86,883","","","","","$","85,557","","","$","3,422","","","3.9","%","","$","1,326","","","1.5","%"],["Occupancy and equipment","","","","","","","14,842","","","14,866","","","","","17,552","","","(24)","","","(0.2)","","","(2,686)","","","(15.3)"],["Data processing","","","","","","","24,350","","","24,595","","","","","22,643","","","(245)","","","(1.0)","","","1,952","","","8.6"],["Professional","","","","","","","6,907","","","10,971","","","","","7,234","","","(4,064)","","","(37.0)","","","3,737","","","51.7"],["Marketing","","","","","","","3,318","","","3,239","","","","","3,498","","","79","","","2.4","","","(259)","","","(7.4)"],["Communications","","","","","","","2,382","","","3,002","","","","","4,052","","","(620)","","","(20.7)","","","(1,050)","","","(25.9)"],["Loan expense","","","","","","","4,586","","","2,014","","","","","2,504","","","2,572","","","127.7","","","(490)","","","(19.6)"],["Amortization of intangible assets","","","","","","","5,410","","","5,855","","","","","6,504","","","(445)","","","(7.6)","","","(649)","","","(10.0)"],["Other real estate owned","","","","","","","5,188","","","1,277","","","","","2,155","","","3,911","","","306.3","","","(878)","","","(40.7)"],["Loss on mortgage servicing rights held for sale","","","","","","","3,250","","","222","","","","","1,692","","","3,028","","","1,364.0","","","(1,470)","","","(86.9)"],["Impairment related to facilities optimization","","","","","","","\u2014","","","\u2014","","","","","12,847","","","\u2014","","","\u2014","","","(12,847)","","","(100.0)"],["Federal Home Loan Bank advances prepayment fees","","","","","","","\u2014","","","8,536","","","","","4,872","","","(8,536)","","","(100.0)","","","3,664","","","75.2"],["Other expense","","","","","","","15,124","","","13,609","","","","","12,900","","","1,515","","","11.1","","","709","","","5.5"],["Total noninterest expense","","","","","","","$","175,662","","","$","175,069","","","","","$","184,010","","","$","593","","","0.3","%","","$","(8,941)","","","(4.9)","%"]]
[[/GREPCENT_TABLE]]

    Salaries and employee benefits. For the year ended December 31, 2022, salaries and employee benefits expense increased $3.4 million as compared to 2021, primarily due to a modest increase in staffing levels in 2022. The Company employed 935 employees at December 31, 2022 compared to 907 employees at December 31, 2021.

Professional fees. For the year ended December 31, 2022, professional fees decreased $4.1 million as compared to the same period in 2021. In 2021, the Company incurred $3.6 million of consulting and legal expenses related to the settlement of a tax issue, as previously discussed.

Other Real Estate Owned. For the year ended December 31, 2022, the Company recorded impairment charges on two properties totaling $4.3 million compared to impairment expense of $0.5 million in 2021.

Loss on mortgage servicing rights held for sale. During the third quarter of 2022, the Company committed to a plan to sell the servicing rights asset associated with this portfolio and transferred $24.0 million of commercial FHA loan servicing rights to held for sale. During the fourth quarter, we recognized a loss of $3.3 million on this asset.

Other expense. For the year ended December 31, 2022, other expense increased $1.5 million as compared to 2021, primarily as a result of increased business activities.

Income Tax Expense. Income tax expense was $30.8 million for the year ended December 31, 2022, as compared to $17.8 million for the year ended December 31, 2021. The resulting effective tax rates were 23.7% and 18.0% for the years ended December 31, 2022 and 2021, respectively. The Company's income tax expense and related effective tax rate for the year ended December 31, 2021 benefited from the $6.8 million in settlements related to the treatment of gains recognized on FDIC-assisted transactions discussed earlier.

Financial Condition

Assets. Total assets increased to $7.86 billion at December 31, 2022, as compared to $7.44 billion at December 31, 2021.

Loans. The loan portfolio is the largest category of our assets. The following table presents the balance and associated percentage of each major category in our loan portfolio at December 31, 2022, 2021 and 2020:

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[[GREPCENT_TABLE]]
[["","December 31,"],["","2022","","2021","","2020"],["(dollars in thousands)","Book Value","","%","","Book Value","","%","","Book Value","","%"],["Loans:"],["Commercial:"],["Equipment finance loans","$","616,751","","","9.8","%","","$","521,973","","","10.0","%","","$","451,437","","","8.8","%"],["Equipment finance leases","491,744","","","7.8","","","423,280","","","8.1","","","410,064","","","8.0"],["Commercial FHA lines","25,029","","","0.4","","","91,927","","","1.8","","","273,298","","","5.4"],["SBA PPP loans","1,916","","","\u2014","","","52,477","","","1.0","","","184,401","","","3.6"],["Other commercial loans","870,878","","","13.8","","","783,811","","","14.9","","","776,439","","","15.2"],["Total commercial loans and leases","2,006,318","","","31.8","","","1,873,468","","","35.8","","","2,095,639","","","41.1"],["Commercial real estate","2,433,159","","","38.6","","","1,816,828","","","34.8","","","1,525,973","","","29.9"],["Construction and land development","320,882","","","5.1","","","193,749","","","3.7","","","172,737","","","3.4"],["Residential real estate","366,094","","","5.8","","","338,151","","","6.5","","","442,880","","","8.7"],["Consumer","1,180,014","","","18.7","","","1,002,605","","","19.2","","","866,102","","","17.0"],["Total loans, gross","6,306,467","","","100.0","%","","5,224,801","","","100.0","%","","5,103,331","","","100.0","%"],["Allowance for credit losses on loans","(61,051)","","","","","(51,062)","","","","","(60,443)"],["Total loans, net","$","6,245,416","","","","","$","5,173,739","","","","","$","5,042,888"]]
[[/GREPCENT_TABLE]]

