MERCANTILE BANK CORP Management report and analysis of financial position and operating results (Form 10-Q)

Forward-looking statements

This report contains forward-looking statements that are based on management's
beliefs, assumptions, current expectations, estimates and projections about the
financial services industry, the economy, and our company. Words such as
"anticipates," "believes," "estimates," "expects," "intends," "is likely,"
"plans," "projects," "indicates," "strategy," "future," "likely," "may,"
"should," "will," and variations of such words and similar expressions are
intended to identify such forward-looking statements. These statements are not
guarantees of future performance and involve certain risks, uncertainties and
assumptions ("Future Factors") that are difficult to predict with regard to
timing, extent, likelihood and degree of occurrence. Therefore, actual results
and outcomes may materially differ from what may be expressed or forecasted in
such forward-looking statements. We undertake no obligation to update, amend, or
clarify forward looking-statements, whether as a result of new information,
future events (whether anticipated or unanticipated), or otherwise.



Future Factors include, among others, adverse changes in interest rates and
interest rate relationships; increasing rates of inflation and slower growth
rates; significant declines in the value of commercial real estate; market
volatility; demand for products and services; the degree of competition by
traditional and non-traditional financial service companies; changes in banking
regulation or actions by bank regulators; changes in the method of determining
Libor and the phase out of Libor; changes in tax laws; changes in accounting
principles and interpretations; changes in prices, levies, and assessments;
potential increases of federal deposit insurance premium expense, and possible
future special assessments of Federal Deposit Insurance Corporation premiums,
either industry wide or specific to our bank; the impact of technological
advances; risks associated with cyber-attacks, information security breaches and
other criminal activities; governmental and regulatory policy changes; our
participation in the Paycheck Protection Program administered by the Small
Business Administration; litigation liabilities; actions of the Federal Reserve
Board; the outcomes of contingencies; trends in customer behavior as well as
their ability to repay loans; changes in local real estate values; damage to our
reputation resulting from adverse publicity, regulatory actions, litigation,
operational failures, the failure to meet client expectations and other facts;
changes in the national and local economies, including the significant
disruption to financial market and other economic activity caused by the
outbreak and continuance of the Coronavirus Pandemic; and risk factors described
in our annual report on Form 10-K for the year ended December 31, 2020, our
March 31, 2021 Form 10-Q, our June 30, 2021 Form 10-Q or in this report. These
are representative of the Future Factors that could cause a difference between
an ultimate actual outcome and a forward-looking statement.



introduction

The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, including Mercantile Bank of
Michigan ("our bank") and our bank's subsidiary, Mercantile Insurance Center,
Inc. ("our insurance company"), at September 30, 2021 and December 31, 2020 and
the results of operations for the three months and nine months ended September
30, 2021 and September 30, 2020. This discussion should be read in conjunction
with the interim consolidated financial statements and footnotes included in
this report. Unless the text clearly suggests otherwise, references in this
report to "us," "we," "our" or "the company" include Mercantile Bank Corporation
and its consolidated subsidiaries referred to above.



Critical accounting policies

GAAP is complex and requires us to apply significant judgment to various
accounting, reporting and disclosure matters. We must use assumptions and
estimates to apply these principles where actual measurements are not possible
or practical. This Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with our unaudited
financial statements included in this report. For a discussion of our
significant accounting policies, see Note 1 of the Notes to our Consolidated
Financial Statements included in our Form 10-K for the fiscal year ended
December 31, 2020 (Commission file number 000-26719). Our critical accounting
policies are highly dependent upon subjective or complex judgments, assumptions
and estimates. Changes in such estimates may have a significant impact on the
financial statements, and actual results may differ from those estimates. We
have reviewed the application of these policies with the Audit Committee of our
Board of Directors.




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Allowance for Loan Losses: The allowance for loan losses ("allowance") is
maintained at a level we believe is adequate to absorb probable incurred losses
identified and inherent in the loan portfolio. Our evaluation of the adequacy of
the allowance is an estimate based on past loan loss experience, the nature and
volume of the loan portfolio, information about specific borrower situations and
estimated collateral values, guidance from bank regulatory agencies, and
assessments of the impact of current and anticipated economic conditions on the
loan portfolio. Allocations of the allowance may be made for specific loans, but
the entire allowance is available for any loan that, in our judgment, should be
charged-off. Loan losses are charged against the allowance when we believe the
uncollectability of a loan is likely. The balance of the allowance represents
our best estimate, but significant downturns in circumstances relating to loan
quality or economic conditions could result in a requirement for an increased
allowance in the future. Likewise, an upturn in loan quality or improved
economic conditions may result in a decline in the required allowance in the
future. In either instance, unanticipated changes could have a significant
impact on the allowance and operating results. Loans made under the Paycheck
Protection Program are fully guaranteed by the Small Business Administration;
therefore, such loans do not have an associated allowance.



The allowance is increased through a provision charged to operating expense.
Uncollectable loans are charged-off through the allowance. Recoveries of loans
previously charged-off are added to the allowance. A loan is considered impaired
when it is probable that contractual interest and principal payments will not be
collected either for the amounts or by the dates as scheduled in the loan
agreement. Impairment is evaluated on an individual loan basis. If a loan is
impaired, a portion of the allowance is allocated so that the loan is reported,
net, at the present value of estimated future cash flows using the loan's
existing rate or at the fair value of collateral if repayment is expected solely
from the collateral. The timing of obtaining outside appraisals varies,
generally depending on the nature and complexity of the property being
evaluated, general breadth of activity within the marketplace and the age of the
most recent appraisal. For collateral dependent impaired loans, in most cases we
obtain and use the "as is" value as indicated in the appraisal report, adjusting
for any expected selling costs. In certain circumstances, we may internally
update outside appraisals based on recent information impacting a particular or
similar property, or due to identifiable trends (e.g., recent sales of similar
properties) within our markets. The expected future cash flows exclude potential
cash flows from certain guarantors. To the extent these guarantors provide
repayments, a recovery would be recorded upon receipt. Loans are evaluated for
impairment when payments are delayed, typically 30 days or more, or when serious
deficiencies are identified within the credit relationship. Our policy for
recognizing income on impaired loans is to accrue interest unless a loan is
placed on nonaccrual status. We put loans into nonaccrual status when the full
collection of principal and interest is not expected.



Financial institutions were not required to comply with the Current Expected
Credit Loss ("CECL") methodology requirements from the enactment date of the
Coronavirus Aid, Relief and Economic Security Act ("CARES Act") until the
earlier of the end of the President's declaration of a National Emergency or
December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted
in December 2020, provided for an extension of the required CECL adoption date
to January 1, 2022, which is the date we expect to adopt. An economic forecast
is a key component of the CECL methodology. As we continued to experience an
unprecedented economic environment whereby a sizable portion of the economy had
been significantly impacted by government-imposed activity limitations and
similar reactions by businesses and individuals, substantial government stimulus
was provided to businesses, individuals and state and local governments and
financial institutions offered businesses and individuals payment relief
options, economic forecasts were regularly revised. Given the high degree of
uncertainty surrounding economic forecasting, we elected to postpone the
adoption of CECL, and have continued to use our incurred loan loss reserve model
as permitted.




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Income Tax Accounting: Current income tax assets and liabilities are established
for the amount of taxes payable or refundable for the current year. In the
preparation of income tax returns, tax positions are taken based on
interpretation of federal and state income tax laws for which the outcome may be
uncertain. We periodically review and evaluate the status of our tax positions
and make adjustments as necessary. Deferred income tax assets and liabilities
are also established for the future tax consequences of events that have been
recognized in our financial statements or tax returns. A deferred income tax
asset or liability is recognized for the estimated future tax effects
attributable to temporary differences that can be carried forward (used) in
future years. The valuation of our net deferred income tax asset is considered
critical as it requires us to make estimates based on provisions of the enacted
tax laws. The assessment of the realizability of the net deferred income tax
asset involves the use of estimates, assumptions, interpretations and judgments
concerning accounting pronouncements, federal and state tax codes and the extent
of future taxable income. There can be no assurance that future events, such as
court decisions, positions of federal and state tax authorities, and the extent
of future taxable income will not differ from our current assessment, the impact
of which could be significant to the consolidated results of operations and
reported earnings.



Accounting guidance requires that we assess whether a valuation allowance should
be established against our deferred tax assets based on the consideration of all
available evidence using a "more likely than not" standard. In making such
judgments, we consider both positive and negative evidence and analyze changes
in near-term market conditions as well as other factors which may impact future
operating results. Significant weight is given to evidence that can be
objectively verified.



Securities and Other Financial Instruments: Securities available for sale
consist of bonds and notes which might be sold prior to maturity due to changes
in interest rates, prepayment risks, yield and availability of alternative
investments, liquidity needs or other factors. Securities classified as
available for sale are reported at their fair value. Declines in the fair value
of securities below their cost that are other-than-temporary are reflected as
realized losses. In estimating other-than-temporary losses, management
considers: (1) the length of time and extent that fair value has been less than
carrying value? (2) the financial condition and near term prospects of the
issuer? and (3) the Company's ability and intent to hold the security for a
period of time sufficient to allow for any anticipated recovery in fair value.
Fair values for securities available for sale are obtained from outside sources
and applied to individual securities within the portfolio. The difference
between the amortized cost and the current fair value of securities is recorded
as a valuation adjustment and reported in other comprehensive income.