Total loans increased $1.08 billion to $6.31 billion at December 31, 2022, as compared to December 31, 2021. The loan growth was primarily reflected in our commercial loans and leases, commercial real estate and consumer portfolios, which increased $132.9 million, $616.3 million and $177.4 million, respectively. These increases were offset in part by payoffs and repayments in the residential real estate portfolio.

Commercial loans and leases, which includes commercial FHA warehouse lines and PPP loans, increased $132.9 million to $2.01 billion at December 31, 2022, as compared to December 31, 2021. Advances on commercial FHA warehouse lines decreased $66.9 million to $25.0 million at December 31, 2022. PPP loans at December 31, 2022, totaled $1.9 million, a decrease of $50.6 million from December 31, 2021. Excluding the decreases in PPP loans and commercial FHA warehouse lines, commercial loans and leases increased $250.3 million, primarily from our equipment financing business.

Consumer loans increased $177.4 million primarily as a result of our new relationship with an additional consumer loan origination firm and our continuing relationship with GreenSky. On January 24, 2023, the Company notified GreenSky that, effective October 21, 2023, the Company would terminate its participation in GreenSky’s loan origination program. Following the termination, GreenSky is expected to continue servicing all loans originated through the program.

The principal segments of our loan portfolio are discussed below:

Commercial loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small- and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs, business expansions and farm operations. Commercial loans generally include lines of credit and loans with maturities of five years or less. The loans are generally made with business operations as the primary source of repayment, but may also include collateralization by inventory, accounts receivable and equipment, and generally include personal guarantees. The commercial loan category also includes loans originated by the equipment financing business that are secured by the underlying equipment.

Commercial real estate loans. Our commercial real estate loans consist of both real estate occupied by the borrower for ongoing operations and non-owner occupied real estate properties. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as owner occupied offices, warehouses and production facilities, office buildings, hotels, mixed-use residential and commercial facilities, retail centers, multifamily properties and assisted living facilities. Our commercial real estate loan portfolio also includes farmland loans. Farmland loans are generally made to a borrower actively involved in farming rather than to passive investors.

Construction and land development loans. Our construction and land development loans are comprised of residential construction, commercial construction and land acquisition and development loans. Interest reserves are generally established on real estate construction loans.

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Residential real estate loans. Our residential real estate loans consist of residential properties that generally do not qualify for secondary market sale.

Consumer loans. Our consumer loans include direct personal loans, indirect automobile loans, lines of credit and installment loans originated through home improvement specialty retailers and contractors. Personal loans are generally secured by automobiles, boats and other types of personal property and are made on an installment basis.

Lease financing. Our equipment leasing business provides financing leases to varying types of businesses nationwide for purchases of business equipment and software. The financing is secured by a first priority interest in the financed asset and generally requires monthly payments.

The following table shows the contractual maturities of our loan portfolio and the distribution between fixed and adjustable interest rate loans at December 31, 2022:

[[GREPCENT_TABLE]]
[["","December 31, 2022"],["","Within One Year","","One Year to Five Years","","Five Years to 15 Years","","After 15 Years"],["(dollars in thousands)","Fixed Rate","","Adjustable Rate","","Fixed Rate","","Adjustable Rate","","Fixed Rate","","Adjustable Rate","","Fixed Rate","","Adjustable Rate","","Total"],["Commercial","$","94,832","","","$","435,129","","","$","630,489","","","$","54,816","","","$","199,600","","","$","95,589","","","$","\u2014","","","$","4,119","","","$","1,514,574"],["Commercial real estate","182,324","","","168,831","","","900,573","","","527,826","","","424,707","","","200,949","","","5,692","","","22,257","","","2,433,159"],["Construction and land development","4,499","","","79,585","","","81,639","","","97,701","","","24,406","","","29,636","","","1,022","","","2,394","","","320,882"],["Total commercial loans","281,655","","","683,545","","","1,612,701","","","680,343","","","648,713","","","326,174","","","6,714","","","28,770","","","4,268,615"],["Residential real estate","1,718","","","5,197","","","8,097","","","17,928","","","31,511","","","39,576","","","146,449","","","115,618","","","366,094"],["Consumer","1,762","","","3,141","","","1,154,339","","","561","","","20,211","","","\u2014","","","\u2014","","","\u2014","","","1,180,014"],["Lease financing","11,634","","","\u2014","","","362,685","","","\u2014","","","117,425","","","\u2014","","","\u2014","","","\u2014","","","491,744"],["Total loans","$","296,769","","","$","691,883","","","$","3,137,822","","","$","698,832","","","$","817,860","","","$","365,750","","","$","153,163","","","$","144,388","","","$","6,306,467"]]
[[/GREPCENT_TABLE]]