Mortgage Servicing Rights: Mortgage servicing rights are recognized as assets
based on the allocated fair value of retained servicing rights on loans sold.
Servicing rights are carried at the lower of amortized cost or fair value and
are expensed in proportion to, and over the period of, estimated net servicing
income. We utilize a discounted cash flow model to determine the value of our
servicing rights. The valuation model utilizes mortgage prepayment speeds, the
remaining life of the mortgage pool, delinquency rates, our cost to service
loans, and other factors to determine the cash flow that we will receive from
serving each grouping of loans. These cash flows are then discounted based on
current interest rate assumptions to arrive at the fair value of the right to
service those loans. Impairment is evaluated quarterly based on the fair value
of the servicing rights, using groupings of the underlying loans classified by
interest rates. Any impairment of a grouping is reported as a valuation
allowance.



Goodwill: GAAP requires us to determine the fair value of all of the assets and
liabilities of an acquired entity, and record their fair value on the date of
acquisition. We employ a variety of means in determination of the fair value,
including the use of discounted cash flow analysis, market comparisons, and
projected future revenue streams. For certain items that we believe we have the
appropriate expertise to determine the fair value, we may choose to use our own
calculation of the value. In other cases, where the value is not easily
determined, we consult with outside parties to determine the fair value of the
asset or liability. Once valuations have been adjusted, the net difference
between the price paid for the acquired company and the value of its balance
sheet is recorded as goodwill.



Goodwill results from business acquisitions and represents the excess of the
purchase price over the fair value of acquired tangible assets and liabilities
and identifiable intangible assets. Goodwill is assessed at least annually for
impairment and any such impairment is recognized in the period identified. A
more frequent assessment is performed if conditions in the market place or
changes in the company's organizational structure occur.





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Coronavirus pandemic

There remains a significant amount of stress and uncertainty across national and
global economies due to the ongoing pandemic of coronavirus disease 2019
("Covid-19") caused by severe acute respiratory syndrome coronavirus 2 (the
"Coronavirus Pandemic"). This uncertainty is heightened as certain geographic
areas continue to experience surges in Covid-19 cases and governments at all
levels continue to react to changes in circumstances, including supply chain
disruptions and inflationary pressures.



The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public
health and economic crisis and may have a material negative impact on our
financial condition and results of operations. We continue to occupy an
asset-sensitive position, whereby interest rate environments characterized by
numerous and/or high magnitude interest rate reductions have a negative impact
on our net interest income and net income. Additionally, the consequences of the
unprecedented economic impact of the Coronavirus Pandemic may produce declining
asset quality, reflected by a higher level of loan delinquencies and loan
charge-offs, as well as downgrades of commercial lending relationships, which
may necessitate additional provisions for our allowance and reduced net income.



The following section summarizes the main measures that have a direct impact on us and our customers.


  ? Paycheck Protection Program


The Paycheck Protection Program ("PPP") reflects a substantial expansion of the
Small Business Administration's 100% guaranteed 7(a) loan program. The CARES Act
authorized up to $350 billion in loans to businesses with fewer than 500
employees, including non-profit organizations, tribal business concerns,
self-employed and individual contractors. The PPP provides 100% guaranteed loans
to cover specific operating costs. PPP loans are eligible to be forgiven based
upon certain criteria. In general, the amount of the loan that is forgivable is
the sum of the payroll costs, interest payments on mortgages, rent and utilities
incurred or paid by the business during a prescribed period beginning on the
loan origination date. Any remaining balance after forgiveness is maintained at
the 100% guarantee for the duration of the loan. The interest rate on the loan
is fixed at 1.00%, with the financial institution receiving a loan origination
fee paid by the Small Business Administration. The loan origination fees, net of
the direct origination costs, are accreted into interest income on loans using
the level yield methodology. The program ended on August 8, 2020. We originated
approximately 2,200 loans aggregating $553 million. As of September 30, 2021, we
recorded forgiveness transactions on over 2,100 loans aggregating $550 million.
Net loan origination fees of $3.7 million were recorded during the first nine
months of 2021.



The Consolidated Appropriations Act, 2021 authorized an additional $284 billion
in Second Draw PPP loans ("Second Draw"). The program ended on May 31, 2021.
Under the Second Draw, we originated approximately 1,200 loans aggregating $209
million. As of September 30, 2021, we recorded forgiveness transactions on about
600 loans aggregating $95.9 million. Net loan origination fees of $4.8 million
were recorded during the first nine months of 2021 under the Second Draw.



A PPP loan is assigned a 0% risk weight under the risk capital rules of federal bank agencies.


  ? Individual Economic Impact Payments


The Internal Revenue Service has made three rounds of Individual Economic Impact
Payments via direct deposit or mailed checks. In general, and subject to
adjusted gross income limitations, qualifying individuals have received payments
of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.





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? Relief from distressed debt restructuring


From March 1, 2020 through 60 days after the end of the National Emergency (or
December 31, 2020 if earlier), a financial institution may elect to suspend GAAP
principles and regulatory determinations with respect to loan modifications
related to Covid-19 that would otherwise be categorized as troubled debt
restructurings. Banking agencies must defer to the financial institution's
election. We elected to suspend GAAP principles and regulatory determinations as
permitted. The Consolidated Appropriations Act, 2021 extended the suspension
date to January 1, 2022.



  ? Current Expected Credit Loss Methodology Delay


Financial institutions are not required to comply with the CECL methodology
requirements from the enactment date of the CARES Act until the earlier of the
end of the National Emergency or December 31, 2020. We elected to postpone CECL
adoption as permitted. The Consolidated Appropriations Act, 2021 extended the
adoption deferral date to January 1, 2022.



In early April 2020, in response to the early stages of the Coronavirus Pandemic
and its pervasive impact across the economy and financial markets, we developed
internal programs of loan payment deferments for commercial and retail
borrowers. For commercial borrowers, we offered 90-day (three payments) interest
only amendments as well as 90-day (three payments) principal and interest
payment deferments. Under the latter program, borrowers were extended a 12-month
single payment note at 0% interest in an amount equal to three payments, with
loan proceeds used to make the scheduled payments. The single payment notes
receive a loan grade equal to the loan grade of each respective borrowing
relationship. Certain of our commercial loan borrowers subsequently requested
and received an additional 90-day (three payments) interest only amendment or
90-day (three payments) principal and interest payment deferment. Under the
latter program, the amount equal to the three payments was added to the original
deferment note which has nine months remaining to maturity; however, the
original 0% interest rate is modified to equal the rate associated with each
borrower's traditional lending relationship with us for the remainder of the
term. At the peak of activity in mid-2020, nearly 750 borrowers with loan
balances aggregating $719 million were participating in the commercial loan
payment deferment program. As of September 30, 2021, we had no loans in the
commercial loan payment deferment program.



For retail borrowers, we offered 90-day (three payments) principal and interest
payment deferments, with deferred amounts added to the end of the loan. As of
September 30, 2020, we had processed 260 principal and interest payment
deferments with loan balances totaling $23.8 million. As of September 30, 2021,
only six borrowers with loan balances aggregating $0.5 million remained in the
retail loan payment deferment program.



Financial overview

We reported net income of $15.1 million, or $0.95 per diluted share, for the
third quarter of 2021, compared to net income of $10.7 million, or $0.66 per
diluted share, during the third quarter of 2020. Net income for the first nine
months of 2021 totaled $47.4 million, or $2.95 per diluted share, compared to
$30.1 million, or $1.85 per diluted share, during the first nine months of 2020.



Commercial loans increased $48.4 million during the first nine months of 2021,
reflecting the combined net growth of core commercial loans and net activity
under the PPP. Core commercial loans increased $298 million, or approximately
16% on an annualized basis, during the first nine months of 2021. Net PPP loans
declined $249 million during the first nine months of 2021, comprised of $209
million in PPP loans extended and $458 million in forgiveness transactions. As a
percentage of total commercial loans, commercial and industrial loans (excluding
PPP loans) and owner occupied commercial real estate ("CRE") loans combined
equaled 55.4% as of September 30, 2021, compared to 53.9% at December 31, 2020.
The new commercial loan pipeline remains strong, and at September 30, 2021, we
had $155 million in unfunded loan commitments on commercial construction and
development loans that are in the construction phase.





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The overall quality of our loan portfolio remains strong, with nonperforming
loans equaling 0.08% of total loans as of September 30, 2021. Accruing loans
past due 30 to 89 days remain very low. Gross loan charge-offs totaled $0.7
million during the third quarter of 2021, and aggregated $0.9 million for the
first nine months of the year, while recoveries of prior period loan charge-offs
equaled $0.4 million and $1.2 million during the respective time periods. A net
loan recovery, as a percentage of average total loans, equaled an annualized
0.01% during the first nine months of 2021.



We recorded a loan loss provision expense of $1.9 million during the third
quarter of 2021, compared to a provision expense of $3.2 million during the
third quarter of 2020. We recorded a negative loan loss provision expense of
$0.9 million during the first nine months of 2021, compared to a provision
expense of $11.6 million during the first nine months of 2020. The provision
expense recorded during the third quarter of 2021 mainly reflected growth in
core commercial loans, while the prior-year third quarter expense was primarily
comprised of increased reserve allocations associated with the downgrading of
certain non-impaired commercial loan relationships to reflect stressed economic
conditions stemming from the Coronavirus Pandemic. The negative provision
expense recorded during the first nine months of 2021 largely reflected reserve
allocations necessitated by core commercial loan growth that were more than
fully mitigated by a lower reserve allocation associated with the economic and
business conditions environmental factor that was upgraded during the second
quarter reflecting improvement in both current and forecasted economic
conditions. The provision expense during the first nine months of 2020 was
primarily comprised of increased reserve allocations associated with the
downgrades of the economic and business conditions environmental factor, the
introduction of a Covid-19 pandemic environmental factor and the aforementioned
third quarter 2020 commercial loan downgrades.