Loan Quality

We use what we believe is a comprehensive methodology to monitor credit quality and prudently manage credit concentration within our loan portfolio. Our underwriting policies and practices govern the risk profile, credit and geographic concentration for our loan portfolio. We also have what we believe to be a comprehensive methodology to monitor these credit quality standards, including a risk classification system that identifies potential problem loans based on risk characteristics by loan type as well as the early identification of deterioration at the individual loan level. In addition to our allowance for credit losses on loans, our purchase discounts on acquired loans provide additional protections against credit losses.

Analysis of the Allowance for Credit Losses on Loans. The allowance for credit losses on loans was $61.1 million, or 0.97% of total loans, at December 31, 2022 compared to $51.1 million, or 0.98% of total loans, at December 31, 2021. The following table allocates the allowance for credit losses on loans by loan category:

[[GREPCENT_TABLE]]
[["","December 31,"],["","2022","","2021","","2020"],["(dollars in thousands)","Allowance","","% (1)","","Allowance","","% (1)","","Allowance","","% (1)"],["Commercial","$","14,639","","","0.97","%","","$","14,375","","","0.99","%","","$","19,851","","","1.18","%"],["Commercial real estate","29,290","","","1.20","","","22,993","","","1.27","","","25,465","","","1.67"],["Construction and land development","2,435","","","0.76","","","972","","","0.50","","","1,433","","","0.83"],["Total commercial loans","46,364","","","1.09","","","38,340","","","1.11","","","46,749","","","1.38"],["Residential real estate","4,301","","","1.17","","","2,695","","","0.80","","","3,929","","","0.89"],["Consumer","3,599","","","0.30","","","2,558","","","0.26","","","2,338","","","0.27"],["Lease financing","6,787","","","1.38","","","7,469","","","1.76","","","7,427","","","1.81"],["Total allowance for credit losses on loans","$","61,051","","","0.97","%","","$","51,062","","","0.98","%","","$","60,443","","","1.18","%"]]
[[/GREPCENT_TABLE]]

(1)Represents the percentage of the allowance to total loans in the respective category.

We measure expected credit losses over the life of each loan utilizing a combination of models which measure probability of default and loss given default, among other things. The measurement of expected credit losses is impacted by

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loan and borrower attributes and certain macroeconomic variables. Models are adjusted to reflect the impact of certain current macroeconomic variables as well as their expected changes over a reasonable and supportable forecast period.

The allowance allocated to commercial loans totaled $14.6 million, or 0.97% of total commercial loans, at December 31, 2022, compared to $14.4 million, or 0.99%, at December 31, 2021. Modeled expected credit losses increased $1.1 million and qualitative factor ("Q-Factor") adjustments related to commercial loans increased $2.1 million. Specific allocations for commercial loans that were evaluated for expected credit losses on an individual basis decreased from $2.9 million at December 31, 2021 to $0 at December 31, 2022.

The allowance allocated to commercial real estate loans totaled $29.3 million, or 1.20% of total commercial real estate loans, at December 31, 2022 compared to $23.0 million, or 1.27% of total commercial real estate loans, at December 31, 2021. Modeled expected credit losses related to commercial real estate loans decreased $0.3 million and Q-Factor adjustments related to commercial real estate loans increased $5.2 million. Specific allocations for commercial real estate loans that were evaluated for expected credit losses on an individual basis increased from $0.1 million at December 31, 2021 to $1.5 million at December 31, 2022.

The allowance allocated to construction and land development loans totaled $2.4 million, or 0.76% of total construction and land development loans, at December 31, 2022, compared to $1.0 million, or 0.50%, at December 31, 2021. Modeled expected credit losses increased $0.6 million and Q-Factor adjustments related to construction and land development loans increased $0.9 million.

The allowance allocated to residential real estate loans totaled $4.3 million, or 1.17% of total residential real estate loans, at December 31, 2022, compared to $2.7 million, or 0.80%, at December 31, 2021. Modeled expected credit losses increased $1.1 million and Q-Factor adjustments related to residential real estate loans increased $0.5 million.

As previously stated, the overall loan portfolio increased $1.08 billion, or 20.7%, which included a $616.3 million, or 33.9%, increase in commercial real estate loans and a $250.3 million, or 14.5%, increase in commercial loans, excluding commercial FHA warehouse lines and PPP loans. The weighted average risk grade for commercial and industrial loans of 4.36 at December 31, 2022, improved from 4.53 at December 31, 2021. The weighted-average risk grade for commercial real estate loans also decreased slightly to 4.87 at December 31, 2022 from 5.02 at December 31, 2021.

In estimating expected credit losses as of December 31, 2022, we utilized certain forecasted macroeconomic variables from Oxford Economics in our models. The forecasted projections included, among other things, (i) year over year change in U.S. gross domestic product ranging from -0.5% to 1.3% over the next three quarters; (ii) U.S. unemployment rate increasing to 4.7% by the fourth quarter of 2023 with Illinois unemployment rates higher at 6.0%; and (iii) an average 10 year Treasury rate forecasted at 3.10% in the fourth quarter of 2023. These economic metrics forecast a slowing economy in 2023.

We qualitatively adjust the model results based on this scenario for various risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. Q-Factor adjustments are based upon management judgment and current assessment as to the impact of risks related to changes in lending policies and procedures; economic and business conditions; loan portfolio attributes and credit concentrations; and external factors, among other things, that are not already captured within the modeling inputs, assumptions and other processes. Management assesses the potential impact of such items within a range of severely negative impact to positive impact and adjusts the modeled expected credit loss by an aggregate adjustment percentage based upon the assessment. As a result of this assessment as of December 31, 2022, modeled expected credit losses were adjusted upwards with a Q-Factor adjustment of approximately 50 basis points of total loans, increasing from 43 basis points at December 31, 2021. The Q-Factor adjustment at December 31, 2022 was based primarily on declining economic conditions, including rising inflation fears and an increasing risk of recession and the impact of rising fuel prices on businesses and consumers.

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The following table provides an analysis of the allowance for credit losses on loans, provision for credit losses on loans and net charge-offs for the years ended 2022, 2021, and 2020:

[[GREPCENT_TABLE]]
[["","","","Years Ended December 31,"],["(dollars in thousands)","","","","","2022","","2021","","2020"],["Balance, beginning of period","","","","","$","51,062","","","$","60,443","","","$","28,028"],["Charge-offs:"],["Commercial","","","","","4,121","","","6,465","","","5,589"],["Commercial real estate","","","","","4,106","","","3,524","","","13,637"],["Construction and land development","","","","","6","","","448","","","376"],["Residential real estate","","","","","344","","","398","","","522"],["Consumer","","","","","1,229","","","1,158","","","1,624"],["Lease financing","","","","","1,297","","","3,427","","","3,706"],["Total charge-offs","","","","","11,103","","","15,420","","","25,454"],["Recoveries:"],["Commercial","","","","","401","","","341","","","147"],["Commercial real estate","","","","","7","","","21","","","324"],["Construction and land development","","","","","30","","","221","","","107"],["Residential real estate","","","","","252","","","249","","","184"],["Consumer","","","","","457","","","514","","","645"],["Lease financing","","","","","1,148","","","743","","","530"],["Total recoveries","","","","","2,295","","","2,089","","","1,937"],["Net charge-offs","","","","","8,808","","","13,331","","","23,517"],["Provision for credit losses on loans","","","","","18,797","","","3,950","","","43,149"],["Impact of adopting ASC 326","","","","","\u2014","","","\u2014","","","8,546"],["Impact of adopting ASC 326 - PCD loans","","","","","\u2014","","","\u2014","","","4,237"],["Balance, end of period","","","","","$","61,051","","","$","51,062","","","$","60,443"],["Gross loans, end of period","","","","","$","6,306,467","","","$","5,224,801","","","$","5,103,331"],["Average total loans","","","","","$","5,811,403","","","$","4,903,447","","","$","4,721,823"],["Net charge-offs to average loans","","","","","0.15","%","","0.27","%","","0.50","%"],["Allowance for credit losses to total loans","","","","","0.97","%","","0.98","%","","1.18","%"]]
[[/GREPCENT_TABLE]]

Individual loans considered to be uncollectible are charged off against the allowance. Factors used in determining the amount and timing of charge-offs on loans include consideration of the loan type, length of delinquency, sufficiency of collateral value, lien priority and the overall financial condition of the borrower. Collateral value is determined using updated appraisals and/or other market comparable information. Charge-offs are generally taken on loans once the impairment is determined to be other-than-temporary. Recoveries on loans previously charged off are added to the allowance. Net charge-offs for 2022 totaled $8.8 million, compared to $13.3 million for 2021. Net charge-offs to average loans were 0.15% and 0.27% for 2022 and 2021, respectively.

Nonperforming Loans. The following table sets forth our nonperforming assets by asset categories as of the dates indicated. Nonperforming loans include nonaccrual loans, loans past due 90 days or more and still accruing interest and loans modified under troubled debt restructurings. Deferrals related to COVID-19 are not included as TDRs as of December 31, 2022

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and December 31, 2021. The balances of nonperforming loans reflect the net investment in these assets, including deductions for purchase discounts.