Interest-earning balances, primarily consisting of funds deposited at the
Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and
interest rate risk sensitivity. During the first nine months of 2021, the
average balance of these funds equaled $649 million, or 14.6% of average earning
assets, compared to $288 million, or 7.7% of average earning assets, during the
first nine months of 2020, and a more typical $93.8 million, or 2.8% of average
earning assets, during the first nine months of 2019. The elevated level during
2020 and year-to-date 2021 primarily reflects increased local deposits stemming
from federal government stimulus payments and reduced business and consumer
investing and spending. The excess level of funds on deposit with the Federal
Reserve Bank of Chicago had a negative impact of 40 basis points to 45 basis
points on our net interest margin during the third quarter and first nine months
of 2021.



Total local deposits increased $480 million during the first nine months of
2021, and are up $1.3 billion since year-end 2019, equating to growth rates of
about 14% and 50%, respectively. Approximately 50% of the local deposit increase
during the first nine months of 2021 and the last 21 months is comprised of
increased noninterest-bearing checking account balances.



Net interest income increased $1.6 million during the third quarter of 2021
compared to the third quarter of 2020, and was up $1.1 million during the first
nine months of 2021 compared to the first nine months of 2020. Both interest
income and interest expense were impacted during the 2021 periods compared to
the prior-year periods primarily by the Federal Open Market Committee's ("FOMC")
federal funds rate cuts totaling 150 basis points in March of 2020 and a low
interest rate environment since that time; however, growth in earning assets,
especially core commercial loans, has provided for the increase in net interest
income. Interest income increased $0.3 million during the third quarter of 2021
from the third quarter of 2020, but was down $4.2 million during the first nine
months of 2021 compared to the first nine months of 2020. During the same time
periods, interest expense was down $1.3 million and $5.4 million, respectively.



Noninterest income during the third quarter of 2021 was $15.6 million, compared
to $13.3 million during the prior-year third quarter. Noninterest income during
the first nine months of 2021 was $43.6 million, compared to $30.8 million
during the same time period in 2020. The improved levels mainly resulted from
ongoing strength in our mortgage banking function and fee income generated from
a commercial lending interest rate swap program that was introduced in the
latter part of 2020. In addition, a gain on the sale of a branch totaling $1.1
million was recorded during the second quarter of 2021.





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Noninterest expense during the third quarter of 2021 was $26.2 million, compared
to $26.4 million during the prior-year third quarter. Noninterest expense during
the first nine months of 2021 was $77.5 million, compared to $72.6 million
during the same time period in 2020. About 60% of the increase in the
year-to-date overhead costs reside in salary and benefits, with almost one-half
of that figure being comprised of increased medical insurance costs. The
remaining portion is primarily comprised of increased Federal Deposit Insurance
Corporation ("FDIC") insurance costs and former facility valuation write-downs.



Financial Condition

Our total assets increased $527 million during the first nine months of 2021,
and totaled $4.96 billion as of September 30, 2021. Total loans increased $120
million, securities available for sale were up $172 million and interest-earning
deposits grew by $178 million, while total deposits increased $457 million and
sweep accounts were up $57.5 million, during the first nine months of 2021.



Commercial loans increased $48.4 million during the first nine months of 2021,
and at September 30, 2021 totaled $2.84 billion, or 85.8% of the loan portfolio.
As of December 31, 2020, the commercial loan portfolio comprised 87.5% of total
loans. The increase in commercial loans reflects the combined net growth of core
commercial loans and net activity under the PPP. Core commercial loans increased
$298 million, or approximately 16% on an annualized basis, while PPP loans
declined $249 million, comprised of $209 million in PPP loans extended and $458
million in forgiveness transactions, during the first nine months of 2021. Core
commercial and industrial loans increased $178 million, non-owner occupied CRE
loans grew $81.3 million, owner occupied CRE loans were up $21.8 million and
multi-family and residential rental property loans increased $33.0 million,
while vacant land, land development and residential construction loans declined
$16.7 million. As a percentage of total commercial loans, commercial and
industrial loans (excluding PPP loans) and owner occupied CRE loans combined
equaled 55.4% as of September 30, 2021, compared to 53.9% at December 31, 2020.



As of September 30, 2021, availability on existing construction and development
loans totaled $155 million, with most of those funds expected to be drawn over
the next 12 to 18 months. Our current pipeline reports indicate continued strong
commercial loan funding opportunities in future periods, including $253 million
in new lending commitments, a majority of which we expect to be accepted and
funded over the next 12 to 18 months. Our commercial lenders also report ongoing
additional opportunities they are currently discussing with existing and
potential new borrowers. We remain committed to prudent underwriting standards
that provide for an appropriate yield and risk relationship, as well as
concentration limits we have established within our commercial loan portfolio.



Residential mortgage loans increased $73.7 million during the first nine months
of 2021, totaling $412 million, or 12.4% of total loans, as of September 30,
2021. Activity within the residential mortgage loan function was very active
during the first nine months of 2021, primarily reflecting refinance
transactions spurred by low residential mortgage loan interest rates, strength
in home purchase activity, and the continuing success of strategic initiatives
that have been implemented over the past several years to gain market share and
increase production. We originated $742 million in residential mortgage loans
during the first nine months of 2021, an increase of almost 15% compared to
originations during the first nine months of 2020. The production composition
during the first nine months of 2021 was almost equal between purchase and
refinance residential mortgage loans; however, the mix changed significantly
during the second and third quarters compared to the first quarter. Refinance
residential mortgage loans comprised approximately 67% of production during the
first three months of 2021, but dropped to about 39% during the second quarter
and approximately 45% during the third quarter. Residential mortgage loans
originated for sale, generally consisting of longer-term fixed rate residential
mortgage loans, during the first nine months of 2021 totaled $514 million, or
approximately 69% of total residential mortgage loans originated. During the
first nine months of 2020, residential mortgage loans originated for sale
totaled $512 million, or about 79% of total mortgage loans originated.
Residential mortgage loans originated not sold are generally comprised of
adjustable rate residential mortgage loans. We are pleased with the results of
our strategic initiatives associated with the growth of our residential mortgage
banking operation over the past few years, and remain optimistic that
origination volumes will remain solid in future periods.





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Other consumer-related loans declined $1.9 million during the first nine months
of 2021, and at September 30, 2021 totaled $59.7 million, or 1.8% of total
loans. Other consumer-related loans comprised 1.9% of total loans as of December
31, 2020. We expect this loan portfolio segment to decline in future periods as
scheduled principal payments exceed anticipated new loan origination volumes.



The following table summarizes our loan portfolio over the past twelve months:



                                         9/30/21             6/30/21             3/31/21            12/31/20             9/30/20
Commercial:
Commercial & Industrial              $ 1,074,394,000     $ 1,103,807,000    

$ 1,284,507,000 $ 1,145,423,000 $ 1,321,419,000
Land development and construction

           38,380,000          43,111,000    

58 738 000 55 055 000 50 941 000 Owner Occupied Commercial RE

             551,762,000         550,504,000    

544 342,000 529 953,000 549 364,000 Non-owner Occupied Commercial RE 998 697,000 950 993,000

932,334,000 917,436,000 878,897,000 Multi-family and residential rentals 179,126,000 161,894,000

     147,294,000         146,095,000         137,740,000
Total Commercial                       2,842,359,000       2,810,309,000       2,967,215,000       2,793,962,000       2,938,361,000

Retail:
1-4 Family Mortgages                     411,618,000         380,292,000   

337,844,000 337,888,000 348,460,000 Home equity and other consumer loans 59,732,000 58 240,000

      59,311,000          61,620,000          63,723,000
Total Retail                             471,350,000         438,532,000         397,155,000         399,508,000         412,183,000

Total                                $ 3,313,709,000     $ 3,248,841,000   

$ 3,364,370,000 $ 3,193,470,000 $ 3,350,544,000




(*) Includes $116 million, $246 million, $455 million, $365 million, and $555
million in loans originated under the Paycheck Protection Program for September
30, 2021, June 30, 2021, March 31, 2021, December 31, 2020, and September 30,
2020, respectively.



Our credit policies establish guidelines to manage credit risk and asset
quality. These guidelines include loan review and early identification of
problem loans to provide effective loan portfolio administration. The credit
policies and procedures are meant to minimize the risk and uncertainties
inherent in lending. In following these policies and procedures, we must rely on
estimates, appraisals and evaluations of loans and the possibility that changes
in these could occur quickly because of changing economic conditions. Identified
problem loans, which exhibit characteristics (financial or otherwise) that could
cause the loans to become nonperforming or require restructuring in the future,
are included on an internal watch list. Senior management and the Board of
Directors review this list regularly. Market value estimates of collateral on
impaired loans, as well as on foreclosed and repossessed assets, are reviewed
periodically. We also have a process in place to monitor whether value estimates
at each quarter-end are reflective of current market conditions. Our credit
policies establish criteria for obtaining appraisals and determining internal
value estimates. We may also adjust outside and internal valuations based on
identifiable trends within our markets, such as recent sales of similar
properties or assets, listing prices and offers received. In addition, we may
discount certain appraised and internal value estimates to address distressed
market conditions.



Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or
more and accruing interest and foreclosed properties, totaled $2.9 million (0.1%
of total assets) as of September 30, 2021, compared to $4.1 million (0.1% of
total assets) as of December 31, 2020. Given the low level of nonperforming
loans and accruing loans 30 to 89 days delinquent, combined with the manageable
and steady level of watch list credits and what we believe are strong credit
administration practices, we remain pleased with the overall quality of the loan
portfolio.




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The following tables provide a breakdown of nonperforming assets by collateral
type:



                                             NONPERFORMING LOANS

                                    9/30/21         6/30/21         3/31/21        12/31/20         9/30/20
Residential Real Estate:
Land Development                  $    33,000     $    34,000     $    34,000     $    35,000     $    36,000
Construction                                0               0               0               0         198,000
Owner Occupied / Rental             2,052,000       2,096,000       2,294,000       2,519,000       2,399,000
                                    2,085,000       2,130,000       2,328,000       2,554,000       2,633,000

Commercial Real Estate:
Land Development                            0               0               0               0               0
Construction                                0               0               0               0               0
Owner Occupied                              0               0         283,000         619,000       1,262,000
Non-Owner Occupied                          0               0               0          22,000          23,000
                                            0               0         283,000         641,000       1,285,000

Non-Real Estate:
Commercial Assets                     673,000         606,000         169,000         172,000         198,000
Consumer Assets                         8,000          10,000          13,000          17,000          25,000
                                      681,000         616,000         182,000         189,000         223,000

Total                             $ 2,766,000     $ 2,746,000     $ 2,793,000     $ 3,384,000     $ 4,141,000






                        OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

                            9/30/21       6/30/21       3/31/21      12/31/20       9/30/20
Residential Real Estate:
Land Development           $       0     $       0     $       0     $       0     $       0
Construction                       0             0             0             0             0
Owner Occupied / Rental       11,000        41,000        11,000        88,000       198,000
                              11,000        41,000        11,000        88,000       198,000

Commercial Real Estate:
Land Development                   0             0             0             0             0
Construction                       0             0             0             0             0
Owner Occupied               100,000       363,000       363,000       613,000       314,000
Non-Owner Occupied                 0             0             0             0             0
                             100,000       363,000       363,000       613,000       314,000

Non-Real Estate:
Commercial Assets                  0             0             0             0             0
Consumer Assets                    0             0             0             0             0
                                   0             0             0             0             0

Total                      $ 111,000     $ 404,000     $ 374,000     $ 701,000     $ 512,000





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The following tables provide a reconciliation of non-performing assets:


                                       NONPERFORMING LOANS RECONCILIATION

                                       3rd Qtr         2nd Qtr         1st Qtr         4th Qtr          3rd Qtr
                                        2021            2021            2021             2020            2020

Beginning balance                    $ 2,746,000     $ 2,793,000     $ 3,384,000     $  4,141,000     $ 3,212,000
Additions, net of transfers to ORE       361,000         492,000         116,000          538,000       1,301,000
Returns to performing status             (50,000 )             0        (115,000 )              0         (72,000 )
Principal payments                      (291,000 )      (484,000 )      (559,000 )     (1,064,000 )      (249,000 )
Loan charge-offs                               0         (55,000 )       (33,000 )       (231,000 )       (51,000 )

Total                                $ 2,766,000     $ 2,746,000     $ 2,793,000     $  3,384,000     $ 4,141,000






                OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

                         3rd Qtr        2nd Qtr       1st Qtr        4th Qtr        3rd Qtr
                           2021          2021           2021           2020          2020

Starting balance $ 404,000 $ 374,000 $ 701,000 $ 512,000 $ 198,000
Additions

                        0        30,000              0        434,000       314,000
Sale proceeds             (209,000 )           0        (77,000 )     (245,000 )           0
Valuation write-downs      (84,000 )           0       (250,000 )            0             0

Total                   $  111,000     $ 404,000     $  374,000     $  701,000     $ 512,000




Gross loan charge-offs totaled $0.7 million during the third quarter of 2021,
and aggregated $0.9 million for the first nine months of the year, while
recoveries of prior period loan charge-offs equaled $0.4 million and $1.2
million during the respective time periods. Net loan charge-offs, as a
percentage of average total loans, equaled an annualized 0.05% during the third
quarter of 2021, while a net loan recovery, as a percentage of average total
loans, equaled 0.01% during the first nine months of 2021. We continue our
collection efforts on charged-off loans, and expect to record recoveries in
future periods; however, given the nature of these efforts, it is not practical
to forecast the dollar amount and timing of the recoveries. The allowance
equaled $37.4 million, or 1.13% of total loans (1.17% of total loans excluding
PPP loans), and over 1,300% of nonperforming loans as of September 30, 2021.



In each accounting period, we adjust the allowance to the amount we believe is
necessary to maintain the allowance at an adequate level. Through the loan
review and credit departments, we establish portions of the allowance based on
specifically identifiable problem loans. The evaluation of the allowance is
further based on, but not limited to, consideration of the internally prepared
allowance analysis, loan loss migration analysis, composition of the loan
portfolio, third party analysis of the loan administration processes and
portfolio, and general economic conditions.





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Financial institutions were not required to comply with the CECL methodology
requirements from the enactment date of the CARES Act until the earlier of the
end of the President's declaration of a National Emergency or December 31, 2020.
The Consolidated Appropriations Act, 2021, that was enacted in December 2020,
provided for an extension of the required CECL adoption date to January 1, 2022,
which is the date we plan to adopt. An economic forecast is a key component of
the CECL methodology. As we continued to experience an unprecedented economic
environment whereby a sizable portion of the economy had been significantly
impacted by government-imposed activity limitations and similar reactions by
businesses and individuals, substantial government stimulus was provided to
businesses, individuals and state and local governments and financial
institutions offered businesses and individuals payment relief options, economic
forecasts were regularly revised. Given the high degree of uncertainty
surrounding economic forecasting, we elected to postpone the adoption of CECL,
and have continued to use our incurred loan loss reserve model as permitted.



The allowance analysis applies reserve allocation factors to non-impaired
outstanding loan balances, the result of which is combined with specific
reserves to calculate an overall allowance dollar amount. For non-impaired
commercial loans, reserve allocation factors are based on the loan ratings as
determined by our standardized grade paradigms and by loan purpose. Our
commercial loan portfolio is segregated into five classes: 1) commercial and
industrial loans; 2) vacant land, land development and residential construction
loans; 3) owner occupied real estate loans; 4) non-owner occupied real estate
loans; and 5) multi-family and residential rental property loans. The reserve
allocation factors are primarily based on the historical trends of net loan
charge-offs through a migration analysis whereby net loan losses are tracked via
assigned grades over various time periods, with adjustments made for
environmental factors reflecting the current status of, or recent changes in,
items such as: lending policies and procedures; economic conditions; nature and
volume of the loan portfolio; experience, ability and depth of management and
lending staff; volume and severity of past due, nonaccrual and adversely
classified loans; effectiveness of the loan review program; value of underlying
collateral; loan concentrations; and other external factors such as competition
and regulatory environment.



We established a Covid-19 reserve allocation factor to address the Coronavirus
Pandemic and its potential impact on the collectability of the loan portfolio
during the second quarter of 2020. The creation of this factor reflected our
belief that the traditional nine environmental factors did not sufficiently
capture and address the unique circumstances, challenges and uncertainties
associated with the Coronavirus Pandemic, which include unprecedented federal
government stimulus and interventions, supply chain disruptions, statewide
mandatory closures on nonessential businesses and periodic changes to such, and
our ability to provide payment deferral programs to commercial and retail
borrowers without the interjection of troubled debt restructuring accounting
rules. We review a myriad of items assessing this new environmental factor,
including virus infection rates, vaccine inoculation trends, economic outlooks,
employment data, business closures, foreclosures, payment deferments and
government-sponsored stimulus programs.



We recorded a loan loss provision expense of $1.9 million during the third
quarter of 2021, compared to a provision expense of $3.2 million during the
third quarter of 2020. We recorded a negative loan loss provision expense of
$0.9 million during the first nine months of 2021, compared to a provision
expense of $11.6 million during the first nine months of 2020. The provision
expense recorded during the third quarter of 2021 mainly reflected growth in
core commercial loans, while the prior-year third quarter expense was primarily
comprised of increased reserve allocations associated with the downgrading of
certain non-impaired commercial loan relationships to reflect stressed economic
conditions stemming from the Coronavirus Pandemic. The negative provision
expense recorded during the first nine months of 2021 largely reflected reserve
allocations necessitated by core commercial loan growth that were more than
fully mitigated by a lower reserve allocation associated with the economic and
business conditions environmental factor that was upgraded during the second
quarter reflecting improvement in both current and forecasted economic
conditions. The provision expense during the first nine months of 2020 was
primarily comprised of increased reserve allocations associated with the
downgrades of the economic and business conditions environmental factor, the
introduction of a Covid-19 pandemic environmental factor and the aforementioned
third quarter 2020 commercial loan downgrades.



Adjustments for specific lending relationships, particularly impaired loans, are
made on a case-by-case basis. Non-impaired retail loan reserve allocations are
determined in a similar fashion as those for non-impaired commercial loans,
except that retail loans are segmented by type of credit and not a grading
system. We regularly review the allowance analysis and make needed adjustments
based upon identifiable trends and experience.





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A migration analysis is completed quarterly to assist us in determining
appropriate reserve allocation factors for non-impaired commercial loans. Our
migration analysis takes into account various time periods, with most weight
placed on the time frame from December 31, 2010 through September 30, 2021. We
believe this time period represents an appropriate range of economic conditions,
and that it provides for an appropriate basis in determining reserve allocation
factors given current economic conditions and the general consensus of economic
conditions in the near future. We are actively monitoring our loan portfolio and
assessing reserve allocation factors in light of the Coronavirus Pandemic and
its impact on the U.S. economic environment and our customers in particular.



Although the migration analysis provides a historical accounting of our net loan
losses, it is not able to fully account for environmental factors that will also
very likely impact the collectability of our commercial loans as of any
quarter-end date. Therefore, we incorporate the environmental factors as
adjustments to the historical data. Environmental factors include both internal
and external items. We believe the most significant internal environmental
factor is our credit culture and the relative aggressiveness in assigning and
revising commercial loan risk ratings, with the most significant external
environmental factor being the assessment of the current economic environment
and the resulting implications on our commercial loan portfolio.