[[GREPCENT_TABLE]]
[["","December 31,"],["(dollars in thousands)","2022","","2021","","2020"],["Nonperforming loans:"],["Commercial","$","7,853","","","$","12,261","","","$","7,995"],["Commercial real estate","29,602","","","19,175","","","27,269"],["Construction and land development","229","","","120","","","2,863"],["Residential real estate","8,449","","","7,912","","","13,030"],["Consumer","921","","","208","","","303"],["Lease financing","2,369","","","2,904","","","2,610"],["Total nonperforming loans","49,423","","","42,580","","","54,070"],["Other real estate owned and other repossessed assets","8,401","","","14,488","","","21,362"],["Nonperforming assets","$","57,824","","","$","57,068","","","$","75,432"],["Nonperforming loans to total loans","0.78","%","","0.81","%","","1.06","%"],["Nonperforming assets to total assets","0.74","%","","0.77","%","","1.10","%"],["Allowance for credit losses to nonperforming loans","123.53","%","","119.92","%","","111.79","%"]]
[[/GREPCENT_TABLE]]

We did not recognize interest income on nonaccrual loans during the years ended December 31, 2022 or 2021 while the loans were in nonaccrual status. Additional interest income that would have been recorded on nonaccrual loans had they been current in accordance with their original terms was $2.8 million and $2.7 million for the year ended December 31, 2022 and 2021 respectively. We recognized interest income on commercial and commercial real estate loans modified under troubled debt restructurings of $0.1 million during each of the years ended December 31, 2022 and 2021.

We utilize an asset risk classification system in compliance with guidelines established by the Federal Reserve as part of our efforts to improve asset quality. In connection with examinations of insured institutions, examiners have the authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: “substandard,” “doubtful,” and “loss.” Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full questionable and there is a high probability of loss based on currently existing facts, conditions and values. An asset classified as loss is not considered collectable and is of such little value that continuance of booking the asset is not warranted.

We use a ten grade risk rating system to categorize and determine the credit risk of our loans. Potential problem loans include loans with a risk grade of 7, which are "special mention," and loans with a risk grade of 8, which are "substandard" loans that are not considered to be nonperforming. These loans generally require more frequent loan officer contact and receipt of financial data to closely monitor borrower performance. Potential problem loans are managed and monitored regularly through a number of processes, procedures and committees, including oversight by a loan administration committee comprised of executive officers and other members of the Bank's senior management team.

The following table presents the recorded investment of potential problem commercial loans by loan category at the dates indicated:

[[GREPCENT_TABLE]]
[["","Commercial","","Commercial real estate","","Construction & land development"],["","Risk category","","Risk category","","Risk category"],["(dollars in thousands)","7","","8 (1)","","7","","8 (1)","","7","","8 (1)","","Total"],["December 31, 2022","$","12,693","","","$","9,579","","","$","42,770","","","$","82,949","","","$","210","","","$","8,415","","","$","156,616"],["December 31, 2021","28,248","","","20,413","","","46,295","","","108,634","","","5,235","","","1,336","","","210,161"],["December 31, 2020","43,890","","","29,708","","","83,424","","","166,769","","","454","","","11,176","","","335,421"]]
[[/GREPCENT_TABLE]]

(1)Includes only those 8-rated loans that are not included in nonperforming loans.

    Commercial loans with a risk rating of 7 or 8 decreased $26.4 million to $22.3 million as of December 31, 2022, compared to $48.7 million as of December 31, 2021. Commercial real estate loans with a risk rating of 7 or 8 decreased $29.2

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million to $125.7 million as of December 31, 2022, compared to $154.9 million as of December 31, 2021, primarily due to risk rating upgrades within the portfolio.

Investment Securities. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk. The types and maturities of securities purchased are primarily based on our current and projected liquidity and interest rate sensitivity positions.

The following table sets forth the book value and percentage of each category of investment securities at December 31, 2022, 2021 and 2020. The book value for investment securities classified as available for sale is equal to fair market value.

[[GREPCENT_TABLE]]
[["","December 31,"],["","2022","","2021","","2020"],["(dollars in thousands)","Book Value","","% of Total","","Book Value","","% of Total","","Book Value","","% of Total"],["Investment securities available for sale:"],["U.S. Treasury securities","$","81,230","","","10.6","%","","$","64,917","","","7.2","%","","$","\u2014","","","\u2014","%"],["U.S. government sponsored entities and U.S. agency securities","37,509","","","4.9","","","33,817","","","3.7","","","35,567","","","5.2"],["Mortgage-backed securities - agency","448,150","","","58.3","","","440,270","","","48.5","","","344,577","","","50.9"],["Mortgage-backed securities - non-agency","20,754","","","2.7","","","28,706","","","3.2","","","20,744","","","3.1"],["State and municipal securities","94,636","","","12.3","","","143,099","","","15.8","","","129,765","","","19.2"],["Corporate securities","85,955","","","11.2","","","195,794","","","21.6","","","146,058","","","21.6"],["Total investment securities, available for sale, at fair value","$","768,234","","","100.0","%","","$","906,603","","","100.0","%","","$","676,711","","","100.0","%"]]
[[/GREPCENT_TABLE]]