The primary risk elements with respect to commercial loans are the financial
condition of the borrower, the sufficiency of collateral, and timeliness of
scheduled payments. We have a policy of requesting and reviewing periodic
financial statements from commercial loan customers, and we have a disciplined
and formalized review of the existence of collateral and its value. The primary
risk element with respect to each residential real estate loan and consumer loan
is the timeliness of scheduled payments. We have a reporting system that
monitors past due loans and have adopted policies to pursue creditors' rights in
order to preserve our collateral position.



As of September 30, 2021, the allowance was comprised of $36.6 million in
general reserves relating to non-impaired loans and $0.8 million in specific
reserves on other loans, primarily accruing loans designated as troubled debt
restructurings. Troubled debt restructurings totaled $21.3 million at September
30, 2021, consisting of $0.8 million that are on nonaccrual status and $20.5
million that are on accrual status. The latter, while considered and accounted
for as impaired loans in accordance with accounting guidelines, are not included
in our nonperforming loan totals. Impaired loans with an aggregate carrying
value of $0.6 million as of September 30, 2021 had been subject to previous
partial charge-offs aggregating $0.5 million over the past eleven years. As of
September 30, 2021, there were no specific reserves allocated to impaired loans
that had been subject to a previous partial charge-off.



The following table provides a breakdown of our loans categorized as troubled
debt restructurings:



                  9/30/21          6/30/21          3/31/21          12/31/20         9/30/20

Performing      $ 20,518,000     $ 20,840,000     $ 19,606,000     $ 23,133,000     $ 11,522,000
Nonperforming        782,000          859,000          431,000          510,000        1,113,000

Total           $ 21,300,000     $ 21,699,000     $ 20,037,000     $ 23,643,000     $ 12,635,000




Although we believe the allowance is adequate to absorb loan losses in our
originated loan portfolio as they arise, there can be no assurance, especially
given the current uncertainties related to the Coronavirus Pandemic and its
impact on the U.S. economic environment, that we will not sustain loan losses in
any given period that could be substantial in relation to, or greater than, the
size of the allowance.




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Securities available for sale increased $172 million during the first nine
months of 2021, totaling $560 million as of September 30, 2021. Purchases of
U.S. Government agency bonds totaled $188 million during the first nine months
of 2021, in part reflecting the reinvestment of proceeds from called U.S.
Government agency bonds that totaled $61.9 million. Purchases of U.S. Government
agency guaranteed mortgage-backed securities totaled $24.4 million during the
first nine months of 2021, consisting of investments in CRA-qualified
securities, in part reflecting the reinvestment of $8.8 million from principal
paydowns on U.S. Government agency guaranteed mortgage-backed securities.
Purchases of municipal bonds totaled $45.3 million during the first nine months
of 2021; proceeds from matured and called municipal bonds totaled $6.8 million.
At September 30, 2021, the portfolio was comprised of U.S. Government agency
bonds (65%), municipal bonds (28%) and U.S. Government agency issued or
guaranteed mortgage-backed securities (7%). All of our securities are currently
designated as available for sale, and are therefore stated at fair value. The
fair value of securities designated as available for sale at September 30, 2021
totaled $560 million, including a net unrealized loss of $0.4 million. We
maintain the securities portfolio at levels to provide adequate pledging and
secondary liquidity for our daily operations. In addition, the securities
portfolio serves a primary interest rate risk management function. We expect
purchases during the remainder of 2021 to generally consist of U.S. Government
agency bonds and municipal bonds, with the securities portfolio maintained at
about 12% of total assets.



FHLBI stock totaled $18.0 million as of September 30, 2021, unchanged from the
balance at December 31, 2020. Our investment in FHLBI stock is necessary to
engage in their advance and other financing programs. We have regularly received
quarterly cash dividends, and we expect a cash dividend will continue to be paid
in future quarterly periods.



Market values on our U.S. Government agency bonds, mortgage-backed securities
issued or guaranteed by U.S. Government agencies and municipal bonds are
generally determined on a monthly basis with the assistance of a third party
vendor. Evaluated pricing models that vary by type of security and incorporate
available market data are utilized. Standard inputs include issuer and type of
security, benchmark yields, reported trades, broker/dealer quotes and issuer
spreads. The market value of certain non-rated securities issued by relatively
small municipalities generally located within our markets is estimated at
carrying value. We believe our valuation methodology provides for a reasonable
estimation of market value, and that it is consistent with the requirements of
accounting guidelines.



Interest-earning balances, primarily consisting of funds deposited at the
Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and
interest rate risk sensitivity. During the first nine months of 2021, the
average balance of these funds equaled $649 million, or 14.6% of average earning
assets, compared to $288 million, or 7.7% of average earning assets, during the
first nine months of 2020, and a more typical $93.8 million, or 2.8% of average
earning assets, during the first nine months of 2019. The elevated level during
2020 and year-to-date 2021 primarily reflects increased local deposits stemming
from federal government stimulus payments and reduced business and consumer
investing and spending. The excess level of funds on deposit with the Federal
Reserve Bank of Chicago had a negative impact of 40 basis points to 45 basis
points on our net interest margin during the third quarter and first nine months
of 2021.



Net premises and equipment equaled $57.5 million at September 30, 2021,
representing a decrease of $1.5 million during the first nine months of 2021. An
aggregate increase of $6.3 million stems from facility remodeling and new lease
activities, while a decline of $3.5 million was recorded from the sale of a
branch facility (along with the associated loans and deposits) to another
financial institution and the sale of a former branch facility. Depreciation
expense totaled $4.3 million during the first nine months of 2021. Foreclosed
and repossessed assets equaled $0.1 million as of September 30, 2021, a
reduction of $0.6 million from December 31, 2020.



Total deposits increased $ 457 million in the first nine months of 2021, totaling $ 3.87 billion To September 30, 2021. Local deposits have increased $ 480 million, while out-of-zone deposits decreased $ 23.0 million. As a percentage of total deposits, out-of-zone deposits amounted to 0.6% at September 30, 2021, compared to 1.4% at December 31, 2020.

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Noninterest-bearing checking accounts and interest-bearing checking accounts
increased $214 million and $62.9 million, respectively, during the first nine
months of 2021, in large part reflecting federal government stimulus, especially
the PPP, as well as lower business investing and spending. Money market deposit
account balances increased $243 million during the first nine months of 2021, of
which $129 million was during the third quarter. Generally, the growth reflects
federal government stimulus programs and lower business and consumer investing
and spending; however, we believe a large portion of the growth during the third
quarter, primarily comprised of additional deposits by a few existing account
holders, are temporary and will be withdrawn over the next three months to six
months. Savings deposits were up $54.2 million, primarily reflecting the impact
of federal government stimulus programs and lower consumer investing and
spending. Local time deposits decreased $93.5 million during the first nine
months of 2021, primarily reflecting the maturity and withdrawal of funds from
certain public unit time deposits and time deposits that were opened as part of
a special time deposit campaign we ran during early 2019. The reduction in
out-of-area deposits during the first nine months of 2021 reflects maturities
during the period that were not replaced as the funds were no longer needed.



Total local deposits have increased $1.3 billion since December 31, 2019.
Noninterest-bearing checking accounts have grown $722 million during this time
period, while interest-bearing checking accounts and money market deposit
accounts are up $204 million and $345 million, respectively. The increases in
these transactional deposit products largely reflect federal government stimulus
programs, especially the PPP, as well as lower business investing and spending.
Savings deposits are up $123 million, primarily reflecting the impact of federal
government stimulus programs and lower consumer investing and spending.



Sweep accounts increased $57.5 million during the first nine months of 2021,
totaling $176 million as of September 30, 2021. The aggregate balance of this
funding type can be subject to relatively large fluctuations given the nature of
the customers utilizing this product and the sizable balances of many of the
customers. The average balance of sweep accounts equaled $152 million during the
first nine months of 2021, with a high balance of $196 million and low balance
of $113 million. Our sweep account program entails transferring collected funds
from certain business noninterest-bearing checking accounts and savings deposits
into over-night interest-bearing repurchase agreements. Such sweep accounts are
not deposit accounts and are not afforded federal deposit insurance, and are
accounted for as secured borrowings.



Aggregate FHLBI Advances $ 394 million from September 30, 2021, unchanged from the 2020 year-end balance. Advances are secured by residential mortgages, first mortgage liens on multi-family real estate loans, first mortgage liens on commercial real estate loans and virtually all of the other assets of our bank, under a comprehensive lien agreement. Our loan line of credit as of September 30, 2021 totaled $ 760 million, with a remaining availability based on an equal guarantee $ 360 million.



Shareholders' equity was $452 million at September 30, 2021, compared to $442
million at December 31, 2020. The $10.7 million increase during the first nine
months of 2021 primarily reflects the positive impact of net income totaling
$47.4 million, partially offset by the negative impact of cash dividends and
common stock repurchases totaling $13.9 million and $19.8 million, respectively.
Reflecting an increase in market interest rates, the change in net unrealized
holding gain/loss on securities available for sale, net of tax effect, had a
$5.8 million negative impact on shareholders' equity during the first nine
months of 2021.



Liquidity

Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, and capital, or cash flow from the repayment of loans and securities.
These funds are used to fund loans, meet deposit withdrawals, maintain reserve
requirements and operate our company. Liquidity is primarily achieved through
local and out-of-area deposits and liquid assets such as securities available
for sale, matured and called securities, federal funds sold and interest-earning
deposit balances. Asset and liability management is the process of managing our
balance sheet to achieve a mix of earning assets and liabilities that maximizes
profitability, while providing adequate liquidity.



To assist in providing needed funds, we have regularly obtained monies from
wholesale funding sources. Wholesale funds, primarily comprised of deposits from
customers outside of our market areas and advances from the FHLBI, totaled $418
million, or 9.4% of combined deposits and borrowed funds, as of September 30,
2021, compared to $441 million, or 11.2% of combined deposits and borrowed
funds, as of December 31, 2020.





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Sweep accounts increased $57.5 million during the first nine months of 2021,
totaling $176 million as of September 30, 2021. The aggregate balance of this
funding type can be subject to relatively large fluctuations given the nature of
the customers utilizing this product and the sizable balances of many of the
customers. The average balance of sweep accounts equaled $152 million during the
first nine months of 2021, with a high balance of $196 million and low balance
of $113 million. Our sweep account program entails transferring collected funds
from certain business noninterest-bearing checking accounts and savings deposits
into over-night interest-bearing repurchase agreements. Such sweep accounts are
not deposit accounts and are not afforded federal deposit insurance, and are
accounted for as secured borrowings.



Information on pensions delivered to September 30, 2021 and in the first nine months of 2021 is as follows:



Outstanding balance at September 30, 2021                                 $ 

175,850,000

Weighted average interest rate at September 30, 2021                               0.11 %
Maximum daily balance nine months ended September 30, 2021                $ 

195,570,000

Average daily balance for nine months ended September 30, 2021            $ 

151,522,000

Weighted average interest rate for the nine months ended September 30, 2021

       0.11 %



Aggregate FHLBI Advances $ 394 million from September 30, 2021, unchanged from the 2020 year-end balance. Advances are secured by residential mortgages, first mortgage liens on multi-family real estate loans, first mortgage liens on commercial real estate loans and virtually all of the other assets of our bank, under a comprehensive lien agreement. Our loan line of credit as of September 30, 2021 totaled $ 760 million, with a remaining availability based on an equal guarantee $ 360 million.



We also have the ability to borrow up to $70.0 million on a daily basis through
correspondent banks using established unsecured federal funds purchased lines of
credit. We did not access the lines of credit during the first nine months of
2021. In contrast, our interest-earning deposit balance with the Federal Reserve
Bank of Chicago averaged $609 million during the first nine months of 2021. We
also have a line of credit through the Discount Window of the Federal Reserve
Bank of Chicago. Using certain municipal bonds as collateral, we could have
borrowed up to $34.9 million as of September 30, 2021. We did not utilize this
line of credit during the first nine months of 2021 or at any time during the
previous twelve fiscal years, and do not plan to access this line of credit in
future periods.



The following table reflects, as of September 30, 2021, significant fixed and
determinable contractual obligations to third parties by payment date, excluding
accrued interest:



                                        One Year            One to           Three to            Over
                                         or Less          Three Years       Five Years        Five Years           Total

Deposits without a stated maturity   $ 3,430,424,000     $           0     $           0     $          0     $ 3,430,424,000
Time deposits                            272,640,000       120,862,000        45,065,000                0         438,567,000
Short-term borrowings                    175,850,000                 0                 0                0         175,850,000
Federal Home Loan Bank advances           84,000,000       160,000,000       100,000,000       50,000,000         394,000,000
Subordinated debentures                            0                 0                 0       48,074,000          48,074,000
Other borrowed money                               0                 0                 0        1,517,000           1,517,000
Property leases                              779,000         1,456,000           367,000        1,157,000           3,759,000




In addition to normal loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of September 30, 2021, we had a total of $1.54 billion in unfunded
loan commitments and $29.4 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $1.29 billion were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $253
million were for loan commitments generally expected to close and become funded
within the next 12 to 18 months. We regularly monitor fluctuations in loan
balances and commitment levels, and include such data in our overall liquidity
management.




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We monitor our liquidity position and funding strategies on an ongoing basis,
but recognize that unexpected events, changes in economic or market conditions,
a reduction in earnings performance, declining capital levels or situations
beyond our control could cause liquidity challenges. While we believe it is
unlikely that a funding crisis of any significant degree is likely to
materialize, we have developed a comprehensive contingency funding plan that
provides a framework for meeting liquidity disruptions.



Capital resources

Shareholders' equity was $452 million at September 30, 2021, compared to $442
million at December 31, 2020. The $10.7 million increase during the first nine
months of 2021 primarily reflects the positive impact of net income totaling
$47.4 million, partially offset by the negative impact of cash dividends and
common stock repurchases totaling $13.9 million and $19.8 million, respectively.
Reflecting an increase in market interest rates, the change in net unrealized
holding gain/loss on securities available for sale, net of tax effect, had a
$5.8 million negative impact on shareholders' equity during the first nine
months of 2021.



In May 2021, we announced that our Board of Directors had authorized a program
to repurchase up to $20.0 million of our common stock from time to time in open
market transactions at prevailing market prices or by other means in accordance
with applicable regulations. This program replaces a similar $20.0 million
program that had been announced in May 2019 that was nearing exhaustion. During
the first nine months of 2021, we repurchased a total of approximately 636,000
shares at a total price of $19.8 million, at an average price per share of
$31.14. Availability under the repurchase plan totaled $8.4 million as of
September 30, 2021. The stock buybacks have been funded from cash dividends paid
to us from our bank. Additional repurchases may be made in future periods under
the authorized plan or a new plan, which would also likely be funded from cash
dividends paid to us from our bank.



We and our bank are subject to regulatory capital requirements administered by
state and federal banking agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. Under the final BASEL III capital rules that
became effective on January 1, 2015, there is a requirement for a common equity
Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in
addition to the other minimum risk-based capital standards in the rule.
Institutions that do not meet this required capital buffer will become subject
to progressively more stringent limitations on the percentage of earnings that
can be paid out in cash dividends or used for stock repurchases and on the
payment of discretionary bonuses to senior executive management. The capital
buffer requirement raised the minimum required common equity Tier 1 capital
ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to
10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of
September 30, 2021, our bank met all capital adequacy requirements under the
BASEL III capital rules on a fully phased-in basis.



As of September 30, 2021, our bank's total risk-based capital ratio was 12.4%,
compared to 13.5% at December 31, 2020. Our bank's total regulatory capital
increased $25.4 million during the first nine months of 2021, in large part
reflecting the net impact of net income totaling $51.1 million and cash
dividends paid to us aggregating $26.0 million. Our bank's total risk-based
capital ratio was also impacted by a $495 million increase in total
risk-weighted assets, primarily resulting from growth in core commercial loans
and securities available for sale. As of September 30, 2021, our bank's total
regulatory capital equaled $483 million, or approximately $94 million in excess
of the 10.0% minimum which is among the requirements to be categorized as "well
capitalized." Our and our bank's capital ratios as of September 30, 2021 and
December 31, 2020 are disclosed in Note 12 of the Notes to Consolidated
Financial Statements.



Results of Operations

We recorded net income of $15.1 million, or $0.95 per basic and diluted share,
for the third quarter of 2021, compared to net income of $10.7 million, or $0.66
per basic and diluted share, for the third quarter of 2020. We recorded net
income of $47.4 million, or $2.95 per basic and diluted share, for the first
nine months of 2021, compared to net income of $30.1 million, or $1.85 per basic
and diluted share, for the first nine months of 2020.





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The improved levels of net income during the 2021 periods compared to the
respective 2020 periods primarily resulted from increased noninterest income and
net interest income and lower provision expense. Growth in noninterest income
during the 2021 periods primarily resulted from fee income generated from an
interest rate swap program that was introduced during the fourth quarter of
2020. A higher level of mortgage banking income also significantly contributed
to the growth in noninterest income during the first nine months of 2021. The
increases in net interest income during the 2021 periods resulted from the
positive impact of earning asset growth, which more than offset the negative
impact of lower net interest margins. A negative loan loss provision was
recorded during the first nine months of 2021, primarily reflecting a reduced
allocation associated with the economic and business conditions environmental
factor. Noninterest expense decreased in the third quarter of 2021 compared to
the prior-year third quarter, mainly reflecting a lower bonus accrual, and
increased during the first nine months of 2021 compared to respective 2020
period, primarily reflecting higher compensation costs.



Interest income during the third quarter of 2021 was $35.9 million, an increase
of $0.3 million, or 0.8%, from the $35.6 million earned during the third quarter
of 2020. The increase resulted from growth in average earning assets, which more
than offset the impact of a lower yield on average earning assets. Average
earning assets equaled $4.56 billion during the current-year third quarter, up
$481 million, or 11.8%, from the level of $4.08 billion during the respective
2020 period; average interest-earning deposits were up $276 million, average
securities increased $220 million, and average loans were down $15.2 million.
The yield on average earning assets was 3.13% during the third quarter of 2021,
compared to 3.45% during the third quarter of 2020. The decline primarily
resulted from a change in earning asset mix. On average, lower-yielding
interest-earning deposits and securities represented 16.1% and 12.0% of earning
assets, respectively, during the third quarter of 2021, up from 11.2% and 8.0%,
respectively, during the third quarter of 2020, while higher-yielding loans
represented 71.9% of earning assets during the current-year third quarter, down
from 80.8% during the prior-year third quarter. A significant volume of excess
on-balance sheet liquidity, which initially surfaced in the second quarter of
2020 as a result of the Covid-19 environment and persisted during the remainder
of 2020 and the first nine months of 2021, negatively impacted the yield on
average earning assets by 51 basis points during the third quarter of 2021. The
excess funds, consisting primarily of low-yielding deposits with the Federal
Reserve Bank of Chicago, are mainly a product of federal government stimulus
programs, lower business and consumer spending and investing, and PPP loan
forgiveness activities.