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The following table sets forth the book value, maturities and weighted average yields for our investment portfolio at December 31, 2022. The book value for investment securities classified as available for sale is equal to fair market value.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","Book value","","% of total","","Weighted average yield"],["Investment securities available for sale:"],["U.S. Treasury securities:"],["Maturing within one year","$","10,210","","","1.3","%","","0.63","%"],["Maturing in one to five years","71,020","","","9.3","","","1.83"],["Maturing in five to ten years","\u2014","","","\u2014","","","\u2014"],["Maturing after ten years","\u2014","","","\u2014","","","\u2014"],["Total U.S. Treasury securities","$","81,230","","","10.6","%","","1.69","%"],["U.S. government sponsored entities and U.S. agency securities:"],["Maturing within one year","$","10,053","","","1.3","%","","4.80","%"],["Maturing in one to five years","15,630","","","2.0","","","1.18"],["Maturing in five to ten years","11,826","","","1.6","","","1.77"],["Maturing after ten years","\u2014","","","\u2014","","","\u2014"],["Total U.S. government sponsored entities and U.S. agency securities","$","37,509","","","4.9","%","","2.25","%"],["Mortgage-backed securities - agency:"],["Maturing within one year","$","2,896","","","0.4","%","","3.02","%"],["Maturing in one to five years","132,438","","","17.2","","","2.50"],["Maturing in five to ten years","202,122","","","26.3","","","2.44"],["Maturing after ten years","110,694","","","14.4","","","1.85"],["Total mortgage-backed securities - agency","$","448,150","","","58.3","%","","2.30","%"],["Mortgage-backed securities - non-agency:"],["Maturing within one year","$","\u2014","","","\u2014","%","","\u2014","%"],["Maturing in one to five years","\u2014","","","\u2014","","","\u2014"],["Maturing in five to ten years","\u2014","","","\u2014","","","\u2014"],["Maturing after ten years","20,754","","","2.7","","","2.55"],["Total mortgage-backed securities - non-agency","$","20,754","","","2.7","%","","2.55","%"],["State and municipal securities (1):"],["Maturing within one year","$","11,888","","","1.5","%","","5.00","%"],["Maturing in one to five years","26,099","","","3.4","","","3.54"],["Maturing in five to ten years","32,599","","","4.3","","","2.52"],["Maturing after ten years","24,050","","","3.1","","","2.86"],["Total state and municipal securities","$","94,636","","","12.3","%","","3.16","%"],["Corporate securities:"],["Maturing within one year","$","\u2014","","","\u2014","%","","\u2014","%"],["Maturing in one to five years","9,658","","","1.3","","","3.57"],["Maturing in five to ten years","76,297","","","9.9","","","3.41"],["Maturing after ten years","\u2014","","","\u2014","","","\u2014"],["Total corporate securities","$","85,955","","","11.2","%","","3.43","%"],["Total investment securities, available for sale","$","768,234","","","100.0","%","","2.47","%"]]
[[/GREPCENT_TABLE]]

(1)Weighted average yield for tax-exempt securities are presented on a tax-equivalent basis assuming a federal income tax rate of 21%.

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The table below presents the credit ratings for our investment securities classified as available for sale, at fair value, at December 31, 2022.

[[GREPCENT_TABLE]]
[["","Amortized","","Estimated","","Average credit rating"],["(dollars in thousands)","cost","","fair value","","AAA","","AA+/-","","A+/-","","BBB+/-","","BBB-","","Not Rated"],["Investment securities available for sale:"],["U.S. Treasury securities","$","86,313","","","$","81,230","","","$","80,986","","","$","244","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","\u2014"],["U.S. government sponsored entities and U.S. agency securities","41,775","","","37,509","","","33,430","","","4,079","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Mortgage-backed securities - agency","522,028","","","448,150","","","12","","","448,138","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Mortgage-backed securities - non-agency","24,922","","","20,754","","","20,754","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["State and municipal securities","102,719","","","94,636","","","6,511","","","76,105","","","1,322","","","992","","","\u2014","","","9,706"],["Corporate securities","95,266","","","85,955","","","\u2014","","","\u2014","","","31,401","","","52,139","","","\u2014","","","2,415"],["Total investment securities, available for sale","$","873,023","","","$","768,234","","","$","141,693","","","$","528,566","","","$","32,723","","","$","53,131","","","$","\u2014","","","$","12,121"]]
[[/GREPCENT_TABLE]]

Cash and Cash Equivalents. Cash and cash equivalents decreased $530.1 million to $150.3 million at December 31, 2022 compared to December 31, 2021, as the excess liquidity was used to fund loan growth during the year.

Loans Held for Sale. Loans held for sale totaled $1.3 million at December 31, 2022, comprised entirely of residential real estate loans, compared to $32.0 million at December 31, 2021, comprised of $19.2 million of commercial real estate and $12.8 million of residential real estate loans.

Liabilities. At December 31, 2022, liabilities totaled $7.10 billion compared to $6.78 billion at December 31, 2021.