A decreased yield on securities also contributed to the lower yield on average
earning assets in the current-year third quarter compared to the respective 2020
period. The yield on securities was 1.46% during the third quarter of 2021, down
from 2.26% during the prior-year third quarter mainly due to lower yields on
newly purchased bonds, reflecting the declining interest rate environment, and
decreased accelerated discount accretion on called U.S. Government agency bonds.
Accelerated discount accretion totaled $0.3 million during the third quarter of
2020; a nominal level of accelerated discount accretion was recorded during the
third quarter of 2021. As part of our interest rate risk management program,
U.S. Government agency bonds are periodically purchased at discounts during
rising interest rate environments; if these bonds are called during decreasing
interest rate environments, the remaining unaccreted discount amounts are
immediately recognized as interest income.





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Interest income during the first nine months of 2021 was $106 million, a
decrease of $4.2 million, or 3.8%, from the $111 million earned during the first
nine months of 2020. The decrease resulted from a lower yield on average earning
assets, which more than offset the impact of growth in average earning assets.
The yield on average earning assets was 3.21% during the first nine months of
2021, compared to 3.91% during the respective 2020 period. The decline primarily
resulted from a change in earning asset mix and lower yields on securities and
loans. On average, lower-yielding interest-earning deposits and securities
represented 14.6% and 10.9% of earning assets, respectively, during the first
nine months of 2021, up from 7.7% and 8.9%, respectively, during the first nine
months of 2020, while higher-yielding loans represented 74.5% and 83.4% of
earning assets during the respective periods. The previously mentioned
significant volume of excess on-balance sheet liquidity negatively impacted the
yield on average earning assets by 46 basis points during the first nine months
of 2021. The yield on securities was 1.53% during the first nine months of 2021,
down from 3.47% during the respective 2020 period mainly due to decreased
accelerated discount accretion on called U.S. Government agency bonds and lower
yields on newly purchased bonds, reflecting the declining interest rate
environment. Accelerated discount accretion totaled $3.0 million during the
first nine months of 2020; accelerated discount accretion of less than $0.1
million was recorded during the first nine months of 2021. The yield on loans
declined from 4.28% during the first nine months of 2020 to 4.06% during the
first nine months of 2021 mainly due to a lower yield on commercial loans, which
equaled 4.32% and 4.08% during the respective periods. The decreased yield on
commercial loans primarily reflected reduced interest rates on variable-rate
commercial loans resulting from the FOMC significantly decreasing the targeted
federal funds rate by a total of 150 basis points in March of 2020, along with
the origination of new loans and renewal of maturing loans in the lower interest
rate environment and a decreased level of PPP net loan fee accretion, which
totaled $8.5 million during the first nine months of 2021, down from $11.1
million during the respective 2020 period. Average earning assets equaled $4.44
billion during the first nine months of 2021, up $684 million, or 18.2%, from
the level of $3.76 billion during the first nine months of 2020; average
interest-earning deposits were up $360 million, average loans increased $175
million, and average securities were up $149 million.



Interest expense during the third quarter of 2021 was $4.8 million, a decrease
of $1.3 million, or 21.7%, from the $6.1 million expensed during the third
quarter of 2020. The decrease is attributable to a lower weighted average cost
of interest-bearing liabilities, which equaled 0.69% in the current-year third
quarter compared to 0.99% in the prior-year third quarter. The decline mainly
reflected lower rates paid on local time deposits and a change in funding mix,
consisting of an increase in average lower-cost interest-bearing non-time
deposits and a decrease in average higher-cost time deposits as a percentage of
average total interest-bearing liabilities. The cost of time deposits declined
from 1.86% during the third quarter of 2020 to 1.16% during the current-year
third quarter due to lower interest rates paid on local time deposits,
reflecting the decreasing interest rate environment, and a change in
composition, primarily reflecting a decrease in higher-cost brokered funds. On
average, lower-cost non-time deposits represented 61.0% of total
interest-bearing liabilities during the third quarter of 2021, up from 52.3%
during the third quarter of 2020, while higher-cost time deposits represented
16.6% and 23.8% of total interest-bearing liabilities during the respective
periods. Average interest-bearing liabilities were $2.74 billion during the
third quarter of 2021, up $293 million, or 12.0%, from the $2.45 billion average
during the third quarter of 2020.





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Interest expense during the first nine months of 2021 was $14.9 million, a
decrease of $5.4 million, or 26.5%, from the $20.3 million expensed during the
first nine months of 2020. The decrease is attributable to a lower weighted
average cost of interest-bearing liabilities, which equaled 0.75% in the first
nine months of 2021 compared to 1.15% in the respective 2020 period. The decline
reflected lower costs of time deposits, non-time deposit accounts, and borrowed
funds and a change in funding mix, consisting of an increase in average
lower-cost interest-bearing non-time deposits and a decrease in average
higher-cost time deposits as a percentage of average total interest-bearing
liabilities. The cost of time deposits declined from 2.04% during the first nine
months of 2020 to 1.30% during the respective 2021 period due to lower rates
paid on local time deposits, reflecting the decreased interest rate environment,
and a change in composition, primarily reflecting a decline in higher-cost
brokered funds. The cost of interest-bearing non-time deposit accounts decreased
from 0.30% during the first nine months of 2020 to 0.21% during the first nine
months of 2021, primarily reflecting lower interest rates paid on money market
accounts; the reduced interest rates mainly reflect the decreasing interest rate
environment. The cost of borrowed funds decreased from 1.98% during the first
nine months of 2020 to 1.72% during the respective 2021 period, primarily
reflecting lower costs of FHLBI advances and subordinated debentures. The cost
of FHLBI advances was 2.06% during the first nine months of 2021, down from
2.22% during the first nine months of 2020, primarily reflecting the impact of a
blend and extend transaction that was executed in June 2020 with the FHLBI to
extend the duration of our advance portfolio as part of our interest rate risk
management program and the declining interest rate environment. The cost of
subordinated debentures was 3.78% during the first nine months of 2021, down
from 5.02% during the respective 2020 period due to decreases in the 90-Day
Libor Rate. A change in composition, mainly reflecting an increase in lower-cost
sweep accounts, also contributed to the decreased cost of borrowed funds. On
average, lower-cost non-time deposits represented 59.5% of total
interest-bearing liabilities during the first nine months of 2021, up from 50.5%
during the first nine months of 2020, while higher-cost time deposits
represented 18.2% and 25.3% of total interest-bearing liabilities during the
respective periods. Average interest-bearing liabilities were $2.67 billion
during the first nine months of 2021, up $316 million, or 13.4%, from the $2.36
billion average during the first nine months of 2020.



Net interest income during the third quarter of 2021 was $31.1 million, an
increase of $1.6 million, or 5.5%, from the $29.5 million earned during the
respective 2020 period. The increase resulted from the positive impact of an
increase in average earning assets, which more than offset a lower net interest
margin. The net interest margin decreased from 2.86% in the third quarter of
2020 to 2.71% in the current-year third quarter due to a lower yield on average
earning assets, which more than offset a reduction in the cost of funds. The
decreased yield on average earning assets reflected a change in earning asset
mix, along with a lower yield on securities, while the decreased cost of funds
mainly reflected lower rates paid on local time deposits and a change in funding
mix. The previously discussed significant level of excess on-balance sheet
liquidity negatively impacted the net interest margin by 44 basis points during
the third quarter of 2021.



Net interest income during the first nine months of 2021 was $91.5 million, an
increase of $1.1 million, or 1.3%, from the $90.4 million earned during the
first nine months of 2020. The increase resulted from the positive impact of an
increase in average earning assets, which more than offset a lower net interest
margin. The net interest margin decreased from 3.19% in the first nine months of
2020 to 2.76% in the respective 2021 period due to a lower yield on average
earning assets, which more than offset a reduction in the cost of funds. The
decreased yield on average earning assets primarily reflected a change in
earning asset mix and lower yields on securities and commercial loans, while the
decreased cost of funds mainly reflected lower costs of deposits and borrowed
funds and a change in funding mix. The aforementioned significant level of
excess on-balance sheet liquidity negatively impacted the net interest margin by
40 basis points during the first nine months of 2021.



The following tables set forth certain information relating to our consolidated
average interest-earning assets and interest-bearing liabilities and reflect the
average yield on assets and average cost of liabilities for the third quarters
and first nine months of 2021 and 2020. Such yields and costs are derived by
dividing income or expense by the average daily balance of assets or
liabilities, respectively, for the period presented. Tax-exempt securities
interest income and yield for the third quarters and first nine months of 2021
and 2020 have been computed on a tax equivalent basis using a marginal tax rate
of 21.0%. Securities interest income was increased by $60,000 in the third
quarter of both 2021 and 2020 and $180,000 in the first nine months of both 2021
and 2020 for this non-GAAP, but industry standard, adjustment. These adjustments
equated to increases in our net interest margin of less than one basis point for
each of the 2021 and 2020 periods.