Deposits. We emphasize developing total client relationships with our customers in order to increase our retail and commercial core deposit bases, which are our primary funding sources. Our deposits consist of noninterest-bearing and interest-bearing demand, savings and time deposit accounts.

Total deposits increased $254.0 million to $6.36 billion at December 31, 2022, as compared to December 31, 2021. Deposits acquired in the second quarter of 2022 from FNBC totaled $79.8 million. Increases in interest-bearing checking and money market accounts of $257.4 million and $315.0 million, respectively, during this period, were partially offset by a decrease in noninterest-bearing demand account balances.

Noninterest-bearing demand accounts decreased $309.9 million to $1.94 billion at December 31, 2022, compared to December 31, 2021, as servicing deposits decreased $374.7 million. Interest-bearing checking accounts and money market accounts increased $257.4 million and $315.0 million, respectively, from December 31, 2021 to December 31, 2022. These increases were the result of strategic relationships with non-bank financial services companies, consumers' flight to safety from the equities markets and increasing deposit rates in response to the rate increases announced by the Federal Reserve.

[[GREPCENT_TABLE]]
[["","December 31,"],["(dollars in thousands)","2022","","2021","","2020"],["","Book Value","","% of Total","","Book Value","","% of Total","","Book Value","","% of Total"],["Noninterest-bearing demand","$","1,935,773","","","30.4","%","","$","2,245,701","","","36.8","%","","$","1,469,579","","","28.8","%"],["Interest-bearing:"],["Checking","1,920,458","","","30.2","","","1,663,021","","","27.2","","","1,568,888","","","30.8"],["Money market","1,184,101","","","18.6","","","869,067","","","14.2","","","785,871","","","15.4"],["Savings","661,932","","","10.4","","","679,115","","","11.1","","","597,966","","","11.7"],["Time","662,388","","","10.4","","","653,744","","","10.7","","","678,712","","","13.3"],["Total deposits","$","6,364,652","","","100.0","%","","$","6,110,648","","","100.0","%","","$","5,101,016","","","100.0","%"]]
[[/GREPCENT_TABLE]]

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The following table summarizes our average deposit balances and weighted average rates for the years ended December 31, 2022, 2021 and 2020:

[[GREPCENT_TABLE]]
[["","December 31,"],["","2022","","2021","","2020"],["(dollars in thousands)","Average Balance","","Weighted Average Rate","","Average Balance","","Weighted Average Rate","","Average Balance","","Weighted Average Rate"],["Deposits:"],["Noninterest-bearing demand","$","1,965,749","","","\u2014","","","$","1,568,005","","","\u2014","","","$","1,255,031","","","\u2014"],["Interest-bearing:"],["Checking","1,828,886","","","1.23","%","","1,645,880","","","0.14","%","","1,499,199","","","0.27","%"],["Money market","1,048,506","","","0.82","","","821,408","","","0.09","","","831,458","","","0.46"],["Savings","703,341","","","0.08","","","655,735","","","0.02","","","567,398","","","0.04"],["Time, insured","493,751","","","0.62","","","551,748","","","1.12","","","611,570","","","1.78"],["Time, uninsured","131,556","","","0.83","","","138,810","","","0.88","","","100,774","","","1.88"],["Time, brokered","16,592","","","1.23","","","32,419","","","1.23","","","24,387","","","2.52"],["Total interest-bearing","4,222,632","","","0.85","","","3,846,000","","","0.28","","","3,634,786","","","0.59"],["Total deposits","$","6,188,381","","","0.58","%","","$","5,414,005","","","0.20","%","","$","4,889,817","","","0.44","%"]]
[[/GREPCENT_TABLE]]

    The following table sets forth the maturity of uninsured time deposits as of December 31, 2022:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Amount"],["Three months or less","","$","15,862"],["Three to six months","","19,795"],["Six to 12 months","","28,753"],["After 12 months","","54,181"],["Total","","$","118,591"]]
[[/GREPCENT_TABLE]]

    Short-Term Borrowings. In addition to deposits, we use short-term borrowings, such as federal funds purchased and securities sold under agreements to repurchase, as a source of funds to meet the daily liquidity needs of our customers and fund growth in earning assets. Short-term borrowings were $42.3 million at December 31, 2022 compared to $76.8 million at December 31, 2021. The weighted average interest rate on our short-term borrowings was 0.26% and 0.13% at December 31, 2022 and 2021, respectively.

Subordinated Debt. Subordinated debt totaled $99.8 million and $139.1 million as of December 31, 2022 and 2021, respectively. On October 15, 2022, the Company redeemed the outstanding fixed-to-floating rate subordinated notes due October 15, 2027, having an aggregate principal amount of $40.0 million, in accordance with the terms of the notes. The interest rate on the subordinated notes was 6.25%.

Capital Resources and Liquidity Management

Capital Resources. Shareholders’ equity is influenced primarily by earnings, dividends, issuances and redemptions of common and preferred stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized holding gains or losses, net of taxes, on available-for-sale investment securities and cash flow hedges.