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                                                       Quarters ended September 30,
                                           2 0 2 1                                       2 0 2 0
                            Average                       Average         Average                       Average
                            Balance        Interest         Rate          Balance        Interest         Rate
                                                          (dollars in thousands)
ASSETS
Loans                     $ 3,276,863     $   33,656           4.07 %   $ 3,292,025     $   33,664           4.03 %
Investment securities         547,336          2,001           1.46         327,668          1,848           2.26
Other interest-earning
assets                        733,801            291           0.16         457,598            142           0.12
Total interest -
earning assets              4,558,000         35,948           3.13       4,077,291         35,654           3.45

Allowance for loan
losses                        (36,369 )                                     (33,580 )
Other assets                  334,980                                       302,913

Total assets              $ 4,856,611                                   $ 4,346,624


LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
deposits                  $ 2,125,920     $    2,184           0.41 %   $ 1,863,302     $    3,466           0.74 %
Short-term borrowings         170,528             46           0.11         140,180             38           0.11
Federal Home Loan Bank
advances                      394,000          2,072           2.06         394,000          2,072           2.06
Other borrowings               49,533            462           3.65          49,814            509           4.00
Total interest-bearing
liabilities                 2,739,981          4,764           0.69       2,447,296          6,085           0.99

Noninterest-bearing
deposits                    1,641,158                                     1,454,887
Other liabilities              19,569                                        14,576
Shareholders' equity          455,903                                       429,865

Total liabilities and
shareholders' equity      $ 4,856,611                                   $ 4,346,624

Net interest income                       $   31,184                                    $   29,569

Net interest rate
spread                                                         2.44 %                                        2.46 %
Net interest spread on
average assets                                                 2.55 %                                        2.70 %
Net interest margin on
earning assets                                                 2.71 %                                        2.86 %





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                                                     Nine months ended September 30,
                                          2 0 2 1                                      2 0 2 0
                            Average                      Average         Average                      Average
                            Balance       Interest         Rate          Balance       Interest         Rate
                                                         (dollars in thousands)
ASSETS
Loans                     $ 3,308,119     $ 100,430           4.06 %   $ 3,132,884     $ 101,428           4.28 %
Investment securities         484,020         5,555           1.53         335,443         8,734           3.47
Other interest-earning
assets                        648,780           642           0.13         288,310           711           0.32
Total interest -
earning assets              4,440,919       106,627           3.21       3,756,637       110,873           3.91

Allowance for loan
losses                        (37,977 )                                    (27,963 )
Other assets                  327,540                                      295,501

Total assets              $ 4,730,482                                  $ 4,024,175


LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
deposits                  $ 2,076,221     $   7,247           0.47 %   $ 1,785,391     $  11,808           0.88 %
Short-term borrowings         151,522           122           0.11         135,474           132           0.13
Federal Home Loan Bank
advances                      394,000         6,149           2.06         384,511         6,499           2.22
Other borrowings               49,584         1,401           3.73          49,744         1,857           4.90
Total interest-bearing
liabilities                 2,671,327        14,919           0.75       2,355,120        20,296           1.15

Noninterest-bearing
deposits                    1,590,969                                    1,228,729
Other liabilities              19,671                                       16,402
Shareholders' equity          448,515                                      423,924

Total liabilities and
shareholders' equity      $ 4,730,482                                  $ 4,024,175

Net interest income                       $  91,708                                    $  90,577

Net interest rate
spread                                                        2.46 %                                       2.76 %
Net interest spread on
average assets                                                2.59 %                                       3.00 %
Net interest margin on
earning assets                                                2.76 %                                       3.19 %




A loan loss provision expense of $1.9 million and $3.2 million was recorded
during the third quarters of 2021 and 2020, respectively. A negative loan loss
provision expense of $0.9 million was recorded during the first nine months of
2021, compared to a provision expense of $11.6 million during the first nine
months of 2020. The provision expense recorded during the current-year third
quarter mainly reflected net core commercial loan growth, while the provision
expense recorded during the prior-year third quarter was primarily comprised of
increased allocations associated with the downgrading of certain non-impaired
commercial loan relationships to reflect stressed economic conditions stemming
from the Covid-19 environment. The negative provision expense recorded during
the first nine months of 2021 was mainly comprised of a reduced allocation
associated with the economic and business conditions environmental factor,
reflecting improvement in both current and forecasted economic conditions, which
more than offset required reserve allocations necessitated by net growth in core
commercial loans.




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The provision expense recorded during the first nine months of 2020 mainly
consisted of increased allocations related to changes in the existing economic
and business conditions environmental factor during the first and second
quarters and an allocation associated with the Covid-19 factor during the second
quarter, along with the increased allocations resulting from the aforementioned
commercial loan downgrades. The Covid-19 factor was added to address the unique
challenges and economic uncertainty resulting from the pandemic and its
potential impact on the collectability of the loan portfolio.



During the third quarter of 2021, loan charge-offs totaled $0.8 million, while
recoveries of prior period loan charge-offs equaled $0.4 million, providing for
net loan charge-offs of $0.4 million, or an annualized 0.05% of average total
loans. During the third quarter of 2020, loan charge-offs totaled $0.1 million,
while recoveries of prior period loan charge-offs equaled $0.2 million,
providing for net loan recoveries of $0.1 million, or an annualized 0.02% of
average total loans. During the first nine months of 2021, loan charge-offs
totaled $0.9 million, while recoveries of prior period loan charge-offs equaled
$1.2 million, providing for net loan recoveries of $0.3 million, or an
annualized 0.01% of average total loans. During the first nine months of 2020,
loan charge-offs totaled $0.5 million, while recoveries of prior period loan
charge-offs equaled $0.6 million, providing for net loan recoveries of $0.1
million, or an annualized 0.01% of average total loans. The allowance for loans,
as a percentage of total loans, was 1.1% as of September 30, 2021, and September
30, 2020, and 1.2% as of December 31, 2020. Excluding PPP loans, the allowance
for loans, as a percentage of total loans, equaled 1.2% as of September 30,
2021, and 1.3% as of December 31, 2020, and September 30, 2020.



Noninterest income during the third quarter of 2021 was $15.6 million, compared
to $13.3 million during the prior-year third quarter. Noninterest income during
the third quarter of 2021 included a recovery of loan collection costs totaling
$0.6 million. Excluding the impact of this transaction, noninterest income
increased $1.7 million, or 12.6%, during the third quarter of 2021 compared to
the respective 2020 period. Noninterest income during the first nine months of
2021 was $43.6 million, compared to $30.8 million during the first nine months
of 2020. Noninterest income during the first nine months of 2021 included a $1.1
million gain on the sale of a branch facility and the aforementioned recovery of
loan collection costs. Excluding the impacts of these transactions, noninterest
income increased $11.1 million, or 36.0%, during the first nine months of 2021
compared to the respective prior-year period. The higher levels of noninterest
income in the 2021 periods mainly reflected fee income generated from an
interest rate swap program, which was introduced during the fourth quarter of
2020 and provides certain commercial borrowers with a longer-term fixed-rate
option and assists us in managing associated longer-term interest rate risk.
Increased mortgage banking income, primarily reflecting increased production and
a higher gain on sale rate, also significantly contributed to the higher level
of noninterest income during the first nine months of 2021. Residential mortgage
loan originations totaled $742 million during the first nine months of 2021,
approximately 15% higher than originations during the first nine months of 2020.
Purchase transactions totaled $370 million during the first nine months of 2021,
compared to $198 million during the respective 2020 period, representing an
increase of $172 million, or approximately 87%. Refinance transactions totaled
$372 million during the first nine months of 2021, compared to $448 million
during the first nine months of 2020, representing a decrease of $75.5 million,
or approximately 17%. Residential mortgage loans originated for sale, generally
consisting of longer-term fixed rate residential mortgage loans, totaled $514
million, or approximately 69% of total mortgage loans originated, during the
first nine months of 2021. During the first nine months of 2020, residential
mortgage loans originated for sale totaled $512 million, or approximately 79% of
total mortgage loans originated. Mortgage banking income remained sound in the
third quarter of 2021 as sustained strength in purchase mortgage originations
largely mitigated the negative impacts of an expected decrease in refinance
activity, a lower mortgage loan sold percentage, and a decreased gain on sale
rate. Purchase transactions totaled $144 million during the third quarter of
2021, compared to $93.1 million during the prior-year third quarter. Refinance
transactions totaled $116 million during the current-year third quarter,
compared to $144 million during the third quarter of 2020. Growth in credit and
debit card income, service charges on accounts, and payroll service fees also
contributed to the increased level of noninterest income during the 2021
periods.




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Noninterest expense totaled $26.2 million during the third quarter of 2021, down
$0.2 million from the third quarter of 2020. The lower level of expense
primarily resulted from decreased compensation costs, mainly reflecting a
reduced bonus accrual and lower stock-based compensation expense, which more
than offset increased regular salary expense primarily stemming from annual
employee merit pay increases. The bonus accrual during the third quarter of 2020
was increased due to a change in estimate as no accruals were recorded during
the first and second quarters of the year due to Covid-19 and associated
weakened economic environment. Noninterest expense during the first nine months
of 2021 was $77.5 million, an increase of $4.9 million, or 6.8%, from the $72.6
million expensed during the first nine months of 2020. The higher level of
expense mainly resulted from increased compensation costs, primarily reflecting
employee merit pay increases, increased residential mortgage loan originator
commissions and associated incentives, a larger bonus accrual, and increased
health insurance costs. Mainly reflecting a higher level of claims, some of
which resulted from the treatment of Covid-19 related medical conditions, health
insurance costs were up $0.2 million in the third quarter of 2021 and $1.2
million during the first nine months of 2021 compared to the respective 2020
periods. FDIC deposit insurance premiums were up $0.2 million in the
current-year third quarter and $0.5 million in the first nine months of 2021
compared to the respective 2020 periods, reflecting an increased assessment base
and rate. Noninterest expense during the first nine months of 2021 included $0.6
million in net losses on sales and write-downs of former branch facilities.



During the third quarter of 2021, we recorded income before federal income tax
of $18.6 million and a federal income tax expense of $3.5 million. During the
third quarter of 2020, we recorded income before federal income tax of $13.2
million and a federal income tax expense of $2.5 million. During the first nine
months of 2021, we recorded income before federal income tax of $58.5 million
and a federal income tax expense of $11.1 million. During the first nine months
of 2020, we recorded income before federal income tax of $37.1 million and a
federal income tax expense of $7.0 million. The increased federal income tax
expense in both 2021 periods resulted from higher levels of income before
federal income tax. Our effective tax rate was 19.0% during both the third
quarter and first nine months of 2021 and the respective 2020 periods.

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