Shareholders’ equity increased $94.7 million to $758.6 million at December 31, 2022 as compared to December 31, 2021. The Company generated net income of $99.0 million during 2022. Offsetting this increase to shareholders’ equity were dividends to common shareholders of $25.9 million, dividends to preferred shareholders of $3.2 million, stock repurchases of $1.1 million and a decrease in accumulated other comprehensive loss of $89.0 million. In addition, the Company completed its preferred stock offering in August 2022, generating net proceeds of $110.5 million as described in Note 17. The Company intends to use the net proceeds from the offering for general corporate purposes, which may include providing capital to support its organic growth or growth through strategic acquisitions, repaying or redeeming outstanding indebtedness, financing investments, capital expenditures, repurchasing shares of its common stock and for further investments in the Bank as regulatory capital.

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The Company had a share repurchase program, whereby the Board of Directors authorized the Company to repurchase up to $75.0 million of its common stock. This program terminated December 31, 2022. As of December 31, 2022, $56.4 million, or 2,996,778 shares of the Company’s common stock, had been repurchased under the program. On December 6, 2022, the Company’s Board of Directors authorized a new share repurchase program, pursuant to which the Company is authorized to repurchase up to $25.0 million of common stock through December 31, 2023.

Liquidity Management. Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders.

Integral to our liquidity management is the administration of short-term borrowings. To the extent we are unable to obtain sufficient liquidity through core deposits, we seek to meet our liquidity needs through wholesale funding or other borrowings on either a short- or long-term basis.

Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction, which represents the amount of the Bank’s obligation. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. Investment securities with a carrying amount of $46.1 million and $78.3 million at December 31, 2022 and December 31, 2021, respectively, were pledged for securities sold under agreements to repurchase.

The Company had available lines of credit of $12.2 million and $55.9 million at December 31, 2022 and December 31, 2021, respectively, from the Federal Reserve Discount Window. The lines are collateralized by a collateral agreement with respect to a pool of commercial real estate loans totaling $14.3 million and $64.8 million at December 31, 2022 and December 31, 2021, respectively. There were no outstanding borrowings under these lines at December 31, 2022 and December 31, 2021.

At December 31, 2022, the Company had available federal funds lines of credit totaling $394.0 million, which were unused.

The Company is a corporation separate and apart from the Bank and, therefore, must provide for its own liquidity. The Company’s main source of funding is dividends declared and paid to it by the Bank. There are statutory, regulatory and debt covenant limitations that affect the ability of the Bank to pay dividends to the Company. Management believed at December 31, 2022, that these limitations will not impact our ability to meet our ongoing short-term cash obligations.

Regulatory Capital Requirements

We are subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action”, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies.

In December 2018, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the CECL accounting standard. In March 2020, the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC published an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company is adopting the capital transition relief over the permissible five-year period.

At December 31, 2022, the Company and the Bank exceeded the regulatory minimums and met the regulatory definition of well-capitalized.

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The following table presents the Company's and the Bank’s capital ratios and the minimum requirements at December 31, 2022:

[[GREPCENT_TABLE]]
[["Ratio","","Actual","","MinimumRegulatoryRequirements (1)","","Well Capitalized"],["Total risk-based capital ratio"],["Midland States Bancorp, Inc.","","12.38","%","","10.50","%","","N/A"],["Midland States Bank","","11.51","","","10.50","","","10.00","%"],["Tier 1 risk-based capital ratio"],["Midland States Bancorp, Inc.","","10.21","","","8.50","","","N/A"],["Midland States Bank","","10.71","","","8.50","","","8.00"],["Common equity tier 1 risk-based capital ratio"],["Midland States Bancorp, Inc.","","7.77","","","7.00","","","N/A"],["Midland States Bank","","10.71","","","7.00","","","6.50"],["Tier 1 leverage ratio"],["Midland States Bancorp, Inc.","","9.43","","","4.00","","","N/A"],["Midland States Bank","","9.90","","","4.00","","","5.00"]]
[[/GREPCENT_TABLE]]

(1)Total risk-based capital ratio, Tier 1 risk-based capital ratio and Common equity tier 1 risk-based capital ratio include the capital conservation buffer of 2.5%.

Off-Balance Sheet Arrangements

We have limited off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets. Most of these commitments mature within two years and are expected to expire without being drawn upon. Standby letters of credit are included in the determination of the amount of risk-based capital that the Company and the Bank are required to hold.

We enter into contractual loan commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards until the time of loan funding. We decrease our exposure to losses under these commitments by subjecting them to credit approval and monitoring procedures. We assess the credit risk associated with certain commitments to extend credit and establish a liability for probable credit losses.

Standby letters of credit are written conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event that the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

We guarantee the distributions and payments for redemption or liquidation of the trust preferred securities issued by our wholly owned subsidiary business trusts to the extent of funds held by the trusts. Although this guarantee is not separately recorded, the obligation underlying the guarantee is fully reflected on our consolidated balance sheets as junior subordinated debentures held by subsidiary trusts. The junior subordinated debentures currently qualify as Tier 1 capital under the Federal Reserve capital adequacy guidelines.